Question

Baden Corporation entered into a lease agreement for 100 photocopy machines for its corporate headquarters. The lease agreement qualifies as an operating lease except there is a bargain purchase option. After the 5-year lease term, the corporation can purchase each copier for $1,000, when the anticipated fair value is $2,500. Jerry Suffolk, the financial vice president, thinks the financial statements must recognize the lease agreement as a finance lease because of the bargain purchase option. The controller, Diane Buchanan, disagrees: "Although I don’t know much about the copiers themselves, there is a way to avoid recording the lease liability." She argues that the corporation might claim that the copier technology advances rapidly and that by the end of the lease term, the machines will most likely not be worth the $1,000 bargain price.

(a) What ethical issue is at stake?
(b) Should the controller’s argument be accepted if she does not really know much about copier technology? Would it make a difference if the controller were knowledgeable about the rate of change in copier technology?
(c) What should Suffolk do?

Answer 1

Answer is explained below

Step-by-step explanation:

A)

The ethical issue at stake is whether to record the lease agreement for 100 photocopy machine as a finance lease or operating lease because in operating lease we don't record it as asset or liability in financial statements but in finance lease, we record both asset and liability generally at the present value of rentals payments. As the bargain option is available this lease agreement will be said to be a finance lease agreement.

B)

No without knowing much about the copier technology the argument of controller should not be accepted.

C)

Suffolk should represent lease as a financial lease but he can get the terms of lease revised as to the fair value of copier revised after the proper analysis and computation of copier value.