On January 1, 2011, Shak, Inc. signed a noncancelable lease for a sneaker shining machine. The machine has an estimated useful life of nine years. The term of the lease is a six-year term with title passing to Shak at the end of the lease. The agreement called for annual payments of $40,000 starting at the end of the first year. Assume aggregate lease payments were determined to have a present value of $200,000, based on implicit interest of 12 percent. What amount of interest expense should Shak report in its 2011 income statement from this lease transaction?
A) $0
B) $16,000
C) $24,000
D) $33,333

Question

Quizplus · Accepted Answer

To calculate the interest expense for the year 2011, we need to first calculate the total amount of lease payments over the six-year term. We know that the annual payments are $40,000, and there are six payments, so the total lease payments will be $240,000.

Next, we need to calculate the interest portion of the lease payments using the implicit interest rate of 12%. We know that the present value of the lease payments is $200,000, so we can use that to calculate the interest portion.

$200,000 = $40,000 x annuity factor for 6 years at 12%

Annuity factor for 6 years at 12% = 3.6058

$200,000 = $40,000 x 3.6058

$200,000 = $144,232

So, the interest portion of the lease payments is $200,000 - $144,232 = $55,768.

We need to allocate this interest expense over the six-year lease term. Since the lease is noncancelable, we can use the straight-line method to do this. The total interest expense over the lease term is $55,768, so the annual interest expense will be $55,768 / 6 = $9,294.

Since the lease started on January 1, 2011, Shak will have made one lease payment by the end of the year. The annual lease payment is $40,000, so the interest portion of this payment will be $9,294. Therefore, the interest expense that Shak should report in its 2011 income statement from this lease transaction is $9,294.

Therefore, the best choice is C.