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Farm Co. leased equipment to Union Co. on July 1, Year 1, and properly recorded the sales-type (finance) lease at $135,000, the present value of the lease payments discounted at 10%. The first of eight annual lease payments of $20,000 due at the beginning of each year was received and recorded on July 3, Year 1. Farm had purchased the equipment for $110,000. What amount of interest revenue from the lease should Farm report in its Year 1 income statement?
A. $5,750
B. $6,750
C. $5,500
D. $0
Answer:A
Choice "A" is correct. The initial lease receivable equals $135,000. After the first lease payment is received two days later, the lease receivable equals $115,000 ($135,000 less $20,000). Year 1 interest revenue equals $5,750 ($115,000 x 10% x 6/12).
Choice "D" is incorrect. Interest revenue on the lease receivable should be accrued.
Choice "C" is incorrect. Interest is not calculated on the cost of the assets.
Choice "B" is incorrect. The $20,000 payment received July 3 should be deducted from the receivable balance before calculating interest.