Lease Example 10 Curriculum page 507 understand, interest, previous, solution, obliged

cchang

Guys,
I am a bit confused with calculation of interest in this example.
As I understand we are obliged to pay 28 679$ every year, but why do we need to calculate interest in the table to solution 4 ( Interest at 10 percent, accrued in previous year)? Can not grasp this concept((

soverby

Hi,
The table which accompanies Solution 4 is showing you the computation of the finance lease principal that is still outstanding at the end of each year.
Any lease payment that you make goes towards paying off not just the principal but first, any interest that has accrued since the last lease payment (which is why you need that interest column).
Take 2010: the opening balance of the finance lease principal outstanding is of course €100,000 and this gets immediately reduced by the entire €28,679 of annual lease payment on 1 January, leaving the amount of principal oustanding at €71,321 (column e).
The lease payment that happens on 1 January 2010 does not pay off any interest (€0 in column c), seeing as no interest has had time accrue yet. Subsequent to 1 January 2010, throughout the year 2010, the company will accrue interest at a rate of 10% on the lease liablity balance oustanding at 1 January, so that’s interest of €7,132 (10% x €71,321).
When the company makes its next annual lease payment, on 1 January 2011, it will first pay off the interest that accrued in 2010, i.e. the previous year, (€7,132), leaving the rest of the payment €21,547 (€28,679 - €7,132) to go towards repayment of principal. That’s why the the balance of the lease liability (prinicipal) at the end of 2011 is €49,774 (€71,321 - €21,547).
The same logic applies to calculation in subsequent rows of the table
Hope that helps!

Viceroy

So you mean that this number 28 679 already assumes some interest in it?
And this interest goes to P&L as interest expense then?