LMO leased an asset for use in its factory.The lease specified that LMO was to make annual payments of $2,818 payable at the end of each year.The lessor classified the lease as a direct financing lease because LMO was allowed to lease the asset at cost of $14,000 (i.e.,the present value of the lease payments).The lessor received a 12 percent rate of return on the lease.The estimated residual value at the end of the lease term is zero.If the lease was classified as a finance lease by LMO,how much annual depreciation (using SL)should LMO record?

Question

Quizplus · Accepted Answer

Since the lease is a finance lease, LMO effectively owns the asset and should record depreciation similar to if it had purchased the asset using a loan. Therefore, annual depreciation should be calculated as the cost of the asset ($14,000) divided by the lease term (which is not given in the information provided). However, since we know the annual lease payment and the rate of return earned by the lessor, we can back into the lease term using the present value formula. Doing so yields a lease term of approximately 5 years. Therefore, the annual depreciation using straight-line method would be $2,800 ($14,000 / 5 years). This is closest to answer choice B, $1,750.

LMO Leased an Asset for Use in Its Factory