Madison’s Cakery
Madison’s Cakery (Madison’s) is a family-owned bakery located in Arlington, Virginia. It began as a neighborhood bakery specializing in small baked goods, such as cupcakes and cookies. With its growing reputation, Madison’s began creating and delivering special occasion cakes in 2015.
In order to complete its deliveries, Madison’s signed an agreement with Mendota Truck Company (Mendota) to lease a cargo van. The relevant information related to the lease agreement is as follows:
1) The lease term is for 2 years with no renewal options offered.
2) Monthly lease payments are $350 and are made at the beginning of each month.
3) Madison depreciates its long-lived assets on a straight-line basis, and it estimates that the truck’s economic life is 7 years.
4) Madison does not have an option to purchase the truck nor does ownership transfer to Madison at the end of the lease.
5) At inception of the lease, similar trucks had a normal sales price of $20,000.
6) Madison has an incremental borrowing rate of 14%, and Madison is aware that Mendota set monthly payments to ensure a 12% rate of return.
7) Based on current GAAP standards, Madison is accounting for the lease as an operating lease.
The CFO at Madison has become aware of new accounting guidance related to leases. He has asked his auditors to determine the effect the new principles would have on Madison’s financial statements.
Required:
You are the staff accountant on the 2015 audit team of Madison’s Cakery. You have been asked by the audit partner to write the research memo on the new accounting treatment for leases requested by the client. Your analysis should include (1) a summary of how accounting for the truck lease will be different under the new principles (including any relevant journal entries), (2) a summary of the effect of the new principles on the balance sheet and income statement as compared to the current principles, and (3) a discussion on when the new principles will become effective for Madison’s. When discussing any of the accounting treatments, you should reference the appropriate FASB guidance which dictates the treatment.