. On January 1, 2012, Porter Corporation signed a five-year non- cancelable leas
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. On January 1, 2012, Porter Corporation signed a five-year non- cancelable lease for certain machinery. The terms of the lease called for: A) Porter to make annual payments of $60,000 at the end of each year (starting on Dec. 31, 2012) for five years. Porter must return the equipment to the lessor end of this period B) The machinery has an estimated useful life of 6 years and no expected salvage value C)Porter uses the straight-line method of depreciation for all of its fixed assets D)Porter's incremental borrowing rate is 8% E) The fair value of the asset at January 1, 2012 is $275,000 Required: . Discuss whether Porter should account for the lease as an operating or capital lease and why 2. Using the above information to show how the lease would affect Porter's financial statements in 2013 in the following sections. Show your calculations. a). Assets: b). Liabilities: c). Expenses: d). Operating Cash flows: e). Investing Cash flows:Explanation / Answer
1.
If the lease term of an asset is greater than 75% of the useful life of the asset, the lease is accounted for as a capital lease.
In the given question, the estimated useful life of the equipment is 6 years and the lease term is 5 years. Therefore, lease term is 83% that is greater than 75% of the useful life of the asset.
Porter should account for the lease as a capital lease.
2.
Assets will decrease by the amount of depreciation on the leased equipment.
Reduction in assets = $275,000/5 = $55,000
Liabilities will decrease by the amount of lease payment applicable towards the lease liability.
Reduction in liabilities = $60,000 - ($237,000 x 8%) = $41,040
Expenses will increase by the amount of interest included in the lease payment.
Increase in expenses = $237,000 x 8% = $18,960
Operating cash flows will decrease by the amount of interest expense.
Decrease in operating cash flows = $18,960
Investing cash flows will decrease by the amount of reduction in liabilities.
Reduction in liabilities = $41,040
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