Question

On January 1, 2014, Lani Company entered into a noncancelable lease for a machine to be used in its manufacturing operations. 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, 2014, 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.

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.

How should Lani account for this lease at its inception and determine the amount to be recorded?

What expenses related to this lease will Lani incur during the first year of the lease, and how will they be determined?

How should Lani report the lease transaction on its December 31, 2014, balance sheet?

Answer 1

1. Lani will record the present value of future cash flows (8 annual installments) as asset and a liability for the same amount.

2. Lani will record interest expense on the Loan installment paid. In addition, it will also record depreciation on the asset.

3. On Balance Sheet - The fixed asset will show up on the asset side and the Liability will be shown under current liability( payments due in next 12 month) and balance as long term liability.

Since this is a Capital lease, Lani will get the depreciation and maintenance.