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Topic: Capital lease - depreciation - lessee (

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divyagovil1
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Joined: 30 Jan 2009
Location: India
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Posts: 1456

Posted: 07 Apr 2009 at 13:59 \| IP Logged

Douglas Co. leased machinery with an economic useful life of six years. For tax purposes, the depreciable life is seven years. The lease is for five years, and Douglas can purchase the machinery at fair value at the end of the lease. What is the depreciable life of the leased machinery for financial reporting?

Answer :- 5 years

Addl. explanation :- Assets acquired under capital lease are depreciated using the same theory as purchased assets. The purchase option is for " fair value." It is not a "bargain purchase option" therefore the assumption cannot be made that Douglas Co. will acquire the machine at the end of the lease period. At the inception of the lease, the best estimate of economic life to Douglas is the five-year lease term.

Can someone pls explain the following statement ":-

"The purchase option is for " fair value." How can we say that it's not the first option "Ownership transfers at the end of lease(upon final payment or required buyout)?

Thanks!

__________________
Divya - CO State

Passed using Becker Review :
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REG - 08/29/09 - 95
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Ethics - 2011

cinnamon
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Joined: 12 Aug 2008
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Posts: 312

Posted: 07 Apr 2009 at 14:37 \| IP Logged

This lease is a capital lease unde the ownS test (75% or more of economic life is leased).

Thus the lease life of 5 years should be used.

As you have correctly identified there is no bargain option. In addition, it is not a required buyout, it is an optional buyout (it is not required from Douglas to acquire the property). I'll take it one step further: if the question asked you "what is the PV of the lease at inception given that Douglas can purchase the machine at 100,000(FV)?" Would you include the 100,000 in the PV calculations? No, because it is an optional buyout.

divyagovil1
Major Contributor

Joined: 30 Jan 2009
Location: India
Online Status: Offline
Posts: 1456

Posted: 07 Apr 2009 at 14:50 \| IP Logged

Alright, I get it now..... Optional buy out... How can I be so dumb ? :)

Thanks a lot,cinnamon !

__________________
Divya - CO State

Passed using Becker Review :
FAR - 04/11/09 - 94
BEC - 05/30/09 - 86
REG - 08/29/09 - 95
AUD - 11/21/09 - 92
Ethics - 2011

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