Comparisons of Operating and Sales Type Leases

On January 1, 2013 Nelson Company leases get property to Queens Company at an annual rental of $60,000 payable in advance at the starting of each year for 8 years. The first payment is gets immediately. The lease property, which is new, cost $175,000 and has an estimated economic life of 8 years and no residual value. The interest rate implicit in the lease is 12% and the lease is noncancelable. Nelson had no other costs related with this lease. It could have accounted for this lease as a sales type lease but mistakenly treated it as an operating lease.

Determine the effect on income before income taxes during the first year of the lease as a result of Nelson's classification of the lease as an operating rather than a sales type lease.