On 2nd January, 2011, Grant Corporation leases an asset to Pippin Corporation under the subsequent conditions:
1. Annual lease payments of $10,000 for 20 years.
2. At end of the lease term the asset is expected to have a value of $2,750.
3. The fair market value of asset at the inception of lease is $92,625.
4. The estimated economic life of lease is 30 years.
5. Grant's implicit interest rate is 12 %; Pippin's incremental borrowing rate is 10 percent.
6. The asset is recorded in Grant's inventory at $75,000 just prior to the lease transaction.
Required:
a. Find what type of lease is this for Pippin? Why?
b. Suppose Grant capitalizes the lease. What financial statement accounts are affected by this lease, and find what the amount of each effect is?
c. Suppose Grant uses straight-line depreciation. Find what are the income statement, balance sheet, and statement of cash flow effects for 2011?
d. How should Grant record this lease and why? Would any additional information be helpful in making this decision?
e. Suppose that Grant treats the lease as a sales-type lease and the residual value is not guaranteed by Pippin. What financial statement accounts are affected on 2nd January, 2011?
f. Suppose instead that Grant records the lease as an operating lease and uses straight-line depreciation. Evaluate what are the income statement, balance sheet, and statement of cash flow effect on 31st December, 2011?