ACCA Applied Skills · Financial Reporting · Leasing
Dunmore Co enters a four-year lease on 1 January Year 1. It pays $50,000 each year in advance, with the first payment on 1 January Year 1. The rate implicit in the lease is 10%, giving a present value of payments of $174,340 at commencement. What is the finance cost for Year 1?
The Year 1 finance cost is $12,434. Because the first $50,000 is paid on day one, interest at 10% runs only on the remaining balance of $124,340. Charging interest on the full $174,340 would overstate the cost.
- A$12,434Correct
- B$17,434
- C$20,000
- D$5,000
Explanation
The first payment is made at commencement, so interest accrues only on the balance outstanding after it: (174,340 - 50,000) x 10% = 12,434. Charging interest on the full 174,340 gives 17,434, which ignores the payment in advance.
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