Question

Dan lives and works in OKC (he occasionally travels for ABC). ABC provides a car for Dan to use when he drives to visit ABC customers in Oklahoma and surrounding states. The car ABC has provided to Dan currently has 200,000 miles so ABC is currently negotiating with Happy Car Ford Dealer to obtain a new car for Dan to use. Happy Car offers two options: 1) ABC can purchase the new car for $20,000 and Happy Car will finance 100% of the purchase price at a 5% rate of interest, monthly payments will be $377 a month for 60 months. 2) ABC can lease the car from Happy Car and the payments would be $376 a month for 60 months. At the end of the 60 months ABC will have the option of purchasing the care from Happy Car for $60. ABC chooses option 2 and signs a document labeled lease. Is there substance over form?

Answer 1

ABC's lease option with a nominal purchase price at the end might suggest that there is substance over form, as it hints at a de facto purchase rather than a simple lease. The economic reality indicates that ABC may gain the benefits and risks of ownership, which is pertinent in assessing whether the lease is a capital or operating lease.

Step-by-step explanation:

The question you've asked revolves around whether substance over form is being considered in ABC's decision between purchasing or leasing a car. ABC chose option 2, which is to lease the car. Substance over form is an accounting principle where the economic reality of a transaction rather than the accounting treatment is considered. In this scenario, ABC is leasing the car with monthly payments of $376 for 60 months and an option to buy the car for $60 at the end of the lease term. This situation requires an analysis of the terms of the lease and comparing them to the criteria for a capital lease versus an operating lease. If the lease meets the characteristics of a capital lease, ABC would record the car as an asset on its balance sheet despite it being a lease agreement. The low purchase option at the end of the lease and the length of the lease term may suggest that the lease could be classified as a capital lease, indicating that there might be substance over form since ABC effectively gains the benefits and risks of ownership through the lease.