You are currently reviewing the following information for JKL Corp:
Starting date of lease:
January 1st, 2002
Annual year-end lease payments:
Term of Lease:
5 years
Buy-back value at end of term:
Interest rate implicit on the lease:


Interest rate on company's general debt:

If the company uses the capitalized lease method of accounting, what would be the interest expense during the second year of the inception of the lease?
A) $14,906
B) $16,600
C) $15,750
D) $14,490

The correct answer is: A)

Lease Payments
Interest Expense
BV of Lease



Interest Expense = (Book Value of Capitalized Lease at beginning of period) x (Effective Interest Rate)
Step 1: Beginning Book Value of Capitalized Lease = present value of lease + present value of the buy-back value.
Present value of buy-back value
FV = -55,000
I = 11%
N = 5
CPT PV = 32,640
Present value of lease
PMT = -32000
I = 11%
N = 5
CPT PV = 118,269
Book value = 32,640 + 118,269 = $150,909
Step 2: Interest Expense = Previous BV of lease x interest rate

We'll show just the first figure for this step:
= 150909 x 11% = $16,600
Step 3: Book value = Previous BV of lease - lease payment + interest expense
Again, we'll run an example of the first figure for this step:
Book Value (year 1) = 150909 - 32000 + 16600 = $135,509
Therefore, the interest expense during the second year of the lease would be $14,906 (135509 x 11%).


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