Western Company leased equipment from Sunshine Industries Th

Western Company leased equipment from Sunshine Industries. The lease agreement qualifies as a finance lease and requires annual lease payments of $120,000 over a five-year lease term (also the asset’s useful life), with the first payment at January 1, 2018, the beginning of the lease. The interest rate is 9%. The asset being leased cost Sunshine $500,000 to produce. The total increase in earnings (pretax) on Sunshine’s December 31, 2018, income statement would be:

a. $0
b. $35,534
c. $43,755
d. $51,375

Solution

Calculation of present value of lease payments Year Lease payments Discount factor @ 9% Present Value 0 $120,000.00                1.00000 $120,000.00 1 $120,000.00                0.91743 $110,091.74 2 $120,000.00                0.84168 $101,001.60 3 $120,000.00                0.77218 $92,662.02 4 $120,000.00                0.70843 $85,011.03 Present Value of lease payments $508,766.39 As this is finance lease transaction , Sunshine (lessor) will book the revenue on sale of an asset with following journal entry Date Account Title Debit Credit Jan.1,2018 Lease receivables $508,766 Sales $508,766 Jan.1,2018 Cost of goods sold $500,000 Inventory $500,000 Sunshine will record the interest lease transactions for 2018 as under, Date Account Title Debit Credit Jan.1,2018 Cash $120,000 Lease receivables $120,000 Jan.31,2018 Interest Receivable $34,989 Interest Income $34,989 The total increase in earnings (pretax) on Sunshine’s December 31, 2018, income statement would be: Profit Margin on sale = Sales - Cost of goods sold = $508766 - $500000 = $8,766 Interest Income of lease liability [($508766-$120000)*9%] = $34,989 The total increase in earnings (pretax) on 2018 income Statement $43,755 The answer is Option c.