Of course it doesn't sound silly!

I think if you try to understand the high level concepts related to long term leases the entries make more sense. Substance over form is the reasoning behind the accounting treatment of long term leases. For example, you could lease a car for 5 years (long term lease) or you could rent a car for a week (operating lease). Both are rental agreements but the long term lease is more of a purchase and should be accounted for as if you were making car payments on a car you purchased.  In many situations management would prefer to keep leases off the balance sheet; however the rule relating to long term leases help provide greater transparency into these agreements.

1. Capital vs. Operating -When a lessee is deciding how to account for a lease, the first thing to do is determine if it is a capital or operating lease. If the lease matches only one criterion it must be accounted for as a capital lease.

Ownership passes at the end of the lease

Written Bargain Purchase Option

Ninety Percent of the price of the asset - PV of min lease payments/FMV of asset

Seventy percent of the life of the asset - Lease life/Asset life

2. Price the lease - If it is a capital lease the lease is recorded at the present value of the minimum lease payments. The first thing to look for is the interest rate to use for the lessee (the lessor always uses the stated rate). The lessee uses the lower of the stated rate or the lessee's borrowing rate. This makes sense because why would the lessee lease equipment with a 15% stated rate if they could go out and borrow money for 10%. Next, when is the first payment made, at the beginning of the lease or after the first year. When the lessee makes the first payment at the start of the lease, use the PV if an annuity due. If the first payment is made after the first year, use the PV of an ordinary annuity.

Annual lease payment x PV factor (annuity due or ordinary annuity) (always greater than 1)

Next, we have to consider bargain purchase option and guaranteed residual value. They are considered and additional lease payment due at the end of the lease. So you use the PV of 1 at the end of the life of the lease, multiplied by the BPO or the guaranteed residual value.

BPO or guaranteed residual value x PV1 (always less than 1)

Add them together and that is the PV of the minimum lease payments.

3. Deprecation - Typically, if the first 2 criteria are met in the OWNS, we assume they are keeping the asset and we have to record depreciation over the life of the asset. However, if only the last 2 criteria are met and they do not indicate they are keeping the asset, we record depreciation over the life of the lease.

4. Recording the Lease - Let's use the number from your problem.

Day of acquisition

DR - Leased Asset (PV if min lease payments) 76,364       

CR - Long term Lease Obligation 76,364

DR - Long term Lease Obligation 9,000

CR - Cash 9,000                                                             

Year one: 12.31.01

DR - Interest Expense 1,364

CR - Accrued Interest 1,364

DR - Long term Lease Obligation 7,636

CR - Current Lease Obligation 7,636

Year two: 01.02.02

DR - Accrued Interest 1,364

DR - Current Lease Obligation 7,636

CR - Cash 9,000

Year two: 12.31.02

DR - Interest Expense 1,500

CR - Accrued Interest 1,500

DR - Long term Lease Obligation 7,500

CR - Current Lease Obligation 7,500

Year three: 01.02.03

DR - Accrued Interest 1,500

DR - Current Lease Obligation 7,500

CR - Cash 9,000

Year three: 12.31.03

DR - Interest Expense 1,650

CR - Accrued Interest 1,650

DR - Long term Lease Obligation 7,350

CR - Current Lease Obligation 7,350