Question

Refer to the following lease amortization schedule. The 10 payments are made annually starting with the beginning of the lease. Title does not transfer to the lessee and there is no purchase option or guaranteed residual value. The asset has an expected economic life of 12 years. The lease is noncancelable.

Payment Cash Payment Effective Interest Decrease in balance Outstanding Balance
87,867
1 13,000 13,000 74,867
2 13,000 7,487 5,513 69,354
3 13,000 6,935 6,065 63,289
4 13,000 6,329 6,671 56,618
5 13,000 5,662 7,338 49,280
6 13,000 4,928 8,072 41,208
7 13,000 4,121 8,879 32,329
8 13,000 3,233 9,767 22,562
9 13,000 ? ? ?
10 13,000 ? ? ?

Required:
a. What is the effective annual interest rate?
b. What would the lessee record as annual amortization on the right-of-use asset using the straight-line method?
c. What is the outstanding balance after payment 9?

Answer 1

Lease Amortization Schedule

a. The effective annual interest rate is:

= 10%.

b. The amount that the lessee would record as annual amortization on the right-of-use asset using the straight-line method is:

= $8,786.70

c. The outstanding balance after payment 9 is:

= $11,818.

Step-by-step explanation:

a) Data and Calculations:

Payment Cash Payment Effective Decrease Outstanding

Interest in balance Balance

87,867

1 13,000 13,000 74,867

2 13,000 7,487 5,513 69,354

3 13,000 6,935 6,065 63,289

4 13,000 6,329 6,671 56,618

5 13,000 5,662 7,338 49,280

6 13,000 4,928 8,072 41,208

7 13,000 4,121 8,879 32,329

8 13,000 3,233 9,767 22,562

9 13,000 2,256 10,744 11,818

10 13,000 1,182 11,818 0

b) The effective annual interest rate = (1+i/n)^n - 1

where i = stated interest rate

and n = number of compounding periods (10 years)

= Effective interest/Outstanding balance

For example for year 10, the rate = $1,182/$11,818 * 100 = 10%

Using the straight-line method, annual amortization on the right-of-use asset = $87,867/10 = $8,786.70

The outstanding balance after payment 9 = $11,818 which is paid in year 10 with an interest of $1,182.