1. On December 31, year 1, Day Co. leased a new machine from Parr with the follo

Question

1. On December 31, year 1, Day Co. leased a new machine from Parr with the following pertinent information:

Lease term 8 years

Annual rental payable at beginning of each year $60,000

Useful life of machine 10 years

Day'sincremental borrowing rate 15%

Implicit interest rate in lease (known by Day) 12%

The lease is not renewable, and the machine reverts to Parr at the termination of the lease. The cost of the machine on Parr's accounting records is $425,000.

Required: At the beginning of the lease term, what should Day record as a lease liability?

2. Timken Company issues a $1,500,000 bond at 10% for 10 years. The market interest rate is 9%.

Required:

a) What is the issue price of these bonds and the bond discount or premium?

b) Assume that Timken uses the effective interest method to amortize the bond discount or premium for the semiannual interest payments, what is the interest expense and the amount of cash paid on the first interest payment?

Explanation / Answer

1)

Day record as a lease liability = pv(rate,nper,pmt,fv,1)

Day record as a lease liability = pv(15%,8,60000,0,1)

Day record as a lease liability = $ 309,625.18

2)

a)

Issue price of these bonds = pv(rate,nper,pmt,fv)

Nper  (indicates the semi annual period) = 10*2 = 20

PV (indicates the price) = ?

PMT (indicate the semi annual payment) = 1500000*10%*1/2 = 75000

FV (indicates the face value) = 1500000

Rate (indicates Half year YTM) = 9%*1/2 = 4.5%

Issue price of these bonds = pv(4.5%,20,75000,1500000)

Issue price of these bonds = $ 1,597,559.52

The Bonds Premium = Issue price of these bonds - Bonds Par value

The Bonds Premium = 1597559.62 - 1500000

The Bonds Premium = $ 97,559.62

b)

Amount of cash paid on the first interest payment = Face value * Interest rate *1/2

Amount of cash paid on the first interest payment = 1500000*10%*1/2

Amount of cash paid on the first interest payment = 75000

Interest expense on the first interest payment = Issue price of these bonds * market interest rate *1/2

Interest expense on the first interest payment = 1597559.52*9%*1/2

Interest expense on the first interest payment = $ 71,890.18

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