Question

Technoid Inc. sells computer systems. Technoid leases computers to Lone Star Company on January 1, 2021. The manufacturing cost of the computers was $12 million. This noncancelable lease had the following terms: Lease payments: $2,466,754 semiannually; first payment at January 1, 2021; remaining payments at June 30 and December 31 each year through June 30, 2025. Lease term: five years (10 semiannual payments). No residual value; no purchase option. Economic life of equipment: five years. Implicit interest rate and lessee's incremental borrowing rate: 5% semiannually. Fair value of the computers at January 1, 2021: $20 million. Technoid would account for this as:

Answer 1

For Technoid Inc., the lease transaction with Lone Star Company would be recorded as a finance lease, with the asset recognized at its fair value of $20 million or the present value of lease payments. The company will recognize interest revenue over the lease term.

Step-by-step explanation:

Technoid Inc.'s lease of computers to Lone Star Company would be accounted for as a finance lease since the lease term is for the entire economic life of the equipment (five years). Under a finance lease, Technoid Inc. would recognize the leased asset at its fair value, which is $20 million, or the present value of the lease payments, whichever is less.

The lease payments need to be discounted using the implicit interest rate of 5% semiannually to find the present value. As payments are made, Technoid would recognize interest revenue and a reduction in the outstanding lease receivable. The asset's cost, which is the manufacturing cost, does not directly affect the initial recording of the asset under finance lease accounting.

Answer 2

A sales type lease with selling profit.

Step-by-step explanation:

Technoid Inc. would account for this as a sales type lease with selling profit. In a sales type lease, the fair value of the leased asset at the start of a lease varies from its carrying amount and there is a transfer of ownership by law to the lessee at the end of the lease period. Cost is $12 million and Fair value is $20 million and Present value of minimum lease payment is also $20 million.

For Lone Star Company, it would account for this as a finance lease.