Question

CASE 13‐5 Lease Accounting: Various Issues

On January 1, prior to the adoption of the FASB’s new lease standard, Borman Company, a lessee, entered into three noncancelable leases for brand‐new equipment: Lease J, Lease K, and Lease L. None of the three leases transfers ownership of the equipment to Borman at the end of the lease term. For each of the three leases, the present value at the beginning of the lease term of the minimum lease payments—excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor and including any profit thereon—is 75 percent of the excess of the fair value of the equipment to the lessor at the inception of the lease over any related investment tax credit retained by the lessor and expected to be realized by the lessor. The following information is peculiar to each lease:

1. Lease J does not contain a bargain purchase option; the lease term is equal to 80 percent of the estimated economic life of the equipment.
2. Lease K contains a bargain purchase option; the lease term is equal to 50 percent of the estimated economic life of the equipment.
3. Lease L does not contain a bargain purchase option; the lease term is equal to 50 percent of the estimated economic life of the equipment.

Required:

1. How should Borman Company classify each of the three leases, and why? Discuss the rationale for your answer.
2. What amount, if any, should Borman record as a liability at the inception of the lease for each of the three leases?
3. Assuming that the minimum lease payments are made on a straight‐line basis, how should Borman record each minimum lease payment for each of the three leases?

Answer 1

a) Lease can be classified as operating lease and capital lease.

Operating Lease:

1 Ownership of the asset is not transferred.

2 There is no option of bargaining power to repurchase the asset.

3 Present value of lease is less than 90% of the present value

4 75% life of asset is not held by lessee

5 At the end ownership of asset is transferred.

Capital Lease:

1 option of bargaining power is available to repurchase the asset.

2 Present value of lease is 90% or more than 90% of present value.

3 At the end, ownership of asset is transferred.

4 75% life of assets is held by lessee.

Lease J classified as capital lease because there is a bargaining option and 80% of life of asset is held with the lessee.

Lease K classified as capital lease because option to exercise bargaining power.

Lease L classified as operating lease because there is no bargaining option.

b) Lease J: It is a liability at the time of commencement of lease

Amount: Present value of lease payment without fair value or executory cost

Lease k: It is a liability at the time of commencement of lease.

Amounts: In lease payment bargaining payment is include.

present value of lease payment or fair value.

Lease L: It is not a liability at the time of commencement of lease.

c) Lease J: In minimum lease payment includes principle amount and interest rate.

  Lease k: In minimum lease payment includes principle amount and interest rate.

Lease L: rent expense will be lease payable.