DIscussion Week 7 Case 20-1 Miscellaneous Lease Issues - On January 1, 2016, Von
ID: 2594534 • Letter: D
Question
DIscussion Week 7 Case 20-1
Miscellaneous Lease Issues- On January 1, 2016, Von Company entered into two noncancelable leases for new machines to be used im its manufacturing operations. The first lease does not contain a bargain purchase option. The lease term is equal to 80% of the estimated economic life of machine. The second lease contains a bargain purchase option. THe lease term is equal to 50% of the estimated economic life of the machine.
REQUIRED:
1. Explain the theoretical basis for requiring lessees to capitalize certain long term leases. Do not discuss the specific criteria for classifying a lease as a capital lease.
2. Explain how a lessee should account for a capital lease at its inception.
3. Explain how a lessee should record each minimum lease payment for a capital lease.
4. Explaine how Von Should classify each of the two leases.
Explanation / Answer
1.Leasing is said to window-dress Fnancial statement. This illustration reveals the important impacts that alternative lease accounting methods can have on Fnancial statements.
While the operating lease method is simpler, the capital lease method is conceptually superior, both from a balance sheet and an income statement perspective. from a balance sheet perspective, capital lease accounting recognizes the benefits (assets) and obligations (liabilities) that arise from a lease transaction.
In contrast, the operating lease method ignores these benefits and obligations and fully reflects these impacts only by the end of the lease term. This means the balance sheet under the operating lease method fails to reflect the lease assets and obligations of the company.
2.A lessee (the party leasing the asset) classifies and accounts for a lease as a capital lease if, at its inception, the lease meets any of four criteria:
(1) the lease transfers ownership of the property to the lessee by the end of the lease term;
(2) the lease contains an option to purchase the property at a bargain price;
(3) the lease term is 75% or more of the estimated economic life of the property; or
(4) the present value of the minimum lease payments (MLPs) at the beginning of the lease term is 90% or more of the fair value of the leased property.
A lease can be classiFed as an operating lease only when none of these criteria are met. Companies often efectively structure leases so that they can be classified as operating leases.
3.When a lease is classified as a capital lease, the lessee records it (both asset and liability) at an amount equal to the present value of the minimum lease payments over the lease term (excluding executory costs such as insurance, maintenance, and taxes paid by the lessor that are included in the MLP).
The leased asset must be depreciated in a manner consistent with the lessee’s normal depreciation policy.
While in Operating lease there is no depreciaTon deducted
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