AFC Corporation leased a piece of machinery and correctly classified and recorded it as a finance lease.At the date of signing, January 1, 2011, the asset and lease obligation were recorded for $42,000.The first lease payment of $8,200 was due December 31, 2011 and the interest rate they used in their calculations was 7%.The lease term was 10 years.Which of the following best describes what would be reported on AFC's income statement for the year ending December 31, 2011?
A)$8,200 lease expense
B)$8,200 lease expense, $4,200 amortization expense
C)$2,940 interest expense, $1,260 amortization expense
D)$2,940 interest expense, $4,200 amortization expense

Question

Quizplus · Accepted Answer

The correct answer is D because for a finance lease, interest expense and amortization expense are reported separately on the income statement. The interest expense for the year is calculated as 7% of the lease obligation ($42,000) which equals $2,940. The amortization expense is the portion of the lease payment that reduces the carrying amount of the leased asset, which is calculated by subtracting the interest expense from the total lease payment ($8,200 - $2,940 = $5,260). However, the correct amortization expense should be calculated based on the straight-line method over the lease term (10 years), which is $42,000 / 10 = $4,200 annually. Therefore, the correct answer includes both the interest expense of $2,940 and the amortization expense of $4,200.

AFC Corporation Leased a Piece of Machinery and Correctly Classified