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A Noncancelable Lease is Classified as a Capital Lease

On January 1, 2006, Lani Company entered into a noncancelable lease for a machine to be used in its manufacturing operation. 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 bases 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?

Solution Preview

a. The theoretical basis for capitalizing a lease is that it is, in fact, a financing transaction. And with any financing transaction, the asset purchased is recorded on the balance sheet of the entity offset by the corresponding debt. The criteria which result in the determination of a capital versus an operating lease establish the fact that a capital lease is actually a purchase financed by a leasing company. Without discussing the four criteria, any one of which will determine the capital status, it is important to consider ...

Solution Summary

In a paragraph for each question, the solution carefully explains how to record, classify, and report a lease transaction in the accounting records and financial statements of Lani Company. This solution totals 354 words.