[cpa1988]

Can someone help me understand what’s going on here? It’s asking for whats in current liabilities as of Dec 31, Year 1. So why are we taking into consideration the payment made in Dec 31 Year 2? And why are we taking out the interest? This whole problem confuses me. Help!

On December 30, Year 1, Rafferty Corp. leased equipment under a capital (finance) lease. Annual lease payments of $20,000 are due December 31 for 10 years. The equipment’s useful life is 10 years, and the interest rate implicit in the lease is 10%. The capital (finance) lease obligation was recorded on December 30 Year 1, at $135,000, and the first lease payment was made on that date. What amount should Rafferty include in current liabilities for this capital lease in its December 31, Year 1 balance sheet?

a. $20,000

b. $8,500

c. $11,500

d. $6,500

Explanation

Choice “b” is correct. $8,500 capital (finance) lease current liability at 12/31/Year 1 (and $106,500 long-term portion)

Present value at December 30, Year 1 (start of lease) of 10 payments at 10% $135,000

Less first payment at start of lease (20,000)

Equals liability under capital lease at December 30, Year 1 115,000

Payment to be made Dec. 30, Year 2 $20,000

Less 10% interest on PV lease liability (10% x $115,000) (11,500)

Equals “current liability” for Capital lease at Dec. 31, Year 1 8,500

Total liability under capital lease at 12/31/Year 2 $106,500

[Lidis]

This entry always help me to solve a problem like that:

Interest Expense

Lease Liability

Cash

Lease liability (lease property) = Lease payment X PV factor (given 135,000)

Interest expense= Lease liability X Effective interest rate (Implicit rate)

Cash payment – interest expense = lease liability current portion

135,000-20,000= 1115,000 x 10%= 11,500

Interest expense 11,500

Lease liability 8,500 (current portion)

Cash 20,000 (given)

[haseltonk]

The current liabilities only refers to the principal portion that is due w/in 12 months, which is why you need to do the calculations to determine the interest expense first, then subtract that from the required payment to reach the principal paid. The interest paid will be reported under interest expense and is not considered a “current liability” even though it is a required payment.

[Author]

Replies