I have 2 questions about two problems.
1) These two questions are asking about the same thing, what is the profit on sale-type/finance lease, but they are solved differently each. Why is the first question using [ PV-Carrying Cost = Profit] on sale while the second question is using [ Selling Price - Cost = Profit ] on sale.
2) my second question how did they calculate the present value of payments in these two questions. It just does not come out right when I do it.
Howe Co. leased equipment to Kew Corp. on January 2, Year 1, for an eight-year period expiring December 31, Year 8. Equal payments under the lease are $600,000 and are due on January 2 of each year. The first payment was made on January 2, Year 1. The list selling price of the equipment is $3,520,000 and its carrying cost on Howe's books is $2,800,000. The lease is appropriately accounted for as a sales-type (finance) lease. The present value of the lease payments at an imputed interest rate of 12% (Howe's incremental borrowing rate) is $3,300,000. What amount of profit on the sale should Howe report for the year ended December 31, Year 1?
Choice "b" is correct. The excess of the present value of the selling price over its cost is recorded as profit.
= Profit on sale $ 500,000
Question # 2.
Peg Co. leased equipment from Howe Corp. on July 1, Year 1 for an eight-year period expiring June 30, Year 9. Equal payments under the lease are $600,000 and are due on July 1 of each year. The first payment was made on July 1, Year 1. The rate of interest contemplated by Peg and Howe is 10%. The cash selling price of the equipment is $3,520,000, and the cost of the equipment on Howe's accounting records is $2,800,000. The lease is appropriately recorded as a sales-type (finance) lease. What is the amount of profit on the sale and interest revenue that Howe should record for the year ended December 31, Year 1?
a.$720,000 & $146,000
b. $720,000 & $176,000
c.$45,000 & $146,000
d. $45,000 & $176,000
Choice "a" is correct. $720,000 profit on sale and $146,000 interest revenue.
Rule: In a sales-type (finance) lease, any difference between the fair value of the leased asset and its carrying value is recognized as manufacturer's or dealer's profit: