14. Lease Classication Two years ago, Wolfram Group entered into a 4-year lease

Question

14. Lease Classication Two years ago, Wolfram Group entered into a 4-year lease of a welding machine from Tungsten Industries. At the inception of the lease, there was no bargain purchase option, the present value of the rents were 50% of the market value of the asset, ownership reverted to Tungsten at the end of the lease, and the economic life of the machine was estimated to be 10 years. Wolfram initially classied this arrangement as an operating lease. Recent advancements in welding technology have curtailed the economic life of this asset. It is now estimated to have a total useful life of 6 years. Stanley Carter, the CEO of Wolfram, asks, ‘‘Since the market has changed, we’re now holding on to this asset for at least 75% of its useful life. That makes this a capital lease, so I want you to put the asset on our books.’’ Research the appropriate Codication and determine whether the CEO’s plan of action is appropriate under GAAP.

Explanation / Answer

Under US GAAP a lease is qualified as finance lease in the following situation:

1. The laese transfers ownwership of the assets to the lessee at the end of lease period

2.The lease contains a purchase option

3.The lease term is atleast 75 percent of the useful life of the asssets

4.The present value of minimum lease is atlaest 90 % of the fairvalue of the assets

Since the lease covers 75 % of the useful life of the assets the decision of CEO's decision to capitalise the lease is correct.

He can capitalise lease: The asset is classified as Laesed Assets and curresponding amount is credited to Laese liability. The amount capitalised is equal to Present value of future lease payments.

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