Question

(Lease Capitalization, Bargain-Purchase Option) Baden Corporation entered into a lease agreement for 10 photocopy machines for its corporate headquarters. The lease agreement qualifies as an operating lease in all terms except there is a bargain-purchase option. After the 5-year lease term, the corporation can purchase each copier for \(1,000, when the anticipated fair value is \)2,500.

Jerry Suffolk, the financial vice president, thinks the financial statements must recognize the lease agreement as a capital lease because of the bargain-purchase option. The controller, Diane Buchanan, disagrees: “Although I don’t know much about the copiers themselves, there is a way to avoid recording the lease liability.” She argues that the corporation might claim that copier technology advances rapidly and that by the end of the lease term the machines will most likely not be worth the $1,000 bargain price.

Instructions

Answer the following questions.

(a) What ethical issue is at stake?

Short answer

Answer

The ethical issues are fairness and integrity of financial reporting.

Step-by-step solution

Step-by-Step Solution

Step 1: Meaning of Accounting Ethics

Accounting ethics are principles and laws that must be observed while conducting accounting transactions. Since the function of each organization is unique, the accountant must conduct each transaction by following certain principles so that the user of accounting cannot be manipulated.

Explaining the ethical issue that is at stake

Fairness and honesty of financial reporting versus profitability and perhaps deceptive financial statements are the ethical challenges. On the one hand, if Buchanan can verify her claim, the deal may be classified as an operational lease. Buchanan, on the other hand, would look to be attempting to distort the financial records for some purpose, potentially debt covenants or minimum levels of specific ratios, if she cannot or will not offer evidence.