Case Study: Treatment of Leases-Current VS. New Lease Requirements and the Impact on Financial Ratios
CASE DESCRIPTION
After decades of continuous controversy since the package of FASB 13, there has been a major change in Lease Accounting effective for the period ending after December 15, 2018.The changes are dramatic and effectively capitalizes all non-cancellable lease terms greater than one year. The liability created by the lease will now become a balance sheet debt item, This case study focuses on the differences in the treatment of leases between the current lease pronouncements and the upcoming new lease rules under US GAAP, and the impact of these differences on financial statements and selected financial ratios. Students will take GAAP financial statements under the present lease requirements and prepare a balance sheet, cash flow statement and income statement reflecting the new lease rules. This case study is suitable for use at both the undergraduate and graduate levels. It may be used in an Intermediate Accounting II, Accounting Theory, Financial Statement Analysis or an International Accounting class, as well as an Investment Finance course. The case can be offered as an individual case study or as a group project.
ADDITIONAL INFORMATION
1. ACE entered into a noncancelable lease on January 2, 2012 with the following terms:
A. ACE leased specialized machinery manufactured by the lessor, Bell Corp., which enables ACE to manufacture their electric cars in a much more efficient manner. This machinery does not have a resale market and was made specifically for ACE to meet its specifications.
B. The lease term is for 3 years with an annual lease payment of $10,000. Payment is due on December 31 of each year, with the first payment due on December 31, 2012. At the end of the lease term, ownership reverts to the lessor. There is no option for ACE to buy the equipment.
C. The lessee will pay all executor costs of $1,500/year which in included in 2102 selling and administration expenses.
D. The estimated useful life of the lease is 49 months (4 1/12 years.)
E. The fair market value of the equipment is $30,000 on January 1, 2012.
F. The implicit rate of Bell Corp. is 6 percent, and the lessee, ACE, knows this.
G. ACE's incremental borrowing rate is 7 percent.
2. ACE Corporation did not sell any plant assets; however plant assets with a cost of $36,000 and accumulated depreciation of $6,000 were destroyed in a hurricane. Insurance proceeds of $10,000 were collected by the company.
3. Two million shares of common stock were issued at the beginning of 2012.
4. Securities available for sale were purchased on December 31, 2012.
5. Cash dividends were paid during 2012.
6. ACE's bonds payable have several covenants that involve net income and cash from operating activities. The controller is especially concerned that IFRS treatment of leases does not violate those covenants. She is concerned that renegotiating the debt covenants will be costly to ACE.
QUESTIONS
3- Under the new proposed GAAP rules, should this lease be classified as an operating or a financing lease? Why?
4- Describe the different reporting results and make the necessary adjusting entries to conform the financial statements to the new lease rules compliance for 2012.
5- In answering the following parts, keep in mind companies usually prefer to report higher net income and higher cash from operating activities (although accounting research has identified exceptions to this).
A. Prepare an income statement under the new lease rules for 2012.
B. Prepare balance sheet under the new lease rules on December 31, 2012.
C. Prepare a cash flow statement under the new lease rules for 2012.
Attachment:- CASE STUDY.rar