Problem:
On January 1, Borman Company, a lessee, entered into three non cancelable leases for brand-new 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 at the beginning of the lease term of the minimum lease payments, 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 percent of the excess of the fair value of the equipment to the lessor at the inception of the lease over any related investment tax credit retained by the lessor and expected to be realized by the lessor.
The following information is peculiar to each lease:
Lease J does not contain a bargain purchase option; the lease term is equal to 80 percent of the estimated economic life of the equipment.
Lease K contains a bargain purchase option; the lease term is equal to 50 percent of the estimated economic life of the equipment.
Lease L does not contain a bargain purchase option; the lease term is equal to 50 percent of the estimated economic life of the equipment.
Required:
1. How should Borman Company classify each of the three leases and why? 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 three leases?
3. Assuming that the minimum lease payments are made on a straight-line basis, how should Borman record each minimum lease payment for each of the three leases?