On June 30, 2020, Sharma Corp. sold equipment for its fair value of $ 300,000. The equipment had a book value of $ 500,000 and a remaining useful life of 10 years. The same day, Sharma leased back the equipment at $ 6,000 per month for 5 years with no option to renew the lease or repurchase the equipment. Sharma's equipment rent expense for this equipment for the year ended December 31, 2020, should be

Question

Quizplus · Accepted Answer

Since Sharma Corp. has sold the equipment and leased it back, it is considered as an operating lease. The lease is for a period of 5 years, which is less than the remaining useful life of the equipment of 10 years. Therefore, the lease is not considered as a finance lease.

The lease payments are $ 6,000 per month, so the total lease payments for the year will be $ 6,000 x 12 = $ 72,000. Since the lease is for one full year, Sharma Corp. should recognize lease rent expense of $ 72,000 in the income statement for the year ended December 31, 2020. However, since the equipment has been sold for $ 300,000, the sale of equipment will result in a gain of $ (300,000 - 500,000) = $ 200,000 in the income statement. Therefore, the net effect on the income statement for the year ended December 31, 2020, will be a gain of $ 200,000 - $ 72,000 = $ 128,000.

The option "B" is the correct answer, as it represents Sharma Corp.'s equipment rent expense for the year ended December 31, 2020.