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Treatement of long term leases

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.

Cubby Corporation entered into a lease agreement for 10 photocopy machines for its corporate headquarters. The lease agreement qualifies as an operating lease in all terms except there is a bargain purchase option. After the 5-year lease term, the corporation can purchase each copier for $1,000, when the anticipated market value is $2,500. Glenn Beckert, the financial vice president, thinks the financial statements must recognize the lease agreement as a capital lease because of the bargain purchase agreement. The controller, Donna Kessinger, disagrees: "Although I don't know much about the copiers themselves, there is a way to avoid recording the lease liability." She argues that the corporation might claim that copier technology advances rapidly
and that by the end of the lease term the machines will most likely not be worth the $1,000 bargain price.

Answer the following questions.
(a) What ethical issue is at stake?
(b) Should the controller's argument be accepted if she does not really know much about copier technology? Would it make a difference if the controller were knowledgeable about the pace of change in copier technology?
(c) What should Beckert do?

Solution Summary

The first answer contains meaning of lease, capital lease, requirement of FASB No:13 and the theoritical basis for treating the long term leases as capital lease instead of discussing the criteria for classification of lease as capital lease and second answer contains ethical issues if the management contravenes FASB no;13.