In each issue of Wharton Magazine, we’ll test your knowledge with a question straight from an actual Wharton exam or crafted by one of the School’s esteemed faculty members. Submit the correct answer and you might just walk off with a great prize—tuition-free attendance at a Wharton Executive Education program.
This Final Exam challenge comes from Wayne Guay, Wharton’s Yageo Professor of Accounting. Good luck!
Winner of the spring issue Final Exam challenge: Gary Caine, W’77
Jet Philly, a new startup airline, leased some flight equipment on January 1, 2011. The lease was structured as a four-year capital lease with four annual payments of $3 million to be made on January 1 each year, beginning in January 2012. The interest rate embedded in the capital lease is 10 percent, and the capital lease assets are to be amortized on a straight-line basis over a four-year period with no salvage value. Jet Philly reported $10 million in income before taxes in 2011.
How much greater or lesser would 2011 income before taxes have been if Jet Philly had been able to classify this lease as an operating lease instead of a capital lease?
Jet Philly’s 2011 income before taxes would have been $328,359 greater if this lease had been classified as an operating lease instead of a capital lease. An equivalent correct answer would be that Jet Philly’s income before taxes would have been $10,328,359 if this lease had been classified as an operating lease instead of a capital lease. (This second answer is simply the first answer added to Jet Philly’s reported income of $10 million as stated in the question.)