Capital Lease Issues – On January 1, 2007 Lani Company entered into a noncancelable lease for a machine to be used in its manufacturing operations. The lease transfers ownership of the machine to Lani by the end of the lease term. The term of the lease is eight years. The minimum lease payment made by Lani on January 1, 2007 was one of eight equal annual payments. At the inception of the lease, the criteria established for classification as a capital lease by the lessee were met.
1. Explain the theoretical basis for the accounting standard that requires certain long-term leases to be capitalized by the lessee. Do not discuss the specific lease as a capital lease.
2. Explain how Lani should account for this lease at its inception and determine the amount to be recorded.
3. Explain what expenses related to this lease Lani will incur during the first year of the lease, and how they will be determined.
4. Explain how Lani should report the lease transaction on its December 31, 2007 balance sheet.