Question

On January 1, 2021, Bombay Corporation signed a five-year noncancelable lease for equipment. The terms of the lease called for Bombay to make annual payments of $180,000 at the beginning of each year for five years with title passing to Bombay at the end of this period. The equipment has an estimated useful life of 7 years and no salvage value. Bombay uses the straight-line method of depreciation for all of its fixed assets. Bombay accordingly accounts for this lease transaction as a finance lease. The lease payments were determined to have a present value of $750,578 at an effective interest rate of 10%.

Required:
In 2022, Cullumber should record interest expense of:______

Answer 1

In 2022, Cullumber should record interest expense of $57,057.80.

Step-by-step explanation:

The interest expense can be calculated using the following formula:

Interest expense = (Present value of lease payments - Annual payments at the beginning of each year) * Effective interest rate .................... (1)

Where:

Annual payments at the beginning of each year = $180,000

Present value of lease payments = $750,578

Effective interest rate = 10%

Substituting the values into equation (1), we have:

Interest expense = ($750,578 - $180,000) * 10% = $57,057.80

Therefore, Cullumber should record interest expense of $57,057.80 in 2022.