Hydra Company entered into a direct-financing lease with Bridges Company for the use of an asset which cost Hydra $195,000.The lease agreement contained a bargain purchase option effective immediately after the fifth rental,which provided that Bridges could purchase the asset at that time.The estimated life of the asset was 10 years with an estimated residual value of $500.Assuming that Bridges uses straight-line depreciation,Bridges's annual depreciation expense would be
A) $19,500
B) $19,450
C) $19,550
D) $19,000

Question

Quizplus · Accepted Answer

Since Bridges Company has a bargain purchase option, it is likely they will exercise this option and buy the asset at the end of the lease term. Therefore, the depreciation expense is calculated based on the cost of the asset minus the residual value, spread over the useful life of the asset. The cost is $195,000 and the residual value is $500, so the depreciable base is $195,000 - $500 = $194,500. Since the asset's estimated life is 10 years, the annual straight-line depreciation expense is $194,500 / 10 = $19,450.

Hydra Company Entered into a Direct-Financing Lease with Bridges Company