Sylvan Inc. entered into a non-cancelable lease arrangement withBreton Leasing Corporation for a certain machine. Breton's primarybusiness is leasing;it is not a manufacturer or dealer. Sylvan willlease the machine for a period of 3 years, which is 50% of themachine's economic life. Breton will take possession of the machineat the end of the initial 3-year lease and lease it to another,smaller company that does not need the most current version of themachine. Sylvan does not guarantee any residual value for themachine and will not purchase the machine at the end of the leaseterm.
Sylvan's incremental borrowing rate is 10%, and the implicitrate in the lease is 9%. Sylvan has no way of knowing the implicitrate used by Breton. Using either rate, the present value of theminimum lease payments is between 90% and 100% of the fair value ofthe machine at the date of the lease agreement.
Sylvan has agreed to pay all executory costs directly, and noallowance for these costs is included in the lease payments.
Breton is reasonably certain that Sylvan will pay all leasepayments. Because Sylvan has agreed to pay all executory costs,there are no important uncertainties regarding costs to be incurredby Breton. Assume that no indirect costs are involved.
Instructions
(a) With respect to Sylvan (thelessee), answer the following.
How should Sylvan compute the appropriate amount to be recordedfor the lease or asset acquired?
What accounts will be created or affected by this transaction,and how will the lease or asset and other costs related to thetransaction be recorded in earnings?
What disclosures must Sylvan make regarding this leasedasset?
(b) With respect to Breton (thelessor), answer the following.
How should this lease be recorded by Breton, and how are theappropriate amounts determined?
How should Breton determine the appropriate amount of revenue tobe recognized from each lease payment?
What disclosures must Breton make regarding this lease?
