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?
Answer – $720,000 profit on sale and $146,000 interest revenue.
PV at inception of the lease at 7/1/Year 1 $ 3,520,000
Less initial payment 7/1/Year 1 (600,000)
Balance during first year 2,920,000
Interest rate x 10%
Interest revenue 7/1/Y1 to 6/30/Year 2 (12 mos) 292,000
Adjust from full year to half year x ½ yr
Interest revenue for year end 12/31/Year 1 $ 146,000
MY question: Why is 3,520,000 PV of minimum lease payments? I thought to get PV you take PV of equal payments of (600,000×7) , not 8 since one payment has been made already.
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