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Chapter 21: 17Q (page 1239)

Describe the effect of a “bargain-purchase option” on accounting for a capital lease transaction by a lessee.

Short Answer

Expert verified

The lessee should increase the present value of the minimum lease payments.

Step by step solution

01

Meaning of bargain purchase option

A bargain-buy option affects lease accounting in the same way that guaranteed residual value does. In other words, if the lease has a guaranteed residual value, the lessee is obligated to pay the residual value at the end of the lease.

02

Explaining the effect of a “bargain-purchase option” on accounting for a capital lease transaction by a lessee

If the lessee has a bargain purchase option, the present value of the minimum lease payments must be increased by the present value of the option price. A bargain buy option also impacts the leased asset's depreciable life since the lessee must depreciate the asset throughout its economic life rather than the lease period.

If the lessee does not exercise the option, the lessee will incur a loss equal to the net book value of the leased asset during the period in which the option expired.

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Most popular questions from this chapter

Lessor Computations and Entries, Sales-Type Lease with Guaranteed Residual Value) Amirante Inc. manufactures an X-ray machine with an estimated life of 12 years and leases it to Chambers Medical Center for a period of 10 years. The normal selling price of the machine is \(411,324, and its guaranteed residual value at the end of the noncancelable lease term is estimated to be \)15,000. The hospital will pay rents of \(60,000 at the beginning of each year and all maintenance, insurance, and taxes. Amirante Inc. incurred costs of \)250,000 in manufacturing the machine and $14,000 in negotiating and closing the lease. Amirante Inc. has determined that the collectibility of the lease payments is reasonably predictable, that there will be no additional costs incurred, and that the implicit interest rate is 10%.

Instructions

(c) Prepare all of the lessor’s journal entries for the first year.

(Lessee 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.

Instructions

(b) How should Evans account for this lease at its inception and determine the amount to be recorded?

Use the information for Indiana Jones Corporation from BE21-9. Assume that for Lost Ark Company, the lessor, collectibility is reasonably predictable, there are no important uncertainties concerning costs, and the carrying amount of the equipment is \(202,921. Prepare Lost Ark’s January 1, 2017, journal entries.

Indiana Jones Corporation enters into a 6-year lease of equipment on January 1, 2017, which requires 6 annual payments of \)40,000 each, beginning January 1, 2017. In addition, Indiana Jones guarantees the lessor a residual value of $20,000 at lease-end. The equipment has a useful life of 6 years. Prepare Indiana Jones’ January 1, 2017, journal entries assuming an interest rate of 10%.

Metheny Corporation’s lease arrangements qualify as sales-type leases at the time of entering into the transactions. How should the corporation recognize revenues and costs in these situations?

The residual value is the estimated fair value of the leased property at the end of the lease term.

(a) Of what significance is (1) an unguaranteed and (2) a guaranteed residual value in the lessee’s accounting for a capitalized-lease transaction?
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