EXERCISE 3–1 On January 1, Year 8, Von Company entered into two noncancellable leases of new machines for use in its manufacturing operations. The first lease does not contain a bargain purchase option and the lease term is equal to 80% of the estimated economic life of the machine. The second lease contains a bargain purchase option and the lease term is equal to 50% of the estimated economic life of the machine.

Required:

a. Explain the justification for requiring lessees to capitalize certain long-term leases. Do not limit your discussion to the specific criteria for classifying a lease as a capital lease.

b. Describe how a lessee accounts for a capital lease at inception.

c. Explain how a lessee records each minimum lease payment for a capital lease.

d. Explain how Von should classify each of the two leases. Provide justification.