On December 31, 2006 Port Co. sold six-month-old equipment at fair value and leased it back. There was a loss on the sale. Port pays all insurance, maintenance, and taxes on the equipment. The lease provides for eight equal annual payments, beginning December 31, 2007, with a present value equal to 85% of the equipment’s fair value and sales price. The lease’s term is equal to 80% of the equipment’s useful life. There is no provision for Port to reacquire ownership of the equipment at the end of the lease term.
Required
1. a. Explain why it is important to compare an equipment’s fair value to its lease payments’ present value, and its useful life to the lease term.
b. Evaluate Port’s leaseback of the equipment in terms of each of the four criteria for determination of a capital lease.
2. Explain how Port should account for the sale portion of the sale-leaseback transaction at December 31, 2006.
3. Explain how Port should report the leaseback portion of the sale-leaseback transaction on its December 31, 2007 balance sheet.