On the first day of its fiscal year,Lessor,Inc.,leased certain property at an annual rental of $100,000 receivable at the beginning of each year for ten years.The first payment was received immediately.The leased property,which is new,had cost $650,000 and has an estimated useful life of thirteen years and no salvage value. Lessor's borrowing rate is 8 percent.The present value of an annuity of $1 payable at the beginning of the period at 8 percent for ten years is 7.247.Lessor had no other costs associated with this lease.Lessor should have accounted for this lease as a sales-type lease,but it mistakenly treated the lease as an operating lease.What was the effect on net earnings during the first year of the lease by having treated this lease as an operating lease rather than as a sales-type lease?

Question

Quizplus · Accepted Answer

By treating the lease as an operating lease instead of a sales-type lease, Lessor has understated its net earnings during the first year of the lease. As per the sales-type lease, the profit is recognized upfront, whereas in the case of operating lease, profit is recognized over the lease term. Therefore, understating the profit during the first year of the lease by treating it as an operating lease.

On the First Day of Its Fiscal Year,Lessor,Inc