Question

Lukawitz Industries leased non-specialized equipment to Seminole Corporation for a four-year period, at which time possession of the leased asset will revert back to Lukawitz. The equipment cost Lukawitz $4 million and has an expected useful life of six years. Its normal sales price is $5.6 million. The present value of the lease payments for both the lessor and lessee is $5.2 million. The first payment was made at the beginning of the lease. How should this lease be classified

(a) by Lukawitz Industries (the lessor)? Why?

(b) by Seminole Corporation (the lessee)? Why?

Answer 1

(a) The lessor should not record any entry at the beginning because it is considered an operating lease.The lessor is only lending the asset for four of the six years of its useful life, which only equals 67%.Because the possession of the asset will revert to Lukawitz, it is more of a rental agreement and is not being financed. The lessor will still account for deferred revenue payments each period and eventually revenue ateach payment received. The lessor will account for depreciation expense and accumulated depreciation because they still own the asset.

(b) Seminol is the lessee and should classify a Right of Use Asset and Lease Payable for the amount of $5.2 million. Although the lease is not purchasing the asset, they still need to record a liability at the beginning of the lease because they have acquired a right to use it for four years.