[SuperAccountingGod]

Q: Glade Co. leases computer equipment to customers under U.S. GAAP direct-financing leases. The equipment has no residual value at the end of the lease and the leases do not contain bargain purchase options. Glade wishes to earn 8% interest on a five-year lease of equipment with a fair value of $323,400. The present value of an annuity due of $1 at 8% for five years is 4.312. What is the total amount of interest revenue that Glade will earn over the life of the lease?

The answer is $51,600. They do this by taking the FV equip/PV factor=annual lease payment, then multiple the payment by the 5 years to get the total lease amount collected. Then subtract out the FV of the equip to get the Int Rev. I get the annual lease payments x number of years, but why do they divide the FV of the equip by the PV factor? For bonds/notes I’m used to taking the stated rate x the face amount to get the annual payment. Is that why, because there is no stated/effective rate for this since it’s not a bond/note?

[Anonymous]

You know the implicit rate so that is what you use here. There is no “stated rate” vs. effective rate in this case. Glade would like 8% so they price the lease payments based on PV factor to achieve this return.
– $323,400/4.312= $75,000
$75,000 * 5 = $375,000
$375,000-323,400= $51,600 interest revenue.

[SuperAccountingGod]

That makes sense. I guess my question is if we have the implicit rate why not just do 8% * 323,400 instead of 323,400/4.312 to get the annual payment? That's what confuses me.

[Anonymous]

I think maybe the confusion here is the difference between a bond and a direct-financing lease.
With a bond- only interest payments are made periodically and all of the principal is paid off at the end.
With this- periodic payments of principal and interest are paid throughout- so there is no “balloon” payment at the end.
Let me know if this makes sense.

[SuperAccountingGod]

Yes now it's clear. This used to all make sense to me the first time back in my prime as an undergrad. Thanks.

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