Leasing Office Space Effect on Earnings

What will be the effect of the lease on LTT's earnings for the first year (ignore taxes)?

Answer:

The earnings will increase by $20,000

Explanation:

This is because none of the five classification criteria is met, this is an operating lease. Accordingly, Lakeside will record lease revenue for each of the four $30,000 payments, increasing its earnings by $120,000 each year. In addition, Lakeside, as the owner of the asset, will record depreciation. Assuming straight-line depreciation of the $2.5 million cost over the 25-year life, that’s $100,000 depreciation expense each year. So, earnings are increased by a net $20,000 ($120,000 − $100,000).

Leasing office space can have a significant effect on a company's earnings, as seen in the case of LTT Corporation leasing from Lakeside Inc. In this scenario, LTT's earnings are set to increase by $20,000 in the first year of the lease agreement.

When a company leases office space, it is important to understand the accounting treatment of the lease. In this case, the lease is classified as an operating lease since none of the five classification criteria for finance leases are met. As a result, Lakeside will record lease revenue for each of the quarterly $30,000 payments, leading to an increase in earnings.

Additionally, as the owner of the leased asset, Lakeside will also record depreciation on the office building. Assuming straight-line depreciation over the 25-year useful life with no residual value, the annual depreciation expense amounts to $100,000. This depreciation expense further impacts the company's earnings.

Overall, the lease agreement between Lakeside Inc. and LTT Corporation not only provides LTT with the required office space but also contributes to an increase in LTT's earnings due to the operating lease structure and associated depreciation expense.