Comparisons of Operating and Sales-Type Leases
Response to the following problem:
On January 1, 2010, 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 eight years. The first payment is received immediately. The leased property, which is new, cost $275,000 and has an estimated economic life of eight years and no residual value. The interest rate implicit in the lease is 12% and the 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.
Required
Compute the effect on income before income taxes during the first year of the lease as a result of Nelson Company's classification of this lease as an operating rather than a sales-type lease.