On January 2, 2008, two identical companies lease similar assets with the following characteristics.
1. The economic life is eight years
2. The term of the lease is five years
3. Lease payment of $20,000 per year is due at the beginning of each year beginning January 2, 2008.
4. The fair market value of the leased property is $96,000.
5. Each firm has an incremental rate of 8 percent and a tax rate of 40 percent.
Company 1 capitalizes the lease, whereas company 2 records the lease as an operating lease. Both firms depreciate assets by the straight-line method, and both treat the lease as an operating lease for federal income tax purposes.
Questions
a. Determine earning (i) before interest and taxes and (ii) before taxes for both firms.
b. Compute any deferred taxes resulting from the lease for each firm in the first year of the lease.
c. Compute the effect of the lease on the 2008 reported cash from operations for both firms. Explain any differences
d. Compute the effect of the lease on 2008 reported cash flows from investing activities for both firms. Explain any differences.
e. Compute the effect of the lease on 2008 reported cash flow from financing activities for both firms. Explain the differences.
f. Compute the effect of the lease on total 2008 cash flows for both firms. Explain any differences.
g. Give reasons why company 1 and 2 may have wanted to use difference methods to report similar transactions.