Question: Jack and Gillian Grant owners of Grant s Ice Cream Shop

Jack and Gillian Grant, owners of Grant’s Ice Cream Shop Ltd., have recently expanded their business by moving into a second location in a nearby town. To open the second location, the company had to obtain three large ice cream machines. To buy the machines would have cost over $15,000, so Jack and Gillian decided to lease them instead.
The lease term is for five years and the machines are expected to have a useful life of eight to 10 years. According to the lease contract, the present value of the lease payments over the lease term is $12,000 and the Grants will have the option to purchase the leased machines for $1,000 at the end of the five-year lease term. Their fair market value is expected to be approximately $4,000 at the end of the lease.
Jack Grant is thrilled with the arrangement. “Not only do we get the machines that we need without a large initial cash outlay, but we don’t have to record any liability on the statement of financial position; we can just report the annual lease payments as equipment rental expense on the statement of income.”
Is Jack correct in assuming that the lease payments will be recorded as an expense and that no debt will have to be reported on the statement of financial position as a result of this transaction? Explain your answer fully, by referring to the criteria for lease classification and the appropriate accounting treatment for this type of lease.

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  • CreatedJune 12, 2015
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