● Case 13-4 Application of SFAC No. 13
On January 1, 2006, Lani Company entered into a non cancelable 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.
a. 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.
b. How should Lani account for this lease at its inception and determine
the amount to be recorded?
c. What expenses related to this lease will Lani incur during the first year
of the lease, and how will they be determined?
d. How should Lani report the lease transaction on its December 31,
2006, balance sheet?
● Case 13-5 Lease Classifications
Doherty Company leased equipment from Lambert Company. The classification
of the lease makes a difference in the amounts reflected on the balance
sheet and income statement of both Doherty and Lambert.
a. What criteria must be met by the lease in order that Doherty Company
classify it as a capital lease?
b. What criteria must be met by the lease meet in order that Lambert
Company classify it as a sales-type or direct financing lease?
c. Contrast a sales-type lease with a direct f
How should Lani account for this lease at its inception and determine
the amount to be recorded?
a. To understand the theoretical basis for the accounting standard that requires certain long-term leases to be capitalized, we need to refer to the relevant standard, which in this case is SFAC No. 13. SFAC No. 13 is a standard issued by the Financial Accounting Standards Board (FASB) that provides guidance on accounting for leases. The theoretical basis for requiring some leases to be capitalized is to ensure that the financial statements of the lessee accurately represent the economic reality of the lease transaction.
The rationale behind capitalizing certain leases is that they essentially involve the transfer of ownership rights or a substantial portion of the risks and rewards of ownership from the lessor to the lessee. By capitalizing these leases, the lessee recognizes both the asset (the leased property) and the related liability (the lease obligation) on its balance sheet. This provides users of the financial statements with a more complete picture of the lessee's financial position and obligations.
b. In this case, Lani Company should account for the lease as a capital lease at its inception and determine the amount to be recorded by using the criteria established for classification as a capital lease. The specific criteria for classifying a lease as a capital lease are not given in the question, but these criteria generally involve the transfer of ownership, the existence of a purchase option, the lease term, and the present value of lease payments.
To determine the amount to be recorded, Lani Company should calculate the present value of the lease payments using the appropriate discount rate. This present value represents the initial obligation under the lease and should be recorded as a liability on the balance sheet. At the same time, Lani Company should recognize an asset, representing the right to use the leased machine, equal to the present value of the lease payments plus any initial direct costs.
c. During the first year of the lease, Lani Company will incur various expenses related to the lease. These expenses include the annual lease payment, which is part of the minimum lease payments made by Lani Company. The amount of the lease payment can be determined by dividing the total minimum lease payments made over the lease term by the number of lease payments.
In addition to the lease payment, Lani Company may also incur other expenses such as maintenance costs, insurance premiums, and property taxes, depending on the terms of the lease agreement. These expenses should be recognized as incurred during the period and recorded as lease expense in the income statement.
d. On its December 31, 2006, balance sheet, Lani Company should report the lease transaction as follows:
- As a current liability: The portion of the lease obligation that is due within one year should be reported as a current liability in the "Current Liabilities" section of the balance sheet.
- As a long-term liability: The portion of the lease obligation that is due after one year should be reported as a long-term liability in the "Long-term Liabilities" section of the balance sheet.
- As a leased asset: Lani Company should report the leased machine as an asset on the balance sheet, either separately or as part of a broader category like "Property, Plant, and Equipment."
Note that the specific presentation and wording may vary depending on the format and requirements of the financial statements. It is important to refer to the relevant accounting standards and follow the appropriate guidance for reporting lease transactions on the balance sheet.