Starting date of lease:  January 1st, 2002 
Annual yearend lease payments:  $32,000 
Term of Lease:  5 years 
Buyback value at end of term:  $55,000 
Interest rate implicit on the lease:  11% 
Interest rate on company's general debt:  13% 
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)
Year 
Lease Payments 
Interest Expense 
BV of Lease 
0 
$150,909 

1 
$32,000 
$16,600 
135,509 
2 
32,000 
14,906 
118,415 
3 
32,000 
13,025 
99,440 
4 
32,000 
10,938 
78,378 
5 
32,000 
8,622 
55,000 
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 buyback value.
TI BAII:
Present value of buyback 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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