Case Scenario:
On January 2, 2006, Grant Corporation leases an asset to Pippin Corporation under the following conditions:
1. Annual lease payments of $10,000 for twenty 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 thirty 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.
Required:
Question 1: What type of lease is this for Pippin? Why?
Question 2: Assume Grant capitalizes the lease. What financial statement accounts are affected by this lease, and what is the amount of each effect?
Question 3: Assume Grant uses straight-line depreciation. What are the income statement, balance sheet, and statement of cash flow effects for 2006?
Question 4: How should Grant record this lease? Why? Would any additional information be helpful in making this decision?
Question 5: 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, 2006?