On January 1, Santiago Company, a lessee, entered into three non-cancelable leases for new equipment, Lease L, Lease M, and Lease N. None of the three leases transfers ownership of the equipment to Santiago at the end of the lease term. For each of the three leases, the present value at the beginning of the lease term of the lease payments is 75% of the fair value of the equipment. The following information is specific to each lease. 1. Lease L does not contain a bargain purchase option. The lease term is equal to 80% of the estimated economic life of the equipment. 2. Lease M contains a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment. 3. Lease N does not contain a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment. Instructions a. How should Santiago classify each of the three leases above, and why? Discuss the rationale for your answer. b. What amount, if any, should Santiago record as a liability at commencement of the lease for each of the three leases above? c. Assuming that the lease payments are made on a straight-line basis, how should Santiago record each lease payment for each of the three leases above?

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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Question

On January 1, Santiago Company, a lessee, entered into three non-cancelable leases for new equipment, Lease L, Lease M, and Lease N. None of the three leases transfers ownership of the equipment to Santiago at the end of the lease term. For each of the three leases, the present value at the beginning of the lease term of the lease payments is 75% of the fair value of the equipment. The following information is specific to each lease.

1. Lease L does not contain a bargain purchase option. The lease term is equal to 80% of the estimated economic life of the equipment.
2. Lease M contains a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.
3. Lease N does not contain a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.

Instructions

a. How should Santiago classify each of the three leases above, and why? Discuss the rationale for your answer.

b. What amount, if any, should Santiago record as a liability at commencement of the lease for each of the three leases above?

c. Assuming that the lease payments are made on a straight-line basis, how should Santiago record each lease payment for each of the three leases above?

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