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Chapter 13 - Solution Manual

C in a sales type lease the excess of the sales price

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c. In a sales-type lease, the excess of the sales price over the carrying amount of the leased equipment is considered manufacturer's or dealer's profit and would be included in income in the period when the lease transaction is recorded. In a direct-financing lease, there is no manufacturer's or dealer's profit. The income on the lease transaction is composed solely of interest. Case 13-7 a.i. Because the present value of the minimum lease payments is greater than 90 percent of the fair value of the asset at the inception of the lease, Milton should record this as a capital lease. ii. Since the given facts state that Milton (lessee) does not have access to information that would enable determination of James (lessor) implicit rate for this lease, Milton should determine the present value of the minimum lease payments using the incremental borrowing rate (10 percent) that Milton would have to pay for a like amount of debt obtained through normal third-party sources (bank or other direct financing). Because the present value is less than 100 percent of fair market value, it should be used as the recorded value of the asset. iii. The amount recorded as an asset on Milton's books should be shown in the fixed assets section of the statement of financial position as "Fixed Assets Acquired Through Lease" or another similar title. Of course, at the same time as the asset is recorded, a corresponding liability ("Obligations Under Capital Leases") is recognized in the same amount. This liability is classified as both current and noncurrent, with the current portion being that amount that will be paid on the principal amount during the next year. The machine acquired by the lease is matched with revenue through depreciation over the life of the lease, since ownership of the machine is not expressly conveyed to Milton in terms of the lease at its inception. The minimum lease payments represent a payment of principal and interest at each payment date. Interest expense is computed at the rate at which the minimum lease payments were discounted and represents a fixed interest rate applied to the declining balance of the debt. Executory costs (such as insurance, maintenance, or taxes) paid by Milton are charged to an appropriate expense, accrual, or deferral account as incurred or paid. iv. For this lease, Milton must disclose the future minimum lease payments in the aggregate and for each of the succeeding fiscal years, with a separate deduction for the total amount for imputed Unknown Deleted: Unknown Deleted: Unknown Deleted:
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283 interest necessary to reduce the net minimum lease payments to present value of the liability (as shown on the statement of financial Position). b.i. Based upon the given facts, James has entered into a direct financing lease. There is no dealer or manufacturer profit included in the transaction; the discounted present value of the minimum lease payments is in excess of 90 percent of the fair value of the asset at the inception of the
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