Unformatted text preview: n years and a payment of $149,388 at the end of Year 10. The essential difference
between the two financing arrangements is that a portion of every lease payment is applied against the
outstanding principal balance while the annual payments under the bank loan do not reduce the principal
balance. c. Option 1
Building (+A) 149,388
Notes Payable (+L) 149,388
Purchased a building.
Option 2
Assets Acquired Under Capital Leases (+A)
Obligations Under Capital Leases (+L)
149,388
Acquired a building under a capital lease. 149,388 Option 3
Under the operating lease, the building would not be capitalized. Instead, on every lease payment date,
Watts Motors would debit Lease Expense or Rent Expense for $26,439 and credit Cash for the same
amount. E11–24 Concluded
d. Payment $26,439.32
26,439.32 Interest Expensea
$149,388.00
$17,926.56
$8,512.76
16,905.03
9,534.29 Principal Reductionb Principal 140,875.24
131,340.95 a Interest Expense = Principal Effective Interest Rateof 12%
b Principal Reduction = Payment – Interest Expense e. Present Value = $26,439.32 Present Value of an Ordinary Annuity Factor for i = 12%
and n = 8
= $26,439.32 4.96764 (from Table 5 in Appendix A)
= $131,341.02 The present value of the future lease payments equals the amount reported on the balance sheet
calculated in part (d). E11–25
Present Value =
= Present Value of Face Value + Present Value of Interest Payment
(Face Value Present Value Factor) + (Periodic Interest Payment Present
Value of an Ordinary Annuity Factor) Note 1
Since the proceeds (i.e., present value) equal the face value, we know that the effective rate equals the
stated rate. Consequently, the effective rate for Note 1 is 8%.
As proof:
Present value (i = 8%, n = 6)
PV of face value
($10,000 .63017 from Table 4 in Appendix A)
PV of interest payments
[($10,000 8%) 4.62288 from Table 5 in Appendix A]
Total present value (i.e., proceeds)
Note 2
$35,056 = PV Factor
PV Factor =
= $ $ 6,301.70 3,698.30
10,000.00 ($100,000 Present Value Factor)...
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 Fall '08
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 Accounting

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