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In: Accounting

On the first day of its fiscal year, Lessor, Inc., leased certain property at an annual...

On the first day of its fiscal year, Lessor, Inc., leased certain property at an annual rental of
$100,000 receivable at the beginning of each year for 10 years. The first payment was received immediately. The
leased property is new, had cost $650,000, and has an estimated useful life of 13 years with no salvage value. The
rate implicit in the lease is 8%. The present value of an annuity of $1 payable at the beginning of the period at 8%
for 10 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 mistakenly treated the lease as an operating lease. Lessor depreciates all of its
properties using the straight-line depreciation method. Ignoring tax effects, what was the effect on net earnings
during the first year of treating this lease as an operating lease rather than as a sale?   why answer is :: Understatement of $74,676.

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Expert Solution

Lessor Accounting:
The lessor shall record the lease receivable at the Present value of Lease payment & residual value in the given case.= $35,20,000
Year Payments (Cash flows) Present Value Factor @8%p.a. Discounted Cash flows/ Present value
1-10 year $                                               1,00,000.00 7.247 $                           7,24,700
Total $                                                     1,00,000                               7,24,700
Lease Receivable at commencement date $                                                     7,24,700
Cost of Sale less Present value of unguaranteed residual value $                                                     6,50,000
1 Gross Income on sale                                                            74,700
2 Interest revenue for 2020                                                            57,976
In the books of Lessor
Journal Entries for Sale type lease
Date Particulars Debit Credit
Year 1 Lease Receivable                     7,24,700
Cost of Machine                               6,50,000
Gain on sale of Equipment                                  74,700
(To record asset given on lease under sale type lease )
Year 1 Cash                     1,00,000
Lease Receivable                               1,00,000
(To record 1st lease payment received)
Last day of Year 1 Lease Receivable                        49,976
Interest income                                  49,976
(To record Interest income on lease receivable)
($724700-100000)*8%=$57976)
Net income recognised under Sale-type lease $                     1,24,676.00 (74700+49976)
Operating lease
Lease revenue $           1,00,000.00
Less: Depreciation $              50,000.00 (650000/13)
Net income recognised under operating lease $                        50,000.00
The effect on net earnings= Understatement of $                        74,676.00

ekkarill92 answered 2 years ago
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