EXERCISE 3-2

Evaluating Accounting for Leases by the LesseeOn 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.