91Ó°ÊÓ

Question: (Lessor and Lessee Accounting and Disclosure) Sylvan Inc. entered into a noncancelable lease arrangement with Breton Leasing Corporation for a certain machine. Breton’s primary business is leasing; it is not a manufacturer or dealer. Sylvan will lease the machine for a period of 3 years, which is 50% of the machine’s economic life. Breton will take possession of the machine at the end of the initial 3-year lease and lease it to another, smaller company that does not need the most current version of the machine. Sylvan does not guarantee any residual value for the machine and will not purchase the machine at the end of the lease term.

Sylvan’s incremental borrowing rate is 10%, and the implicit rate in the lease is 9%. Sylvan has no way of knowing the implicit rate used by Breton. Using either rate, the present value of the minimum lease payments is between 90% and 100% of the fair value of the machine at the date of the lease agreement.

Sylvan has agreed to pay all executory costs directly, and no allowance for these costs is included in the lease payments. Breton is reasonably certain that Sylvan will pay all lease payments. Because Sylvan has agreed to pay all executory costs, there are no important uncertainties regarding costs to be incurred by Breton. Assume that no indirect costs are involved.

Instructions

1. With respect to Sylvan (the lessee), answer the following.

(3) What accounts will be created or affected by this transaction, and how will the lease or asset and other costs related to the transaction be matched with earnings?

Step by step solution

01

Meaning of Lease Accounting

Considering the variation in lease accounting depending on the end-user is an essential accounting part. Lessors and lessees have different methods of reporting and accounting for leases. A lessee makes use of the leased asset by making payments to the lessoron a regular basis.

02

Explaining the account that is affected by the transaction

The amount recorded as an asset on Sylvan's books should be labeled "Leased Equipment" or something similar in the fixed assets section of the balance sheet. Of course, a matching liability ("Lease Liability" or similar titles) is recognized in the same amount at the same time as the asset.

The current component of this responsibility is the amount that will be paid on the principal amount during the next year, while the noncurrent portion is the amount that will be paid on the principal amount during the following year. Through depreciation taken on the equipment during the lease's life, the cost of the lease is matched with income. The period of the lease is the proper depreciable life because ownership of the machine is not expressly granted to Sylvan in terms of the lease at its beginning.

At each payment date, the minimum lease payments constitute a payment of principal and interest. Interest expenditure is calculated using the discounted minimum lease payments and reflects a set interest rate applied to the debt's dropping amount. Sylvan charges execution expenses (such as insurance, maintenance, and taxes) to the appropriate expenditure, accrual, or deferral account when they are incurred or paid.

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