On the first day of its fiscal year, Lessor, Inc., leased certain property at an annual rental o $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?
A)Understated
B)The effect depends on the method selected for income tax purposes
C)No effect
D)Overstated

Question

Quizplus · Accepted Answer

By treating the lease as an operating lease instead of a sales-type lease, Lessor, Inc. did not recognize the sale and profit at the inception of the lease. In a sales-type lease, the lessor recognizes the present value of the lease payments as sales revenue and cost of goods sold at the beginning, which could lead to higher net earnings in the first year compared to the operating lease treatment, where only the rental income is recognized. Thus, net earnings were understated.

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