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?
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?
Related questions
# Warren Co. recorded a right-of-use asset of $800,000 in a10-year Type A lease. The interest rate charged by the lessor was8%. Under the new ASU, the balance in the right-of-use asset aftertwo years will be:
#Refer to the following lease amortization schedule. The 10payments are made annually starting with the inception of thelease. Title does not transfer to the lessee and there is nobargain purchase option or guaranteed residual value. The asset hasan expected economic life of 12 years. The lease isnoncancelable.
| Payment | Cash Payment | Effective Interest | Decrease in balance | Balance |
| 63,282 | ||||
| 1 | 10,000 | 10,000 | 53,282 | |
| 2 | 10,000 | 6,394 | 3,606 | 49,676 |
| 3 | 10,000 | 5,961 | 4,039 | 45,638 |
| 4 | 10,000 | 5,477 | 4,523 | 41,114 |
| 5 | 10,000 | 4,934 | 5,066 | 36,048 |
| 6 | 10,000 | 4,326 | 5,674 | 30,373 |
| 7 | 10,000 | 3,645 | 6,355 | 24,018 |
| 8 | 10,000 | 2,882 | 7,118 | 16,901 |
| 9 | 10,000 | ? | ? | ? |
| 10 | 10,000 | ? | ? | ? |
What would the lessee record as annual depreciation on the assetusing the straight-line method?
#XYZ Company leased equipment to West Corporation under a leaseagreement that qualifies as a capital lease to West but not as aresult of a bargain purchase option or a title transfer. Thepresent value of the asset is $600,000. The expected economic lifeof the asset is 10 years. The lease term is five years. Using thestraight-line method, what would West record as annualdepreciation?
# If the lessee and lessor use different interest rates toaccount for a capital lease, then:
Total expenses for the lessee will be different from thelessor's total revenues.
Total expenses for the lessee will equal the lessor's totalrevenues.
GAAP has been violated by at least one party.
The lessee will report more net income for the year.
##
Technoid Inc. sells computer systems. Technoid leases computersto Lone Star Company on January 1, 2016. The manufacturing cost ofthe computers was $12 million.
This noncancelable lease had the following terms:
⢠Lease payments: $2,466,754 semiannually; first payment at January1, 2016; remaining payments at June 30 and December 31 each yearthrough June 30, 2020.
⢠Lease term: five years (10 semiannual payments).
⢠No residual value; no bargain purchase option.
⢠Economic life of equipment: five years.
⢠Implicit interest rate and lessee's incremental borrowing rate:5% semiannually.
⢠Fair value of the computers at January 1, 2016: $20million.
Collectibility of the rental payments is reasonably assured, andthere are no lessor costs yet to be incurred.
Lone Star Company would account for this as:
A capital lease.
A direct financing lease.
A sales type lease.
An operating lease.
##
Refer to the following lease amortization schedule. The 10payments are made annually starting with the inception of thelease. Title does not transfer to the lessee and there is nobargain purchase option or guaranteed residual value. The asset hasan expected economic life of 12 years. The lease isnoncancelable.
| Payment | Cash Payment | Effective Interest | Decrease in balance | Balance |
| 63,282 | ||||
| 1 | 10,000 | 10,000 | 53,282 | |
| 2 | 10,000 | 6,394 | 3,606 | 49,676 |
| 3 | 10,000 | 5,961 | 4,039 | 45,638 |
| 4 | 10,000 | 5,477 | 4,523 | 41,114 |
| 5 | 10,000 | 4,934 | 5,066 | 36,048 |
| 6 | 10,000 | 4,326 | 5,674 | 30,373 |
| 7 | 10,000 | 3,645 | 6,355 | 24,018 |
| 8 | 10,000 | 2,882 | 7,118 | 16,901 |
| 9 | 10,000 | ? | ? | ? |
| 10 | 10,000 | ? | ? | ? |
What would be the outstanding balance after payment 10?
## Cady Salons leased equipment from Smith Co. on January 1,2016, in a Type B lease. The present value of the lease paymentsdiscounted at 10% was $80,000. Ten annual lease payments of $12,000are due at each January 1 beginning January 1, 2016. Following theguidance of the new ASU, the amortization of the right-of-use assetfor the reporting year ending December 31, 2016, would be:
## Karla Salons leased equipment from Smith Co. on July 1, 2016,in a Type A lease. The present value of the lease paymentsdiscounted at 10% was $80,000. Ten annual lease payments of $12,000are due each year beginning July 1, 2016. Smith Co. had constructedthe equipment recently for $66,000, and its retail fair value was$80,000.
Under the new ASU, what amount of interest revenue from the leaseshould Smith Co. report in its December 31, 2016, incomestatement?
### If the leaseback portion of a sale-leaseback transaction isclassified as an operating lease:
Any gain is deferred and recognized as a reduction of rentexpense.
Any gain is deferred and recognized as a reduction ofdepreciation.
Any gain is recognized at the lease's inception.
There can be no gain.
