Theory and Analysis - Coursework Example

CASE 13-4 Under a capital lease, each payment is distributed as interest expense and reduction of principal liability. Like any loan payment schedule, each successive payment allocates a greater amount to the reduction of the principal and a lesser amount to interest expense. Through this process loan is reflected on the balance sheet at the present value of the future cash flows discounted at the effective interest rate (Schroeder, Clark, & Cathey, 2005). a) Lani should account for this lease by comparing the present value of interest payments which are $20,000 per year for five years.

The amount to be recorded would be either the present value or the fair market value of the asset. In this case the amount to be recorded is the present value which is calculated by discounting annuity due payments by discount rate of 8%. Amount totaled to be $86,243 in comparison to $96,000 i.e. the fair market value. b) The costs associated with the lease are taxes, insurance, maintenance and depreciation. These costs are obligatory to pay as it is considered incidental to ownership. These costs would be determined during the operations conducted by or on the property.

Depreciation can be charged through straight line method. c) Lani would record lease transaction on December 31st,2006 on the balance sheet as: {Principal-[Payment-(Principal*interest percentage)]} This will give you the amount to be balanced as “Lease” in the liability section as well as provide you with the proportion of interest payment from the Annual annuity paid. CASE 13-5: Lease in order should meet the following criteria for Doherty Company to classify it as a capital lease: Firstly, the lease should transfer ownership of the good to the lessee at the end of the lease term.

Also, it should be noncancelable plus renewal options and periods should be attached. Secondly, the purchase price should be lower than anticipated fair market price of the property at the date when options becomes exercisable and assurance is felt if the option is exercised. Thirdly, lease term should be 75% or more than remaining economic life. This could be changed only if the lease term is within the last 25% of remaining economic life of property. Lastly, at the inception of the lease, present value of minimum lease payment equals or exceeds 90% of market value of property after deducting any related investment tax credit. a) In order for lease to be classified as sales type or direct financing lease, following criteria should be met: For sales type, a capital lease would be recorded as sales type if there is producer’s or dealer’s profit or loss realized.

In other words, that asset is taken as inventory and the seller is earning a margin on the sale of it. It usually occurs if leasing is used to market your products. For direct leasing, if the manufacturer or dealer doesn’t record any profit or loss, then a capital lease can be called as direct financing lease. The lesser is viewed as a lending institute and each payment is allocated between interest revenue and investment recovery. b) A sales type lease is recorded when manufacturer or dealer records profit or loss.

On the other hand, direct financing records it when there is no profit or loss recorded by manufacturer. In a sale type lease asset is taken as an inventory and earning is recorded by sale of it. In contrast, the lesser lends the property to lessee and realizes payment as between interest revenue or investment recovery. In direct financing gross investment is found out in the same way as in sales-type leases, but unearned income is calculated by taking the difference between gross investment and the cost of the leased property.

Work Cited Schroeder, R.G., Clark, M.W., & Cathey, J.M. (2005). Financial Accounting Theory and Analysis (8th ed.). : John Wiley & Sons, Inc..