Nilsson Company closes its books on 31 December each year. During the past year they have taken a three-year lease on a computer web server to support the development of their e-business activities. The terms and conditions of the lease agreement are provided as Exhibit 1. The lease contract itself is summarized in Exhibit 2.
Required
1. Explain how this contract should be recorded in Nilsson’s books if the company does not capitalize the lease.
2. Calculate the implicit interest rate in this lease contract. Prepare the schedule of amortization of a loan that would have the same principal, the same semi-annual reimbursements and the same residual value. Break down each semi-annual reimbursement between interest expense and principal reimbursement.
3. Illustrate the accounting entries required if the lease is capitalized.
4. Prepare the relevant information that should be placed in the Notes to the financial statements if the leased equipment is not capitalized.
In the case of an outright acquisition of the web server, Nilsson would have depreciated it on a straightline basis over five years.