Question

At the beginning of its fiscal year, Lakeside Inc. leased office space to LTT Corporation under a seven-year operating lease agreement. The contract calls for quarterly rent payments of $30,000 each. The office building was acquired by Lakeside at a cost of $2.5 million and was expected to have a useful life of 25 years with no residual value.

What will be the effect of the lease on LTT's earnings for the first year (ignore taxes)?

Answer 1

The earnings will increase by $20,000

Step-by-step explanation:

This is because none of the five classification criteria is met, this is an operating lease. Accordingly, Lakeside will record lease revenue for each of the four $30,000 payments, increasing its earningsby $120,000 each year. In addition Lakeside, as owner of the asset, will record depreciation. Assuming straight-line depreciation of the $2.5 million cost over the 25-year life, that’s $100,000depreciation expense each year. So, earnings are increased by a net $20,000 ($120,000 − $100,000).