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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.