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Laveaux Industries leased equipment to Hart Corporation for a four-year period, at which time...

Question:

Laveaux Industries leased equipment to Hart Corporation for a four-year period, at which time possession of the leased asset will revert back to Laveaux.

The equipment cost Laveaux $4 million and has an expected useful life of six years.

Its normal sales price is $5.6 million.

The present value of the minimum lease payments for both the lessor and lessee is $5.2 million.

The first payment was made at the inception of the lease.

Collectibility of the remaining lease payments is reasonably assured, and Laveaux has no material cost uncertainties.

How should this lease be classified

(a) by Laveaux Industries (the lessor) and

(b) by Hart Corporation (the lessee)? Why?

Lease:

Lease is a type of finance arrangement under which purchase do not need to pay the full purchase cost at the time of purchase. Lease agreement is classified as an operating lease or a capital lease from the view point of lessee.Lease agreement is classified as an operating lease, direct-financing lease or a sales-type lease from the view point of lessor.

Answer and Explanation:

(a) Laveaux Industries (the lessor) would classify this lease as a sales-type lease.

Explanation: The leased asset has been leased above the cost of the leased asset and the present value of minimum lease rental is more than 90% of the cost of the asset.

(b) Hart Corporation (the lessee) would classify this lease as a capital lease.

Explanation: Lease is classifies as a capital lease if following conditions are satisfies: -

(1) If the lease agreement contain a bargain-purchase option at the end of the lease life.

(2) The present value of minimum lease rental is more than the 95% of the asset value.

(3) The asset has been leased for more than 75% life of the leased asset.

(4) The leased asset is transferred to lessee at the end of the lease period.

A capital lease is classified as a sales-type lease if the present value of minimum lease rental is more than the cost of the leased asset and the collectibility of the remaining lease payments is reasonably assured.


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