Pisa, Inc. leased equipment from Tower Company under a four-year lease requiring equal annual payments of $172,076, with the first payment due at lease inception. The lease does not transfer ownership, nor is there a bargain purchase option. The equipment has a 4-year useful life and no salvage value. Pisa, Inc.'s incremental borrowing rate is 10% and the rate implicit in the lease (which is known by Pisa, Inc.) is 8%. Assuming that this lease is properly classified as a capital lease, what is the amount of interest expense recorded by Pisa, Inc. in the first year of the asset's life? PV Annuity Due PV Ordinary Annuity 8%, 4 periods 3.57710 3.31213 10%, 4 periods 3.48685 3.16986

Answer: $35,477

Explanation:

GIVEN the following;

Equal annual payment = $172,076

Implicit rate (Pisa's known rate) = 8%

At 8%, 4 periods:

PV annuity due = 3.57710

PV ordinary annuity = 3.31213

At 10%,4 periods:

PV annuity due = 3.48685

PV ordinary annuity = 3.16986

Amount of interest expense recorded by Pisa Inc. will be calculated using the implicit rate (rate known to Pisa Inc.):

First we calculate the amount recorded at inception:

At year 0:

Annual payment * PV annuity due

$172,076 * 3.57710 = $615,533

Therefore, interest expense recorded by Pisa Inc. In first year is:

(Expense recorded at inception - annual payment) * Interest rate

$ (615,533 - 172,076) * 0.08 =

$443,457 * 0.08

= $35,476.56 = $35, 477