Schott Sausages, in trying to lease a sausage machine, is concerned about whether the machine will be reported as a capital or operating lease.Consider the following facts in your deliberations:

• Annual lease payment required, $30,000

• Term of lease and useful life of machine, five years

• Discount rate, 10 percent Required

a. Should the sausage machine be reported as a capital or operating lease?

Why?

b. Calculate the annual expense for the first two years associated with a capital lease, using straight-line depreciation and zero residual value. Show the impact of this lease on the accounting equation.

c. Why are the capital lease costs higher than the operating lease costs in part b?