On January 2, 2018, Hernandez, Inc. signed a 10-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 capital 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%.

Question

Business

Cheddar

6 March, 12:06

On January 2, 2018, Hernandez, Inc. signed a 10-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 capital 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%.

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Maxwell Hickman · Answer 1

The below additional piece of information is missing from the question:

In its 2018 income statement, what amount of interest expense should Hernandez report from this lease transaction?

The interest expense for 2018 is $150,000

Explanation:

Interest expense for 2018 is the implicit interest 10% multiplied by the difference present value of $1,800,000 minus annual payment of $300,000.

In order to compute the interest expense, the annual payment must be deducted first since the annual payment was made at the start of the year, hence interest is only due on the net amount of $1,500,000 ($1,800,000-$300,000).

Interest expense=$1,500,000*10%=$150,000