Chapter 23.10

Assignments from the Readings

Sonia Napier

ACC/400

November 9, 2010

Gentian Mataj

Assignments from the Readings

Case 13-4 Application of SFAC No. 13

On January 1, 2006, Lani Company entered into a noncancelable lease for a machine to be used in its manufacturing operations. The lease transfers ownership of the machine to Lani by the end of the lease term. The term of the lease is eight years. The minimum lease payment made by Lani on January 1, 2006, was one of eight equal annual payments. At the inception of the lease, the criteria established for classification as a capital lease by the lessee were met.

Required:

   1. What is the theoretical basis for the accounting standard that requires certain long-term leases to be capitalized by the lessee? Do not discuss the specific criteria for classifying a specific lease as a capital lease.

When a lease transfers substantially all of the risks and benefits incident to the ownership of property to the lessee, it should be capitalized by the lessee.  The economic effect of such a lease on the lessee is similar, in many respects, to that of an installment purchase.

   2. How should Lani account for this lease at its inception and determine the amount to be recorded?

Lani should account for this lease at its inception as an asset and an obligation at an amount equal to the present value at the beginning of the lease term of minimum lease payments during the lease term, excluding that portion of the payments representing executor costs, together with any profit thereon.  However, if the amount so determined exceeds the fair value of the leased machine at the inception of the lease, the amount recorded as the asset and obligation should be the machine's fair value.

   3. What expenses related to this lease will Lani incur during the first year of the lease, and how will they be determined?

Lani will incur interest expense equal to the interest rate used to capitalize the...