Question

Question: (Lessor and Lessee Accounting and Disclosure) Sylvan Inc. entered into a noncancelable lease arrangement with Breton Leasing Corporation for a certain machine. Breton’s primary business is leasing; it is not a manufacturer or dealer. Sylvan will lease the machine for a period of 3 years, which is 50% of the machine’s economic life. Breton will take possession of the machine at the end of the initial 3-year lease and lease it to another, smaller company that does not need the most current version of the machine. Sylvan does not guarantee any residual value for the machine and will not purchase the machine at the end of the lease term.

Sylvan’s incremental borrowing rate is 10%, and the implicit rate in the lease is 9%. Sylvan has no way of knowing the implicit rate used by Breton. Using either rate, the present value of the minimum lease payments is between 90% and 100% of the fair value of the machine at the date of the lease agreement.

Sylvan has agreed to pay all executory costs directly, and no allowance for these costs is included in the lease payments. Breton is reasonably certain that Sylvan will pay all lease payments. Because Sylvan has agreed to pay all executory costs, there are no important uncertainties regarding costs to be incurred by Breton. Assume that no indirect costs are involved.

Instructions

(b) With respect to Breton (the lessor), answer the following.

(1) What type of leasing arrangement has been entered into? Explain the reason for your answer.Step-by-Step Solution

Short answer

Answer

Breton has entered into a direct-financing lease.

Step-by-step solution

Meaning of lease arrangements

A leasing arrangement refers to a lease contract or other similar arrangement for a specified period in which the lessee is expected to make full or partial payments to the lessor in exchange for using the piece of a lease for a specific period.

Explaining the type of lease and the reason.

Breton has signed a direct-financing lease based on the information provided. There is no dealer or manufacturer profit in the transaction, the discounted present value of the minimum lease payments is greater than 90% of the asset's fair value at the start of the lease arrangement, minimum lease payment collectability is reasonably assured, and there are no significant uncertainties surrounding the lessor's un-reimbursable costs.