Sfaac Case 13-13

Case 13-4 Application of SFAC No. 13 1) On January 1, 2006, Lani Company entered into a noncancelable lease for a machine to be used in its manufacturing operations. The lease transfers ownership of the machine to Lani by the end of the lease term. The term of the lease is eight years. The minimum lease payment made by Lani on January 1, 2006, was one of eight equal annual payments. At the inception of the lease, the criteria established for classification as a capital lease by the lessee were met.
Required:
a.) What is the theoretical basis for the accounting standard that requires certain long-term leases to be capitalized by the lessee? Do not discuss the specific criteria for classifying a specific lease as a capital lease.
When a lease transfers substantially all of the risks and benefits incident to the ownership of property to the lessee, it should be capitalized by the lessee.
The economic effect of such a lease on the lessee is similar, in many respects, to that of an installment purchase.
b) How should Lani account for this lease at its inception and determine the amount to be recorded?
Lani should account for this lease at its inception as an asset and an obligation at an amount equal to the present value at the beginning of the lease term of minimum lease payments during the lease term, excluding that portion of the payments representing executory costs, together with any profit thereon. However, if the amount so determined exceeds the fair value of the leased machine at the inception of the lease, the amount recorded as the asset and obligation should be the machine's fair value.
c) What expenses related to this lease will Lani incur during the first year of the lease, and how will they be
determined? Lani will incur interest expense equal to the interest rate used to capitalize the lease at its inception multiplied by the appropriate net carrying value of the liability. In addition, Lani will incur an expense relating to depreciation of the capitalized cost of the leased asset. This depreciation should be based on the estimated useful life of the leased asset and depreciated in a manner consistent with Lani's normal depreciation policy for owned assets.
d) How should Lani report the lease transaction on its December 31, 2006, balance sheet? The asset recorded under the capital lease and the accumulated depreciation should be reported on Lani's December 31, 2006 balance sheet classified as noncurrent and should be separately identified by Lani in its balance sheet or notes thereto. The related obligation recorded under the capital lease should be reported on Lani's December 31, 2006 balance sheet appropriately classified into current and noncurrent categories and should be separately identified by Lani in its balance sheet.
Case 13-5 Lease Classifications 2) Doherty Company leased equipment from Lambert Company. The classification of the lease makes a difference in the amounts reflected on the balance sheet and income statement of both Doherty and Lambert.
Required:
a) What criteria must be met by the lease in order that Doherty Company classify it as a capital lease?
For Doherty Company to classify the lease as a Capital Lease, it must meet one or more of the following criteria:
1. Transfer of ownership at end of lease
2. Bargain purchase option
3. Lease term is 75% or more of the estimated economic life of the asset
4. Present value of minimum lease payments is 90% or more of fair value of the leased property to the lessor b) What criteria must be met by the lease meet in order that Lambert Company classify it as a sales-type or direct financing lease?
For Lambert Company to classify the lease as a sales-type or direct financing lease, it must meet one or more of the following conditions: * The lease transfers ownership of the property to the lessee by the end of the lease term.
* The lease contains a bargain purchase option * The lease term is equal to 75% or more of the estimated economic life of the leased property. * The present value of the minimum lease payments is at least 90% of the fair value of the leased property to the lessor.
In addition, a sales-type lease must involve a manufacturer's or dealer's profit or loss, which exists when the asset's fair value at the inception of the lease differs from its cost or carrying value. The amount of profit or loss is the difference between (a) the present value of the minimum lease payments (net of executory costs) computed at the interest rate implicit in the lease (i.e., the sales price), and (b) the cost or carrying value of the asset plus any initial direct costs less the present value of the unguaranteed residual value accruing to the benefit of the lessor. c) Contrast a sales-type lease with a direct financing lease.
The basic difference in accounting for a sales-type lease is that the carrying value of the asset is charged to cost of asset leased (expense), and the present value of the minimum lease payments is recorded as the amount of the sale. In a direct
financing lease, no sales or expense is recognized. Instead, the asset is removed from the books and the difference between its carrying value and the undiscounted minimum lease payments is recorded as unearned interest revenue. The net investment in a sales type lease is accounted for in a similar manner to that for a direct financing
lease.