When is a lease a capital idea? Laurie Gocker, Inc., entered into a lease arrangement with Nathan Morgan Leasing Corporation for an industrial machine. Morganâ€™s primary business is leasing. The cash purchase price of the machine is $1,000,000. Its economic life is six years. Gockerâ€™s balance sheet reflects total assets of $10 million and total liabilities of $7.5 million. Among the liabilities is a $2.5 million long-term note outstanding at Last National Bank. The note carries a restrictive covenant that requires the companyâ€™s debt ratio to be no higher than 75%. The companyâ€™s revenues have been falling of late and the shareholders are concerned about profitability.
Gocker and Morgan are engaging in negotiations for terms of the lease. Some other relevant facts are as follows:
1. Morgan wants to take possession of the machine at the end of the initial lease term.
2. The term may run from four to five years, at Gockerâ€™s discretion.
3. Morgan estimates the machine will have no residual value, and Gocker will not purchase it at the end of the lease term.
4. The present value of minimum lease payments on the machine is $890,000.
1. What is (are) the ethical issue(s) in this case?
2. Who are the stakeholders? Analyze the consequences for each stakeholder from the following standpoints:
3. How should Gocker structure the lease agreement?
4. As of the date of this text, the FASB and IASB have issued a joint exposure draft of a new standard on long-term leases that will require companies to capitalize most leases like this one. How will the analysis of this case change when this standard is issued?