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

$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

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