1. What were the lease reporting requirements for leases based upon U.S. GAAP?

2. For the following five leases of Memorial Hospital, determine the appropriate classification of each lease (finance or operating) and its proper treatment on the financial statements. Prepare an amortization schedule for each lease. In addition, prepare the journal entries to record the lease on the financial statements as of January 1, 2018 (assuming a calendar fiscal year) and the subsequent year-end entries for 2018, 2019, and 2020 that reflect proper treatment using the new requirements for accounting for leases. (LO 1)

Lease 1The lease was entered into on November 1, 2012 with Beaugard Properties for a medical office tower attached to the hospital. The lease was for 10 years with an option to renew for an additional 10 years. The lease called for monthly payments in the amount of $17,397.76, with a 3% annual increase. The estimated value of the medical office tower was $7,500,000. The incremental borrowing rate at the time the lease was finalized was 6.3%.

Lease 2The lease was entered into on January 1, 2013 with Smith Family Trust for land that the hospital occupied. The lease was for 20 years with two options to renew for 20 years each. The lease called for monthly payments in the amount of $20,472.07, with a 5% increase every 10 years. The estimated value of the property was $6,200,000. The incremental borrowing rate at the time the lease was finalized was 6.7%.

Lease 3The lease was entered into on March 1, 2013 with Managed Medical Supply for infusion pumps. The lease was for seven years with a monthly payment of $13,785.64 and the exclusive purchase of consumables. The estimated value of the pumps was $750,000. The expected useful life of the equipment was 10 years. There was not an option to renew the lease. The incremental borrowing rate at the time the lease was finalized was 7.6%.

Lease 4The lease was entered into on October 1, 2012 with Copper View Medical Supply for compression sleeves. The lease was for two years with a monthly payment of $6,886.80 and the exclusive purchase of consumables. The estimated value of the compression sleeves was $500,000. The expected life of the equipment was 10 years. There were five options to renew the lease in increments of two years. The incremental borrowing rate at the time the lease was finalized was 6.3%.

Lease 5The lease was entered into on January 1, 2014 with U.S. Medical for 20 irrigation solution warmers. The lease did not indicate a term or any extensions, but required the purchase of consumables. The estimated cost for each warmer was $7,500. The expected life of the equipment was seven years. The incremental borrowing rate at the time the lease was finalized was 6.1%.

3. Using the leases provided in the case, which financial ratios would be impacted by the new accounting principle? Explain the potential impact that the change in accounting for leases may have on the debt covenant provisions of debt obligations of Memorial Hospital, and on the hospitals ability to secure debt and equity financing.

4. What are some actions that Memorial Hospital can take to reduce the impact of the changes on future operations and financial performance?