Leases Essay

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Case 11-6 Lessee Ltd. 1. Was the junior accountant’s analysis correct? Why or why not? Lessee’s junior accountant thinking that since the leased equipment would revert back to Lessor Inc. classified the lease as an operating lease; this classification is incorrect based on IAS 17.10 (c) (d). According to IAS 17.10 (c) (d) Accounting for leases situations that normally lead to leases being classified as a finance lease include the following: (c) “the lease term is for the major part of the economic life of the asset, even if the title is not transferred (d) at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.” Lessee Ltd. Is leasing the equipment for three years and the useful life of the equipment is four years which calculates the lease term to 75% of the economic life of the equipment, meeting IAS requirement 17.10 (c). Additionally, when calculating the present value of the minimum payments of $263,716 and comparing it to the fair value of the equipment of $265,000 the present value of the minimum lease payment would be 99 ½ % of the fair value of the equipment meeting IAS 17.10 (d). In addition, the junior accountant failed to include the guaranteed residual value in the minimum lease payment calculation. This guaranteed residual value should be included as part of the minimum payments present value because the guaranteed residual value is part of residual value being guaranteed by the Lessee Ltd. (IAS 17.4 (b) The $263,716 minimum payment which includes the guaranteed residual value affects the amounts that Lessee Ltd. will record as a leased asset and a leased liability. Finally, according to IAS 17.20 a lessee’s incremental borrowing rate is only used when the implicit rate is unknown. In the following case Lessor’s implicit rate of

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