CFA Practice Question

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CFA Practice Question

Clifton Company leased a computer from Jan Corporation on January 1, 2015, for a 10-year period, the useful life of the asset. Equal rental payments of $5,000 are due on January 1 of each year. The first payment was made on January 1, 2015. The present value of the minimum lease payments over the lease term discounted at 10% was $33,795. The balance in Clifton's liability account (including accrued interest) on December 31, 2015 should be ______.
A. $27,256
B. $30,392
C. $31,675
Explanation: Lease liability (December 31, 2015):
= Acquisition cost - First lease payment interest for 2010
= $33,795 - $5,000 + ([$33,795 - $5,000] x 10%)
= $28,795 + $2,880
= $31,675

User Contributed Comments 20

User Comment
shasha now i understand that for annuity due, first payment of $5,000 is deducted from pv to reach an acquisition cost as the beginning lease liability, then next payment of $5,000 is treated as the FIRST lease payment.
BZZNone Acquisition cost is $33,795, which is PV of annuity due. First payment of $5000 is on 01/01/2010 and reduces balance to $28,795. Second payment is on 12/31/2010 and includes interest $33,795 - $5,000 = $2880 and amortization $5,000 - $2,880 = $2,120. So balance is $28,795 - $2,120 = $26,675.
shasha BZZNone: 31,675 is the correct answer.

Although lease pmt of $5,000 on Jan 1 '00 was paid-out that day, on bookkeeping, its interest part 10%*(33,795-5,000)= $2,880 was accrued on the B/S of Dec. 31 '00, by which day the next lease pmt of $5,000 hadn't been paid yet. (NB. "2nd" pmt was on 1/1/01, not 12/31/00)!

I wanted to say on my last post that when we calculate the accrued interest, we use 33,795-5,000 as beginning lease liability instead of 33,795.
KSB1 The first time I tried this question, I did what BZZNone did and got his answer.
I then tried this method: $33795 x 10% = $3379.50 (Interest Payment)
$5000 - $3379.5 = $1,620.50 (Reduction in Lease Liability)
Repeating this process for the next payment gives us:
$32174.50 x 10% = $3217.45 (Interest Pmt)
$5000 - $3217.45 = $1782.55 (Reduction in Lease Liability)
Deducting $1782.55 from $32174.50 gives us $30,392
The only way I can explain 31,675 to myself is if I assume that the first payment went directly towards reducing the lease liability and nothing towards interest. Is this correct?
kalps The correct answer is 100% 31,675! look at what sasha did in his/er second explanation and you will see that it is correct - this is a common question in CPA examinations
cutehinano so basically the answer should be lease liab + interest payable on dec 31, 2010.
armanaziz Am I correct to say that the first lease payment doesn't have any interest component in it because no time has elapsed since entering into the lease contract?
chuong N=1, I/Y=10 PMT=5,000, PV=33,795 then FV=31,674.50 so that C is correct (remember to set the calculator to BGN payment mode not END mode)
danlan In Chuong's post, should set PMT=-5000.
Or simply (31674.5-5000)*1.1=31675
Shelton BGN: n=1, I/Y=10, PV=-33795 => FV=31674.5
wink44 How I did it...

BGN n=9 i/y=10 pmt=(5000) PV=31674.5
ml42085 BGN n=9 is the easiest way...
danrow Actually I think is simplier than it looks. The 2879.5 is the accrued interest during the year (the first 5000 dollars reduce the amount of the liability to 28,795, hence the interest of 10% applies to that total. The question asks the liablity account + ACCRUED INTEREST. Those 2879.5 are the accrued interest applied.
Nando1 The first $5,000 pmt has NO interest component since it is an annuity due.
homersimpson Thanks wink44! You rock!
jayj001 [33795-5000] * 1.1 = 31675
Mikehuynh Good job, wink44!
Mikehuynh Annuity due of lease pmt with N=9.
davcer annuity due n=9 (1- (1/1.1exp9))/.1 =5.759 then 5000*5.759= 28795 this is the pv of regular annuity, annuity due is 28795*1.1= 31674.7
birdperson I'm with @Wink44
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