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    Comparison of Operating and Sales-Type Leases

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    January 1, 2007 Nelson Company leases certain property to Queens Company at an annual rental of $60,000 payable in advance at the beginning of each year for 8 years. First payment received immediately. Leased property, which is new cost 275,000 and has an estimated economic life of 8 years and no residual value. Interest rate implicit in the lease is 12% and lease is noncancelable. Nelson company had no other costs associated with this lease. It should have accounted for this lease as a sales-type lease but mistakenly treated it as an operating lease.

    Compute the effect on income before income taxes during the first year of the lease as a result of Nelson company classification of this lease as an operating lease rather than a sales-type lease.

    I need to figure out the Incremental effect on income before income taxes

    Less: Cost of goods sold
    Gross margin
    Add: Interest revenue
    Incremental revenue recognized

    Computation of the effect on income before income taxes using the operating lease method
    Rental revenue
    Depreciation expense ]

    Incremental effect on income before income taxes
    Rent revenue
    Less: depreciation expense

    Effect on income before income taxes
    Income before income tases

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    Solution Summary

    Comparison of operating and sales type leases are examined.