Lakeside Incorporated Leases Office Space to LTT Corporation
How will the lease impact LTT Corporation's earnings for the first year?
At the beginning of its fiscal year, Lakeside Incorporated leased office space to LTT Corporation under a seven-year operating lease agreement. The contract calls for quarterly rent payments of $25,000 each. The office building was acquired at a cost of $2 million and was expected to have a useful life of 25 years with no residual value. What will be the effect of the lease on LTT's earnings for the first year (ignore taxes)?
The Impact of the Lease on LTT Corporation's Earnings
The effect of the lease on LTT's earnings for the first year is a reduction of $20,000. The effect of the lease on LTT Corporation's earnings for the first year can be calculated by considering the quarterly rent payments and the useful life of the office building.
First, let's calculate the total rent payments for the first year. Since the contract calls for quarterly rent payments of $25,000 each, the total rent payments for the year will be 4 times the quarterly rent payment, which is $25,000 x 4 = $100,000.
Next, let's determine the depreciation expense for the office building. The office building was acquired at a cost of $2 million and has a useful life of 25 years with no residual value. To calculate the annual depreciation expense, we divide the cost of the building by its useful life: $2,000,000 / 25 = $80,000 per year.
Now, let's calculate the effect of the lease on LTT's earnings for the first year:
1. Subtract the total rent payments for the year from the depreciation expense: $80,000 - $100,000 = -$20,000
The negative sign indicates that the lease will have a negative effect on LTT's earnings for the first year. Specifically, LTT's earnings will be reduced by $20,000 due to the lease. It's important to note that this calculation is based on the assumption that there are no other expenses or revenues related to the lease. Also, please keep in mind that this calculation is done without considering taxes.
In summary, the effect of the lease on LTT's earnings for the first year is a reduction of $20,000.