Explaining and Interpreting Leases

On January 1, Borman Company, a lessee, entered into three noncancellable leases for new equipment identified as: Lease J, Lease K, and Lease L. None of the three leases transfers ownership of the equipment to Borman at the end of the lease term. For each of the three leases, the present value at the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor, including any profit thereon, is 75% of the excess of the fair value of the equipment to the lessor at the inception of the lease over any related investment tax credit retained by the lessor and expected to be realized by the lessor. The following additional information is distinct for each lease:

Lease J does not contain a bargain purchase option; the lease term is equal to 80% of the estimated economic life of the equipment.

Lease K contains a bargain purchase option; the lease term is equal to 50% of the estimated economic life of the equipment.

Lease L does not contain a bargain purchase option; the lease term is equal to 50% of the estimated economic life of the equipment.

CHECK (a) Leases J and K are capital leases

Required:

a. Explain how Borman Company should classify each of these three leases. Discuss the rationale for your answer.

b. Identify the amount, if any, Borman records as a liability at inception of the lease for each of the three leases.

c. Assuming that Borman makes the minimum lease payments on a straight-line basis, describe how Borman should record each minimum lease payment for each of these three leases.

d. Assess accounting practice in accurately portraying the economic reality for each lease.