Capitalized and Operating Leases
Response to the following problem:
On January 1, Borman Company, a lessee, entered into three noncancelable leases for brandnew equipment, Lease J, Lease K, and Lease L. None of the three leases transfers ownership of the equipment to Borman at the end of the lease term. For each of the three leases, the present value of the minimum lease payments at the beginning of the lease term, excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor, including any profit thereon, is 75% of the fair value of the equipment to the lessor at the inception of the lease.
The following information is peculiar to each lease:
(a) Lease J does not contain a bargain purchase option. The lease term is equal to 80% of the estimated economic life of the equipment.
(b) Lease K contains a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.
(c) Lease L does not contain a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.
Required
1. Explain how Borman Company should classify each of the preceding three leases. Discuss the rationale for your answer.
2. What amount, if any, should Borman record as a liability at the inception of the lease for each of the preceding three leases?
3. Assuming that the minimum lease payments are made on a straight-line basis, how should Borman record the minimum lease payment for each of the preceding three leases?