Ward Products leased office space under a 10-year operating lease agreement. The lease specified 120 monthly rent payments of $5,000 each, beginning at the inception of the lease. In addition to the first rent payment, Ward also paid a $100,000 advance payment at the lease’s inception. What will be the effect of the lease on Ward’s earnings for the first year (ignore taxes)?
Answer:
Ward’s rent expense for the year reduces its earnings by $70,000 each year.
Working notes for the above answer:
This is an operating lease, so here he will record rent expense for each of the $5,000 payments.
Here advance payment also represents rent, recorded initially as prepaid rent and allocated equally over the ten years of the lease.
$5,000 x 12
= $60,000
$100,000 / 10
= 10,000
So 60,000+10,000
=$70,000
As a result, Ward’s rent expense for the year reduces its earnings by $70,000 each year.
