On January 2, 2011, Grant Corporation leases an asset to Pippin Corporation under the following conditions:
1. Annual lease payments of $10,000 for 20 years.
2. At the end of the lease term the asset is expected to have a value of $2,750.
3. The fair market value of the asset at the inception of the lease is $92,625.
4. The estimated economic life of the lease is 30 years.
5. Grant's implicit interest rate is 12 percent; Pippin's incremental borrowing rate is 10 percent.
6. The asset is recorded in Grant's inventory at $75,000 just prior to the lease transaction.
a. What type of lease is this for Pippin? Why?
b. Assume Grant capitalizes the lease. What financial statement accounts are affected by this lease, and what is the amount of each effect?
c. Assume Grant uses straight-line depreciation. What are the income statement, balance sheet, and statement of cash flow effects for 2011?
d. How should Grant record this lease? Why? Would any additional information be helpful in making this decision?
e. Assume that Grant treats the lease as a sales-type lease and the residual value is not guaranteed by Pippin. What financial statement accounts are affected on January 2, 2011?
f. Assume instead that Grant records the lease as an operating lease and uses straight-line depreciation. What are the income statement, balance sheet, and statement of cash flow effect on December 31, 2011?
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