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.

(2) How should this lease be recorded by Breton, and how are the appropriate amounts determined?

Short answer

Answer

Breton should record a Lease Receivable for the present value of the minimum lease payments and the present value of the residual value.

Step-by-step solution

Meaning of Lease Receivable

The present value of the minimum lease paymentsplus thepresent value of the unguaranteed residual value of a direct-financing lease can be described as the lease receivable. In direct-financing leases, the lessor must replace the leased asset with a lease receivable.

Explaining the recording of the lease by Breton  

Breton should record rent as an instant financing lease, and in order to be designated as such, all of the related requirements must be met.

1. The rent must adhere to all of the established models for residents.
2. A sensible selection of the smallest rent instalments.
3. Lessor's exhibition must be nearly complete.
4. The fair value of the rented resource must be equal to the lessor's book value.