Question

Cleveland Inc. leased a new crane to Abriendo Construction under a 5-year noncancelable contract starting January 1, 2014. Terms of the lease require payments of $33,000 each January 1, starting January 1, 2014. Cleveland will pay insurance, taxes, and maintenance charges on the crane, which has an estimated life of 12 years, a fair value of $240,000, and a cost to Cleveland of $240,000. The estimated fair value of the crane is expected to be $45,000 at the end of the lease term. No bargain-purchase or renewal options are included in the contract. Both Cleveland and Abriendo adjust and close books annually at December 31. Collectibility of the lease payments is reasonably certain, and no uncertainties exist relative to unreimbursable lessor costs. Abriendo’s incremental borrowing rate is 10%, and Cleveland’s implicit interest rate of 9% is known to Abriendo.

1. Identify the type of lease involved and give reasons for your classification. Discuss the accounting treatment that should be applied by both the lessee and the lessor.

2. Discuss what should be presented in the balance sheet, the income statement, and the related notes of both the lessee and the lessor at December 31, 2014.

Answer 1

A.	This type of lease is operating lease for the reasons mentioned hereunder:
	i) The term of lease is for 5 years, i.e., less than the economic life of asset (15 years)
	ii) All the taxes, insurance and maintenance charges will be borne by Cleveland Inc. i.e., lessor
	iii) does not transfer ownership
	Lessee’s Entries			Debit	Credit
	i)	Rent Expense		33000
			Cash		33000
	Lessor’s Entries
	i)	Insurance Expense		xxx
		Tax Expense		xxx
		Maintenance Expense		xxx
			Cash or Accounts Payable		xxx
	ii)	Depreciation Expense		18750
			Accumulated Depreciation—Crane
			[($240,000 – $15,000) ÷ 12]		18750
	iii)	Cash		33000
			Rental Revenue		33000
i)	In the Books of Lesee: Abriendo shall claim rent expense of $33000 in the income statement and in the notes the future minimum rental payments required as of January 1 (in total, $132,000) and for each of the succeed­ing four years: 2012—$33,000; 2013—$33,000; 2014—$33,000; 2015— $33,000. Nothing relative to this lease would appear on the lessee’s balance sheet
ii)	In the Books of Lessor: Cleveland shall disclose in the balance sheet or in the notes the cost of the leased crane ($240,000) and the accumulated depreciation of $18,750 separately from assets not leased. Also Cleveland must disclose in the notes the minimum future rentals as a total of $132,000, and for each of the succeeding four years: 2012—$33,000; 2013—$33,000; 2014—$33,000; 2015—$33,000