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
81,108
1 12,000 12,000 69,108
2 12,000 6,911 5,089 64,019
3 12,000 6,402 5,598 58,421
4 12,000 5,842 6,158 52,263
5 12,000 5,226 6,774 45,489
6 12,000 4,549 7,451 38,038
7 12,000 3,804 8,196 29,842
8 12,000 2,984 9,016 20,826
9 12,000 ? ? ?
10 12,000 ? ? ?
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

Answer:

a) What is the effective annual interest rate?

Effective annual interest rate = 6,911/69,108

Effective annual interest rate = 0.100003

Effective annual interest rate = 10.00%

b) What would the lessee record as annual amortization on the right-of-use asset using the straight-line method?

Annual amortization on the right-of-use asset = Right of use asset / Lease term

= $81,108/10

= $8,110.8

c) What is the outstanding balance after payment 9?

Outstanding balance after 8th payment = $20,826

Effective interest = $20,826*10%

Effective interest = $2,082.60

Cash payment = $12,000

Decrease in balance = $12,000 - $2,082.60

Decrease in balance = $9,917.4

Outstanding balance after payment 9 = Outstanding balance after 8th payment - Decrease in balance

Outstanding balance after payment 9 = $20,826 - $9,917.4

Outstanding balance after payment 9 = $10,908.60