ACC 2020 Module 3 Leases Written Assignment Example

Barnegat Marine Supply, Inc.: A Finance Lease for Delivery Vans and an Operating Lease for a Warehouse

Student Name

Bachelor of Science in Business Administration, Thomas Edison State University

ACC-2020: Intermediate Accounting II

Mentor Name

Month Day, Year

Barnegat Marine Supply, Inc.: A Finance Lease for Delivery Vans and an Operating Lease for a Warehouse

Introduction

Before 2019, most leases stayed off the balance sheet, disclosed only in the notes. The current standard requires lessees to recognize a right-of-use asset and a lease liability for nearly every lease longer than twelve months (Financial Accounting Standards Board [FASB], 2016). The classification as finance or operating still matters, because it changes how expense is reported. Barnegat signed two leases on January 1, 2025.

Part A: Classification

Spiceland et al. (2020) set out five tests, and meeting any single one makes the lease a finance lease: the lessee ends up owning the asset; it is all but certain to buy it; it will use it for most of its working life; what it pays, in present value terms, comes close to the asset's whole fair value; or the asset is built so specifically for the lessee that the lessor could not lease it to anyone else.

Part B: The Van Lease as a Finance Lease

Barnegat pays $40,000 at the start of each year for five years. The lessor's implicit rate of 7% is known. Because payments come at the beginning of each period, the present value uses the annuity due factor of 4.38721: $40,000 x 4.38721 = $175,488.

Total 2025 expense for the vans is $44,582: interest of $9,484 plus amortization of $35,098. Had the lease included a residual value guarantee, the expected guaranteed amount would have been added to the payments measured. At year end the liability is $144,972, which includes the interest that will be paid with the January 2026 installment, and the asset's carrying amount is $140,390. Expense is higher in early years and falls as interest declines, the same front-loaded pattern as owning the vans with a loan.

Part C: The Warehouse Lease as an Operating Lease

The warehouse costs Barnegat $60,000 a year, paid every December 31, through 2028. The lessor's rate is not known, so Barnegat uses its 6% incremental borrowing rate. Discounting four year-end payments at 6% uses a factor of 3.46511, so the liability starts at $60,000 x 3.46511, or $207,907.

On the income statement, Barnegat reports a single operating lease cost of $60,000, the straight-line amount. The asset reduction is a plug that makes total cost equal to the payment each year. The liability and asset stay equal here because there were no prepaid rent, incentives or initial direct costs.

Part D: Comparing the Two

Both leases add roughly equal assets and liabilities to the balance sheet, so ratios such as debt to equity rise either way. The difference lies in the income statement and cash flow statement. The finance lease shows interest and amortization separately, with expense falling over time, and its principal payments are financing cash flows. The operating lease shows one level cost, and its payments are operating cash flows. Bringing operating leases onto the balance sheet formalized what credit analysts had long done informally; Altamuro et al. (2014) found evidence that credit assessments already adjusted for operating lease commitments before the standard required recognition.

References

Altamuro, J., Johnston, R., Pandit, S., & Zhang, H. (2014). Operating leases and credit assessments. Contemporary Accounting Research, 31(2), 551-580. https://doi.org/10.1111/1911-3846.12033

Financial Accounting Standards Board. (2016). Leases (Topic 842) (Accounting Standards Update No. 2016-02).

Spiceland, J. D., Nelson, M. W., & Thomas, W. B. (2020). Intermediate accounting (10th ed.). McGraw-Hill Education.