Question

(Lessee Accounting and Reporting) On January 1, 2017, Evans Company entered into a noncancelable lease for a machine to be used in its manufacturing operations. The lease transfers ownership of the machine to Evans by the end of the lease term. The term of the lease is 8 years. The minimum lease payment made by Evans on January 1, 2017, was one of eight equal annual payments. At the inception of the lease, the criteria established for classification as a capital lease by the lessee were met.

Instructions

(c) What expenses related to this lease will Evans incur during the first year of the lease, and how will they be determined?

Short answer

Evans will incur interest costs and pay depreciation charges.

Step-by-step solution

Meaning of Interest Expense

Interest expense can be referred to as the entire interest amount that accrues from any borrowed fundssuch as loans or credits. Too much interest expense can cut into a company's profits.

Explaining the expenses related to the lease

Evans will incur an interest cost equal to the interest rate used to capitalize the lease at the start of the period multiplied by the liability's applicable net carrying value at the start of the period.

Evans will also have to pay a depreciation charge on the capitalized cost of the leased asset. This depreciation should be calculated using the leased asset's anticipated useful life and depreciated in accordance with Evans' standard depreciation policy for owned assets.