Chapter 13 - Solution Manual

If the lease transfers substantially all of the risks

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economic effect on the parties is similar, in many respects, to that of an installment purchase. If the lease transfers substantially all of the risks and benefits of ownership from the lessor to the lessee, then when the lessor also meets the certainty criteria and recognizes a manufacturer or dealer’s profit, the lessor has a sales type lease. Similarly, the lessee would have received the risks and benefits of ownership and as a result, cannot have an operating lease. WWW Case 13-9 An asset is expected to provide future benefits in use. These benefits are controlled by the lessee. The benefits result from a prior transaction or event. A capital lease is in substance a purchase of an asset. The lessee controls the use of the asset during the lease term. The assets provide benefits in use during the lease term. The inception of the lease resulting from the lease contract is a transaction or event that results in the lessee acquiring the expected future benefits. Liabilities are probable future sacrifices of economic resources of an entity resulting from a prior transaction or event. The lease transaction obligates the lessee to make lease payments. The payments will occur over the lease term and will be future sacrifices of economic resources of the lessee. Hence, a lease obligation, particularly one that is noncancellable meets the definition of a liability. A capital lease is in substance a purchase of an asset. The lease agreement must meet at least one of the four capital lease criteria. If title passes to the lessee, the lessee will own the leased assets. In this case, there is no doubt that the capital lease is a purchase. If there is a bargain purchase, there is a high probability that the lessee will take advantage of the bargain. Hence, in these cases there is probable future benefit beyond the lease term indicating that the lease is like a purchase of all of the service potential of the asset. If the life criterion or fair value criterion is met, the lessee uses virtually all of the service potential asset making the lease tantamount to the purchase of the asset. In all three cases, the obligation makes the capital lease similar to a purchase . Case 13-10 Unknown Deleted: s
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291 a. The project was undertaken because many users think that operating leases give rise to assets and liabilities that should be recognized in the financial statements of lessees. Consequently, users routinely adjust current and future obligations in an attempt to recognize those assets and liabilities and reflect the effect of lease contracts in profit or loss. In 2005, the SEC estimated there are currently $1.25 trillion dollars of liabilities omitted from balance sheets because of operating lease classifications. b. As a result: 1. The existence of two very different accounting models for leases - the capital lease model (termed the finance lease model by the IASB) and the operating lease model means that similar transactions can be accounted for very differently. This reduces comparability for users.
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