Question

On January 1, 2021, Cullumber Corporation signed a 5-year noncancelable lease for equipment. The terms of the lease called for Cullumber to make annual payments of $ 201000 at the beginning of each year for 5 years beginning on January 1, 2021 with the title passing to Cullumber at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Cullumber uses the straight-line method of depreciation for all of its fixed assets. Cullumber accordingly accounts for this lease transaction as a finance lease. The lease payments were determined to have a present value of $ 824592 at an effective interest rate of 11%. In 2021, Cullumber should record interest expense of $

a.$132405.
b.$90705.
c.$ 110295
d.$ 68595?

Answer 1

The interest expense Cullumber Corporation should record in the first year of the finance lease is calculated by applying the effective interest rate (11%) to the present value of the lease payments ($824,592), resulting in $90,705.

Step-by-step explanation:

The student is asking how to calculate the interest expense for Cullumber Corporation in the first year of a finance lease. To find the interest expense, we apply the effective interest rate to the present value of the lease payments at the beginning of the year. In this case, the effective interest rate is 11%, and the present value of the lease payments is $824,592. Therefore, the interest expense for the first year is 11% of $824,592, which is $90,705.

Here is the calculation for clarity:

• Effective interest rate: 11%
• Present value of lease payments: $824,592

Interest Expense = Present value of lease payments × Effective interest rate

Interest Expense = $824,592 × 11%

Interest Expense = $90,705