Now assume that Company ABC leases an equipment for 5 years instead. Other information mostly remains the same (except for highlighted texts)

*Leased assets have an expected life of 5 years.

*Depreciation is straight line.

*Annual lease payment is $2,505.

*Interest rate is 8%.

*the ownership of the property goes back to the lessor at the end of the lease term

*Lease payments are made at beginning of each year.

*the present value of the lease payment is 10,000 (Present value of 2,505 ordinary annuity for 5 years at 8%)

*Fair value of the equipment is 10,000.

*The lease does not contain a bargain purchase option

Second, at the time the lessee makes cash payment of $2505, a portion of that is considered payment of interest expense (calculated as principle times interest rate); the rest is considered repayment of principle (this is exactly like when you pay a mortgage on a car or a house)

Dr: Interest expense Correct _________ Help

Dr: Lease liability Correct __________ Help

Cr: Cash Correct 2505 Correct