ExpertMedium1 markMultiple Choice
CPA · Question 46 · Area III: Select Transactions
On January 1, Year 1, Lessee Co. enters a 5-year lease for equipment. <br/>- Annual payments: $20,000 (due Dec 31)<br/>- Rate: 5%<br/>- PV of payments: $86,590<br/>- Useful life of asset: 6 years<br/>- No purchase option or transfer of ownership.<br/>- The lease is classified as an Operating Lease.<br/><br/>What is the Lease Expense for Year 1?
On January 1, Year 1, Lessee Co. enters a 5-year lease for equipment. <br/>- Annual payments: $20,000 (due Dec 31)<br/>- Rate: 5%<br/>- PV of payments: $86,590<br/>- Useful life of asset: 6 years<br/>- No purchase option or transfer of ownership.<br/>- The lease is classified as an Operating Lease.<br/><br/>What is the Lease Expense for Year 1?
Answer options:
A.
$20,000
B.
$17,318
C.
$21,648
D.
$4,330
How to approach this question
Operating Lease: Total Lease Expense is recognized on a straight-line basis (Total Payments / Term). If payments are level ($20k/yr), Expense = Payment ($20k). <br/>(Note: On the BS, you still book ROU Asset and Liability, but the IS shows one straight-line expense).
Full Answer
A.$20,000✓ Correct
A
For an operating lease, lease expense is recognized on a straight-line basis over the lease term. Since payments are level at $20,000/year, the annual expense is $20,000. (This comprises both interest and amortization of the ROU asset, but is reported as a single line item).
Common mistakes
Applying Finance Lease accounting (Interest + Amortization separately).
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