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On January 1, Plugs Company, a lessee, entered into three non-cancelable leases for new equipment, Lease L, Lease M, and Lease N. None of the three leases transfers ownership of the equipment to Plugs 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 lease payments is 75% of the fair value of the equipment. The following information is specific to each lease.

· Lease L does not contain a bargain purchase option. The lease term is equal to 80% of the estimated economic life of the equipment.

· Lease M contains a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.

· Lease N does not contain a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.

Required:

1. Please show the calculation(s)/discussion of the test you use to answer the following questions:

a. What type of lease is Lease L for the lessee?

b. What type of lease is Lease M for the lessee?

c. What type of lease is Lease N for the lessee?

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Casey Durgan
Casey DurganLv2
28 Sep 2019

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Related questions

Lessee Santi contracts for three leases of three machines forsix months: lease A, lease B and Lease C. Each lease isnon-cancelable and each machine reverts to the lessor at the end ofthe lease term. The first rental payment for each machine is paidat the inception of the lease, with the balance to be paid in equalamounts at the start of each of five quarters thereafter. Thelessors agreed to pay the executory costs and included this amountin the lease rentals. For each of the machine the present value ofthe minimum lease payment is equal to 55% of the fair value of themachine. The following information is peculiar to each lease:

1. Lease A: it is agreed that at the time of the sixth payment,for an added bargain purchase option payment Lessee Santi can buythe property. The lease term is equal to 70% of the estimatedeconomic life of the asset.

2. Lease B: does not give the lessee the option to buy themachine. The lease term is equal to 90% of the estimated economiclife of the asset.

3. Lease C: does not give the lessee the option to buy themachine. The lease term is equal to 70% of the estimated economiclife of the asset.

Required:

1. How should Santi classify each of the three leases above, andwhy? Discuss the rationale for your answer.

2. What amount, if any, should Santi record as a liability atthe inception of the lease for each of the three leases above?

3. Assuming that the minimum lease payments are made on astraight-line basis, how should Santi record minimum lease paymentfor each of the three leases above?

Brief Exercise 21-1 (Essay)

Callaway Golf Co. leases telecommunications equipment. Assume the following data for equipment leased from Photon Company. The lease term is 5 years and requires equal rental payments of $31,000 at the beginning of each year. The equipment has a fair value at the inception of the lease of $138,000, an estimated useful life of 8 years, and no residual value. Callaway pays all executory costs directly to third parties. Photon set the annual rental to earn a rate of return of 10%, and this fact is known to Callaway. The lease does not transfer title or contain a bargain-purchase option.

How should Callaway classify this lease?

Classification of Capital or Operating Lease:

Clintonia Power Station leases fuel rods for its nuclear power plant. The lease agreement does not contain a bargain purchase option or transfer of ownership. In addition, Clintonia Power Station leases the fuel rods for half of their economically productive life. A component of the present value of lease payments (5%) includes costs related to insurance of the rods paid by the lessor. Clintonia Power Station capitalizes the lease of the nuclear fuel rod since the present value of the lease payments equal $2,680,000, while the fair market value of the fuel rods is $3,000,000

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