Question

On January 2, 2021, Hernandez, Inc. signed a ten-year noncancelable lease for a heavy duty drill press. The lease stipulated annual payments of $300,000 starting at the beginning of the first year, with title passing to Hernandez at the expiration of the lease. Hernandez treated this transaction as a finance lease. The drill press has an estimated useful life of 15 years, with no salvage value. Hernandez uses straight-line depreciation for all of its plant assets. Aggregate lease payments were determined to have a present value of $1,800,000, based on implicit interest of 10%. In its 2021 income statement, what amount of interest expense should Hernandez report from this lease transaction

Answer 1

The amount of interest expense should Hernandez report from this lease transaction is $150,000.

Interest expense

Depreciation expenses=Present value-Scrap value/Estimated useful life

Depreciation expenses=$1,800,000-$0/15

Depreciation expenses=$120,000

Interest expenses

Interest expenses=Depreciation expenses+(Annual payments×Implicit interest)

Interest expenses=$120,000+($300,000×10%)

Interest expenses=$120,000+$30,000

Interest expenses=$150,000

Inconclusion the amount of interest expense should Hernandez report from this lease transaction is $150,000.

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