This question tested an understanding of the effect on profit or loss of treating a lease as an operating lease as opposed to a finance lease.
To compute the correct answer, it is necessary to calculate the charges to profit or loss for depreciation and finance costs that would be reported from treating the lease as a finance lease and comparing those charges with the charge that had been made by treating the lease as an operating lease (the annual rental of $19,000).
With the lease capitalised at $60,000 and a life of four years this would give an annual depreciation charge of $15,000. As the annual rental was payable in arrears there would be a finance charge of $6,000 ($60,000 x 10%).
This would give total charges to profit or loss of $21,000, the difference between this and the $19,000 operating lease rental charge would require an additional charge of $2,000.
Thus, incorrectly treating the lease as an operating lease would mean the profit for the year was overstated (as expenses were understated) by $2,000 – answer A.
Many candidates calculated the difference as $13,000, presumably comparing the operating rental of $19,000 with the finance cost of $6,000 thus ignoring the depreciation.
Of the candidates that correctly calculated the difference as $2,000, a significant number thought the effect was an understatement rather than an overstatement of profit.