Kay Animal Hospital leased a building to expand its services downtown. The 10-year lease is recorded as a long-term lease. The annual payments are $10,000 and the recorded cost of the asset is $67,100. The straight-line method is used to calculate depreciation. Which of the following statements is true?

Question

Quizplus · Accepted Answer

The correct answer is a. The company will record depreciation expense of $6,710 each year.
Here's why:
When a company leases an asset under a long-term lease that is classified as a finance (or capital) lease, it recognizes the leased asset as if it has been purchased. This means the asset is recorded on the balance sheet, and the company must depreciate the asset over its useful life.
In this case, the cost of the leased asset is recorded at $67,100. The lease term is 10 years, and the straight-line method of depreciation is used. The straight-line method divides the cost of the asset, less any residual value, by the useful life of the asset to determine the annual depreciation expense.
Assuming there is no residual value at the end of the lease term, the annual depreciation expense would be calculated as follows:
Depreciation Expense = Cost of the Asset / Useful Life
Depreciation Expense = $67,100 / 10 years
Depreciation Expense = $6,710 per year
Therefore, the company will record a depreciation expense of $6,710 each year for the duration of the lease.
The other options are incorrect for the following reasons:
b. The company will record depreciation expense of $10,000 each year. This is incorrect because the annual lease payment amount does not affect the calculation of depreciation expense.
c. No depreciation expense will be recorded. This is incorrect because the lease is classified as a long-term lease, and the asset is recorded on the balance sheet, which requires depreciation.
d. No interest expense will be recorded. This statement is not relevant to the calculation of depreciation expense. However, if the lease is a finance lease, there would typically be an interest expense associated with the lease liability. The interest expense would be calculated separately from the depreciation expense and is not addressed in the given information.

Kay Animal Hospital Leased a Building to Expand Its Services