Question

(Operating Lease for Lessee and Lessor) On February 20, 2017, Barbara Brent Inc. purchased a machine for \(1,500,000 for the purpose of leasing it. The machine is expected to have a 10-year life, no residual value, and will be depreciated on the straight-line basis. The machine was leased to Rudy Company on March 1, 2017, for a 4-year period at a monthly rental of \)19,500. There is no provision for the renewal of the lease or purchase of the machine by the lessee at the expiration of the lease term. Brent paid $30,000 of commissions associated with negotiating the lease in February 2017.

Instructions

(b) What income or loss before income taxes should Brent record as a result of the facts above for the year ended December 31, 2017? (Hint: Amortize commissions over the life of the lease.)

Short answer

Income from lease before taxes is $63,750.

Step-by-step solution

Meaning of Lessor

The person who gives the right to use the assets on lease to the lessee is called the lessor. A lessor is the owner of the asset and he should be paid by the lessee as per the lease agreement.

Explaining the income or loss that should be before income taxes Brent record as a result of the facts above for the year ended December 31, 2017

Note: Under principles of accrual accounting, the commission should be amortized over the life of the lease:

BARBARA BRENT INC. Income or Loss from Lease before Taxes For the Year Ended December 31, 2017
Rental revenue ($19,500 X 10 months)	$195,000
Less: expenses
Depreciation $125,000
Commission 6,250	131,250
Income from lease before taxes	$ 63,750

Working Notes:

Calculation of the amount of depreciation per year

$$\begin{gathered} \mathrm{Depreciation}\mathrm{per}\mathrm{year}=\frac{\mathrm{Machine}\mathrm{Value}}{\mathrm{Useful}\mathrm{Life}} \\ =\frac{\$1,500,000}{10} \\ =\$150,000 \end{gathered}$$

Calculation of the amount of depreciation during the year

$$\begin{gathered} \mathrm{Depreciation}\mathrm{during}\mathrm{the}\mathrm{year}=\mathrm{Depreciation}\times \mathrm{Total}\mathrm{Month} \\ =\$150,000\times \frac{10}{12} \\ =\$125,000 \end{gathered}$$

Note: Under principles of accrual accounting, the commission should be amortized over the life of the lease:

Calculation of the amount of Commission

$$\begin{gathered} \mathrm{Commission}=\left(\frac{\mathrm{Commission}\mathrm{Paid}}{\mathrm{TotalPeriodof}\mathrm{Rental}}\right)\times \mathrm{Total}\mathrm{month} \\ =\left(\frac{\$30,000}{4}\right)\times \frac{10}{12} \\ =\$7,500\times \frac{10}{12} \\ =\$6,250 \end{gathered}$$