Question

On January 1, 2021, Worchester Co. leased non-specialized machinery under a 6-year lease. The machinery has a 10-year economic life. The present value of the monthly lease payments is determined to be 70% of the machinery's fair value. The lease contract includes neither a transfer of title to Worchester nor a bargain purchase option. Worchester will record straight-line lease expense:

Multiple Choice
A. neither using U.S. GAAP nor IFRS.
B. if using U.S. GAAP, but not IFRS.
C. if using IFRS, but not U.S. GAAP.
D. if using either U.S. GAAP or IFRS.

Answer 1

Worchester Co. will record the lease expense on a straight-line basis if using either U.S. GAAP or IFRS, as the lease is considered an operating lease under both accounting frameworks. The correct answer is option D.

Step-by-step explanation:

The student's question pertains to the accounting treatment of a lease for non-specialized machinery under both U.S. GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards). Since the lease does not transfer ownership and does not include a bargain purchase option, along with the fact that the present value of the lease payments is less than substantially all (usually interpreted as 90%) of the fair value of the asset, it would typically be classified as an operating lease.

Under both U.S. GAAP and IFRS, operating lease expenses are generally recognized on a straight-line basis over the lease term, despite the lease payment structure. Therefore, Worchester Co. will record straight-line lease expense if using either U.S. GAAP or IFRS.