Question: Sable Inc. is a company based in San Francisco, CA, that manufactures and supplies earthmoving and construction equipment. Sable either sells the equipment to customers or leases it under terms specific to a customer's needs. Buildit Inc. is a growing construction company in Los Angeles, CA, that specializes in building residential properties. Buildit recently entered into a contract with Sable to lease a bulldozer, which Buildit will use for a new project involving the construction of several condominiums in the Los Angeles area. The pertinent terms of the lease are as follows:
- The lease term is for 10 years, while the economic life of the bulldozer is estimated to be 15 years. The useful life of the bulldozer is also estimated to be 15 years.
- Annual lease payments of $16,000 are due at the end of each year. Buildit is also responsible for all maintenance, insurance, and taxes arising from the lease of the bulldozer.
- The residual value of the bulldozer is estimated to be $24,000 at the end of the lease term. Sable does not have a residual value guarantee.
- The lease does not transfer ownership of the bulldozer to Buildit by the end of the lease term or provide an option for Buildit to purchase the equipment.
- The bulldozer costs Sable $100,000 to manufacture and this model is currently listed for sale at $135,000 should customers wish to purchase it outright. Sable believes that the lease payments from Buildit will be collected when they are due.
In addition, the equipment is fully constructed and no additional costs will be incurred to complete production of the bulldozer before lease commencement. As a result of a recent economic downturn that has directly impacted the construction industry, a number of companies in the industry have modified their sales or lease terms to maintain profitability. Some of Sable's direct competitors have negotiated lower lease payments or reduced their selling prices in an effort to stimulate sales. For example, several bulldozers with the same specifications as the one leased to Buildit have recently sold for an average sales price of $125,000, as opposed to Sable's current list price of $135,000. The rate implicit in the lease is 6.93 percent assuming the fair value of the bulldozer is $125,000 at the beginning of the lease term and 5.45 percent assuming the fair value is $135,000. Copyright 2014 Deloitte Development, LLC All Rights Reserved
Required: 1. Summarize the facts of the case (1 paragraph)
2. How should Buildit classify the lease in its accounting records? Research and cite the FASB Codification to support your answer. Hint: criteria for determining capital versus operating lease and Direct financing versus sales-type lease. (1-2 paragraphs)
3. What is the fair value of the bulldozer? Support your answer. (1 paragraph)
4. Under the new ASU effective in 2018 (Topic 842), how would Buildit's accounting treatment change for this lease?
Reference the Codification to support your answer. (1-2 paragraphs). This is an individual writing assignment, therefore you should be researching and writing your response on your own. Your submission should be well written using the attached rubric and above requirements as a guideline.