Question

Karla Salons leased equipment from Smith Co. on July 1, 2021, in a finance lease. The present value of the lease payments discounted at 6% was $58,500. Ten annual lease payments of $7,500 are due each year beginning July 1, 2021. Smith Co. had constructed the equipment recently for $53,500, and its retail fair value was $58,500. The total decrease in earnings (pretax) in Karla's December 31, 2021, income statement would be (ignore taxes):

Answer 1

Answer:

$4,455

Explanation:

The computation of total decrease in earnings (pretax) in Morris Dec. 31, 2021, income statement is given below:-

Interest expense upto 31 Dec 2021 = (Total present value of lease payment - Lease payment on July 1, 2021) × 6% × 6 ÷ 12

= ($58,500 - $7,500) × 6% × 6 ÷ 12

= $51,000 × 6% × 6 ÷ 12

= $1,530

Depreciation expense upto 31 Dec 2021 = Fair value of equipment ÷ Useful life × 6 ÷ 12

= $58,500 ÷ 10 × 6 ÷ 12

= $5,850 × 6 ÷ 12

= $2,925

So, the total decrease in earnings (pretax) in Morris Dec. 31, 2021, income statement = Interest expense upto 31 Dec 2021 + Depreciation expense upto 31 Dec 2021

= $1,530 + $2,925

= $4,455