Lessee Ltd

In: Business and Management

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Words 1236
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Group 4
Case 11-6
Lessee Ltd.

Lessee Ltd. (a British company that applies IFRSs) and Lessor Inc. had a lease agreement starting on January 1, 2007 which Lessee Ltd. rents equipment from Lessor Inc. for three years. The remaining useful life of the equipment is four years. The fair value of the equipment is $265,000. At the end of the lease term, Lessee Ltd. has guaranteed $20,000 as the residual value. The agreement contains no purchase or renewal options, which means at the end of the lease term, Lessee Ltd. needs to return this equipment to Lessor Inc. in original condition. According to the agreement, Lessee Ltd. needs to make lease payments of $100,000 to Lessor Inc. each year. Also, Lessee Ltd. is responsible for other expenses like insurance, tax and maintenance that cost $2,000 per year. The lessee’s incremental borrowing rate is 11% and Lessor’s implicit rate is 10%.

Two accountants of Lessee Ltd. analyzed the assets of the lease. For the present value of lease obligation, if using the implicit rate in the lease (10%), the residual value would be $15,026 and the present value of annual payment would be $248,690. If using the incremental borrowing rate (11%), the residual value would be $14,624 and present value of annual payment would be $244,370. But on the computations of lease payments, the junior and senior accountant used two different ways. The junior accountant defined it is an operating lease and simply added lease expense and insurance expense together. The senior accountant used three steps to calculate the expense. He classified the lease as finance one and used the incremental borrowing rate to determine the present value of lease payments, then allocated of the interest and the reduction in the lease liability. The issue of this case is to determine which accountant’s analysis is correct and how the answer would differ under U.S. GAAP.…...

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Lessee Ltd.

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Lessee Ltd.

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Case 11-6 Lessee, Ltd

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