The Bare Minimum

1152 Words May 14th, 2013 5 Pages
The Bare Minimum

Overall Case Facts
Big Bear Power (Big Bear) must determine what factors should be included in the minimum lease payments for the lease of a combustion turbine from Goliath Co. For each of the following three provisions, we determine what components should be included in “minimum lease payments” per ASC 840.

Provision 1
At the beginning of the lease, Big Bear pays $500,000 to its legal counsel as well as $1 million in legal fees incurred by Goliath Co. The Company is required to pay the latter expense, but not the former.

1. Include both of the legal costs in the minimum lease payments
2. Include neither of the legal costs
3. Include one but not the other legal cost

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We believe that this excludes 840-10-25-14(c) and, therefore, we determine that the penalty should be included in the minimum lease payments.
Provision 3
The minimum lease payment will be increased year to year by the change in the consumer price index (CPI) between the current year and previous year. The existing incremental percentage of CPI is 4% as of the inception of the lease.

1. Include the CPI increase in the minimum lease payments
2. Do not include the CPI increase in the minimum lease payments

Accounting Literature/Recommendation
ASC 840-20-25-2(b) defines the term “contingent rental” as an “increase or decrease in rentals that [is] dependent on future events such as future sales volume, future inflation, future property taxes, and so forth”. Because the Big Bear lease agreement considers monetary inflation in valuing the lease payment, we believe this occasion falls into the definition of a contingent rental. ASC 840-10-25-4 also states that CPI changes specifically qualify as contingent rentals and that the existing differential rate of CPI at the lease inception will be used to determine changes. Thus, we determine that the 4% increase in the CPI should be included in the minimum lease payments.

IFRS Implications
The current IFRS model of “risk and reward’’ describes how to assign the risks and rewards to lessors and lessees. Accordingly, this model results in an off-balance sheet approach to lease transactions. IAS 7 also