Response to the following problem:
Wright Company leases an asset for five years on December 31, 2000. Annual lease cost of $10,000 is payable on each December 31 beginning with the year 2001. In addition to the annual lease cost, the lease contract calls for a guaranteed residual value of $3,000.
The asset has an economic life of seven years. Wright's incremental borrowing rate is 8 percent. The asset has an acquisition cost of $45,000. There are no purchase options.
Required :
a. As things now stand, is this a capital lease or an operating lease? Show figures.
b. What can Wright do to convert this lease to an operating lease? Explain and show figures.
c. Will lessee and lessor's accounting for this lease be symmetrical (capital lease for both lessor and lessee or operating lease for both lessor and lessee)? Explain.
d. Do you think that Wright's action in (b) represents a loophole to avoid capitalization or is it a useful part of the present leasing rules? Explain.