Can you help me understand 3-3, 3-5, 3-6, 4-2, and 4-9?
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a. A lease may be classified as a capital lease if it meets the any one of the following criteria
(1) if the lease life exceeds 75% of the life of the asset
(2) if there is a transfer of ownership to the lessee at the end of the lease term
(3) if there is an option to purchase the asset at a "bargain price" at the end of the lease term.
(4) if the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of the fair market value of the asset.
Using these criteria
Lease J would be a capital lease since the lease term is greater than 75% of the life of the asset
Lease K is a capital lease since it contains a bargain purchase option
Lease L will be an operating lease since it does not meet any of the above criteria.
b. For capital leases, the amount of liability at the inception would be the present value of the minimum lease payments excluding executory costs at the start of the lease. If the present value is greater than the fair value of the leased asset, then the lease amount would be the fair value of the leased asset. This is for Lease J and K
For Lease L which is an operating lease, no lease liability is recorded.
c. For capital lease, minimum lease payments are divided into interest expense and principal amount which goes towards reducing the lease liability. The interest payment is calculated as the opening lease liability X the interest rate. The difference between the minimum lease payment and interest expense reduces the lease liability. This is for lease J and K
For lease L, the minimum lease payment would be recorded as rental expense.
d. Capital lease and operating lease do represent the economic reality. In capital lease, since the lessee uses the assets as an owner only and that to for a substantial part of the economic life of the asset, it is correctly recorded in the balance sheet as an asset and liability. An operating lease is for a shorter duration as compared to the life ...
The solution explains various questions from Chapter 3 - Analyzing Financing Activities/Chapter 4 - Analyzing Investing Activities
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