Lease Accounting and Reporting

On January 1, 2017, Evans Company entered into a noncancelable lease for a machine to be used in its manufacturing operations. The lease transfers ownership of the machine to Evans by the end of the lease term. The term of the lease is 8 years. The minimum lease payment made by Evans on January 1, 2017, was one of eight equal annual payments. At the inception of the lease, the criteria established for classification as a capital lease by the lessee were met.

Answer the following questions in the Discussion Board:

  1. What is the theoretical basis for the accounting standard that requires certain long-term leases to be capitalized by the lessee? Do not discuss the specific criteria for classifying a specific lease as a capital lease.
  2. How should Evans account for this lease at its inception and determine the amount to be recorded?
  3. What expenses related to this lease will Evans incur during the first year of the lease, and how will they be determined?
  4. How should Evans report the lease transaction on its December 31, 2017, balance sheet?

Just do response each posted # 1to 3 down below only?

Posted 1

Hello Everyone,

The theoretical basis for capitalizing a long-term lease under accounting standards is when such lease agreement transfers full ownership of the property to the lessee at the end of the lease term. Noting that this long-term lease agreement cannot be rescinded. In this case, Evans Company, the lessee, should record this lease as a long-term liability and record the value of the machine lease agreement minus any executory costs, as an asset. Upon inception of the lease agreement, Evan Company will incur interest expense, depreciation expense, and executory costs. After the 1st term of the lease agreement, Evans Company must adjust the book value of the machine to reflect accurate asset values on the balance sheet. (Kieso, pgs. 1200-1208)

Posted 2

Hello all,

The theoretical basis for accounting standard that requires long-term leases to be capitalized by the lessee is when the lease transfers everything such as benefits/risks to the ownership of the lessee, and they cannot cancel this lease. Evans should account for this lease at its inception. Inception is the “The start of a business, organization etc. The date on which an agreement or system becomes effective.” this can be done at the machines fair value at the time of the inception. During the first year Evans will incur interest expense and deprecation expense. The interest will be the interest capitalized at the time of its inception times the value of the liability in the beginning. The deprecation will be determined by the estimation of the useful life of this asset. This transactions should be reported on the balance sheet on December 31, 2017 as follows, non-current asset of accumulated depreciation, and on the liability side it should be recorded with current and non-current liabilities with capital lease.

Posted 3

a/ “In order to record a lease as a capital lease, the lease must be noncancelable” (Kieso, Weygant & Warfield, 2016, p. 1200). From this scenario, Evans Company was the lessee. When the lease got transferred to the lessee at the end of the lease term, the equipment would belong to the lessee. It would be treated as a capital asset and it would be eligible for depreciation. Keiso, Weygandt, & Warfield stated, “The FASB apparently agrees with the capitalization approach when the lease is similar to an installment purchase” (2016, p. 1200) which is similar to Evans Company’s case.

b/ The transaction would be recorded as a liability as well besides recording it as an asset like mentioned earlier and excludes the executory costs, like insurance, maintenance, and tax expenses. In other words, it would have been recorded the amount equal the annual lease subtract the executory costs in eight years. When doing this, it used the same amount of present value at the time making the first lease payment. If the lessee paid executory costs to the third parties, then the amount would be without the adjustment.

c/ During the first year of the lease, Evans would incur the expenses, including interest expense, executory costs (insurance, taxes, and maintenance, etc.), and the depreciation expense.

d/ Evans should report the equipment as a capital lease and as a non-current asset at its carrying value less the accumulated depreciation for the year on the balance sheet at December 31, 2017.