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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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BuyFindarrow_forward

Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Types of Leases

On January 1, Hazard Company, a lessee, entered into three noncancelable leases for brand new general equipment: Lease J, Lease K, and Lease L. None of the three leases transfers ownership of the equipment to Hazard at the end of the lease term. For each of the three leases, the present value of the lease payments at the beginning of the lease term, excluding that portion of the payments representing executory costs, is 75% of the fair value of the equipment to the lessor at the inception of the lease. Each piece of equipment has an expected economic life of 5 years.

The following information is peculiar to each lease:

  1. a. Lease J does not contain a bargain purchase option. The lease term is equal to 60% of the estimated economic life of the equipment.
  2. b. Lease K contains a bargain purchase option. The lease term is equal to 60% of the estimated economic life of the equipment.
  3. c. Lease L does not contain a bargain purchase option. The lease term is for 12 months.

Required:

  1. 1. Explain how Hazard should classify each of the preceding three leases. Discuss the rationale for your answer.
  2. 2. What amount, if any, should Hazard record as a liability at the inception of the lease for each of the preceding three leases?
  3. 3. Assuming that the lease payments are made on a straight-line basis, how should Hazard record expense for each of the preceding three leases?

1.

To determine

Explain the manner in which Company H should classify each of the preceding three leases explain the same.

Explanation

Lease: Lease is a contractual agreement whereby the right to use an asset for a particular period of time is provided by the owner of the asset to the user of the asset. The owner, who possesses the asset, is termed as ‘Lessor’ and user, to whom the right is transferred to, is termed as ‘Lessee’.

Operating leases: In an operating lease lessor retains all ownership risks and responsibilities.

Capital leases: In capital lease all the ownership risks and responsibilities are transferred from the lessor to the lessee.

In case the lease is transferring “effective control” of the leased property by meeting any one of the four criteria established by GAAP then that lease is classified as a capital lease...

2.

To determine

Identify the amount that Company H should record as a liability at the inception of the lease for each of the preceding three leases.

3.

To determine

Explain the way Company H should record the expenses for each of the preceding three leases.

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