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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Comparisons of Operating and Sales-Type Leases On January 1, 2019, Nelson Company leases certain property to Queens Company at an annual rental of $60,000 payable in advance at the beginning of each year for 8 years. The first payment is received immediately. The leased property, which is new, cost $275,000 and has an estimated economic life of 8 years and no residual value. The interest rate implicit in the lease is 12% and the lease is noncancelable. Nelson had no other costs associated with this lease. It should have accounted for this lease as a sales-type lease but mistakenly treated it as an operating lease.

Required:

Next Level Compute the effect on income before income taxes during the first year of the lease as a result of Nelson’s classification of this lease as |in operating rather than a sales-type lease. Round your answer to the nearest dollar.

To determine

Analyse the effect on net income before income taxes during the first year of the lease.

Explanation

Lease: Lease is a contractual agreement whereby the right to use an asset for a particular period of time is provided by the owner of the asset to the user of the asset. The owner, who possesses the asset, is termed as ‘Lessor’ and user, to whom the right is transferred to, is termed as ‘Lessee’.

Sale type Lease: In a Sales-Type lease, the lessor sells the asset to the lessee and records a receivable. In this type of lease, the lessor records a dealer’s or manufacturer’s profit or loss depending upon the difference between the fair value of the asset and the carrying value of the asset.

Analyse the effect on net income before income taxes during the first year of the lease:

Determine the sales amount and the cost of leased asset:

Sales = PV factor for 8 payments at 12%×Lease payment receivable         = 5.563757(as per present value table)×$60,000         = $333,825

Cost of the leased asset = Cost of the property                                      = $275,000

Determine the interest revenue of the lease:

Interest Revenue-Leases= 12%×(Lease receivablesInitial payment)= 12%×($333,825.42$60,000)= 12%×$273,825

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