Based on what you see in the sentences with the different colors in it, do you think that, based on the details that make up the financial information, do you think this lease is a capital lease or an operating lease?

The present value of the minimum lease payment is $101,513.84.

U.S. GAAP recognizes two types of leases: operating and capital. The basic concept of GAAP is that a lease that transfers substantially all the risks and benefits of own- ership from the lessor to the lessee is, in economic substance, a purchase by the les- see and a sale by the lessor. This type of lease is a capital lease. For the lessce, a capital lease is in substance an asset acquisition and the incurrence of a related liability to make future payments. From the lessor's perspective, it is viewed as either the sale of an asset and the creation of a financial instrument (a receivable under a sales-type lease) or as only the creation of a financial instrument (a receivable under a direct financing lease). A lease that does not transfer substantially all the risks and benefits of ownership is classified as an operating lease. An operating lease is viewed by both the lessee and the lessor as a rental agreement, conveying the rights to use an asset for a finite period, but not convey- ing the majority of the benefits or risks of the asset. GAAP specifies that a lessee should consider a lease as a transfer of the majority of the risks and benefits of ownership and account for the lease as a capital lease if it meets any one of the following four capitalization criteria in Exhibit 20.i. The fourth criterion in Exhibit 20.1 refers to the present value of the minimum lease payments. For the lessee, minimum lease payments are the expected payments over the term of the lease, including: minimum periodic payments required by the lease payment required by a bargain purchase option (if one exists) any guaranteed residual value any payments resulting from failure to renew or extend the lease EXHIBIT 20.1 term. Lease Capitalization Criteria 1. The lease transfers ownership of the property to the lessee by the end of the lease 2. The lease contains a bargain purchase option. 3. The lease term is equal to 75% or more of the estimated economic life of the leased property. 4. The present value of the minimum lease payments is equal to 90% or more of the fair value of the leased property to the lessor.' If a lease does not meet any of the four capitalization criteria the lease is classified as an operating lease, and the lessce does not recognize an asset or a liability. Under an operat- ing lease, the lessee simply recognizes rent expense cach period and discloses the terms of the lease in a footnote. To qualify as a capital lease for the lessor, GAAP adds a second step to the decision framework. A lessor classifics a lease as a capital lease if it meets any one of the four capitalization criteria that are listed in Exhibit 20.1 and meets both of the recognition criteria in Exhibit 20.2. EXAMPLE 20.10 Application of Lessee Classification Criteria by Cardinal No No Criteria Met? Remarks Capitalization Criteria 1. Transfer of ownership at end of No lease 2. Bargain purchase option 3. Lease term is 75% or more of It is 50% (5 years + 10 years) economic life 4. Present value of minimum lease The present value is payments is 90% or more of fair $201,867.45, or 67% of value the $300,000 fair value Decision: A capital lease must meet one or more of the capitalization criteria; otherwise, the lease is an operating lease. Conclusion: The lease is an operating lease. It does not meet any of the criteria. No 6. Second, we need to correctly adjust the lease asset and liability for the ovens which were leased for $20.000-and-we need to report the PRESENT VALUE of the Lease obligation which we calculate using the-PV of an Annuity at-5% (given) for 6 periods. The factor from the table is 5.0757. So take-$20,000-x-5.0757 =-AMOUNT of the PV of the Lease. Once calculated, we debit-Baking equipment (Add-a-line-below the current account in the-Trial balance so that we can see this amount fully!) and Credit Lease Liability for the same amount. D E F 1 2 Capital Leases 3 4 Time (n) 5 Interest (0) 6 Present value (PV) 7 Payment (PMT) 8 Future value (FV) 9 6 5% (5101,513.84) $20.000 S0.00 Rounded to the nearest hundredths, so it is $101.514.00. $101.514.00 or 10 11 *5%, the implicit interest rate (or interest rate implicit) 0.05 1 +0.05 1.05 12 13 14 15 Periods (e.g., Year) 16 17 18 2 3 4 Annual Lease Payments $20,000.00 $20,000.00 $20.000.00 $20.000.00 $20,000.00 $20,000.00 Formula 1.054-1 1.054-2 1.054-3 1.054-4 1.054-5 1.05^-6 Present value interest factor Present (Fair) value of Lease Payment(s) 0.952380952 $19,047.62 0.9070 $18.140.59 0.8638 $17.276.75 0.8227 $16,454.05 0.7835 $15.670.52 0.7462 $14.924.31 19 20 5 21 6 26 Adjusting Journal Entries for Leases 27 Account Title & Explanation Credit 28 Date 29 Dec 31, 2017 30 31 Debit $101,514 Baking equipment (A+) Lease liability (L+) $101,514 Recorded leased asset and liability U.S. GAAP recognizes two types of leases: operating and capital. The basic concept of GAAP is that a lease that transfers substantially all the risks and benefits of own- ership from the lessor to the lessee is, in economic substance, a purchase by the les- see and a sale by the lessor. This type of lease is a capital lease. For the lessce, a capital lease is in substance an asset acquisition and the incurrence of a related liability to make future payments. From the lessor's perspective, it is viewed as either the sale of an asset and the creation of a financial instrument (a receivable under a sales-type lease) or as only the creation of a financial instrument (a receivable under a direct financing lease). A lease that does not transfer substantially all the risks and benefits of ownership is classified as an operating lease. An operating lease is viewed by both the lessee and the lessor as a rental agreement, conveying the rights to use an asset for a finite period, but not convey- ing the majority of the benefits or risks of the asset. GAAP specifies that a lessee should consider a lease as a transfer of the majority of the risks and benefits of ownership and account for the lease as a capital lease if it meets any one of the following four capitalization criteria in Exhibit 20.i. The fourth criterion in Exhibit 20.1 refers to the present value of the minimum lease payments. For the lessee, minimum lease payments are the expected payments over the term of the lease, including: minimum periodic payments required by the lease payment required by a bargain purchase option (if one exists) any guaranteed residual value any payments resulting from failure to renew or extend the lease EXHIBIT 20.1 term. Lease Capitalization Criteria 1. The lease transfers ownership of the property to the lessee by the end of the lease 2. The lease contains a bargain purchase option. 3. The lease term is equal to 75% or more of the estimated economic life of the leased property. 4. The present value of the minimum lease payments is equal to 90% or more of the fair value of the leased property to the lessor.' If a lease does not meet any of the four capitalization criteria the lease is classified as an operating lease, and the lessce does not recognize an asset or a liability. Under an operat- ing lease, the lessee simply recognizes rent expense cach period and discloses the terms of the lease in a footnote. To qualify as a capital lease for the lessor, GAAP adds a second step to the decision framework. A lessor classifics a lease as a capital lease if it meets any one of the four capitalization criteria that are listed in Exhibit 20.1 and meets both of the recognition criteria in Exhibit 20.2. EXAMPLE 20.10 Application of Lessee Classification Criteria by Cardinal No No Criteria Met? Remarks Capitalization Criteria 1. Transfer of ownership at end of No lease 2. Bargain purchase option 3. Lease term is 75% or more of It is 50% (5 years + 10 years) economic life 4. Present value of minimum lease The present value is payments is 90% or more of fair $201,867.45, or 67% of value the $300,000 fair value Decision: A capital lease must meet one or more of the capitalization criteria; otherwise, the lease is an operating lease. Conclusion: The lease is an operating lease. It does not meet any of the criteria. No 6. Second, we need to correctly adjust the lease asset and liability for the ovens which were leased for $20.000-and-we need to report the PRESENT VALUE of the Lease obligation which we calculate using the-PV of an Annuity at-5% (given) for 6 periods. The factor from the table is 5.0757. So take-$20,000-x-5.0757 =-AMOUNT of the PV of the Lease. Once calculated, we debit-Baking equipment (Add-a-line-below the current account in the-Trial balance so that we can see this amount fully!) and Credit Lease Liability for the same amount. D E F 1 2 Capital Leases 3 4 Time (n) 5 Interest (0) 6 Present value (PV) 7 Payment (PMT) 8 Future value (FV) 9 6 5% (5101,513.84) $20.000 S0.00 Rounded to the nearest hundredths, so it is $101.514.00. $101.514.00 or 10 11 *5%, the implicit interest rate (or interest rate implicit) 0.05 1 +0.05 1.05 12 13 14 15 Periods (e.g., Year) 16 17 18 2 3 4 Annual Lease Payments $20,000.00 $20,000.00 $20.000.00 $20.000.00 $20,000.00 $20,000.00 Formula 1.054-1 1.054-2 1.054-3 1.054-4 1.054-5 1.05^-6 Present value interest factor Present (Fair) value of Lease Payment(s) 0.952380952 $19,047.62 0.9070 $18.140.59 0.8638 $17.276.75 0.8227 $16,454.05 0.7835 $15.670.52 0.7462 $14.924.31 19 20 5 21 6 26 Adjusting Journal Entries for Leases 27 Account Title & Explanation Credit 28 Date 29 Dec 31, 2017 30 31 Debit $101,514 Baking equipment (A+) Lease liability (L+) $101,514 Recorded leased asset and liability