FASB Accounting CaseNew Standards for Capital Leases

Case Overview and Key Issues

Sable., a company located in San Fransico, CA, specializes in the manufacturing of heavy equipment and have different financing options for clients to own or lease the heavy equipment that they produce. The first option is to purchase the machinery in a traditional standard sale for a lump sum price of $135,000 in which the customers purchases the equipment outright. Another option is for a client to lease the equipment for a period of ten years and pay the lease payment on an annual basis. Sable has been charging $16,000 annually each year to lease the equipment during the ten-year period. However, both options are being effected by the economic conditions that loom in the external environment and some of the company's competitors are reducing their fees for similar equipment options and charging an average of $125,000. Once of its customers, Buildit, is a construction company in San Francisco that has recently entered into a lease for the regular price before the economic downtown took effect. The primary consideration in this case is how to deal with the accounting aspects of this transaction because the financial evaluation has changed due to the economic conditions in the external environment.

Recent Changes on FASB Lease Accounting

The Financial Accounting Standards Board (FASB) instituted new guidelines for lease accounting in early 2016. The new standards have been...

Under the current accounting model, an organization applies a classification test to determine the accounting for the lease arrangement (FASB, 2016):
• Some leases are classified as capital leases (for example, a lease of equipment for nearly all of its useful life) whereby the lessee would recognize lease assets and liabilities on the balance sheet.

• Other leases are classified as operating leases (for example, a lease of office space for 10 years) whereby the lessee would not recognize lease assets or liabilities on the balance sheet.

The SEC and a number of other studies have all concluded that much of the reporting conducted with leased items occurs off-balance sheet in a way that is detrimental to the transparency and the representation of assets to investors.

To improve transparency, the FASB has rewritten much of the reporting requirements about leases and breaks down the previous category into to sub-categories, capital leases and operating leases. The section, 840 Leases, 30 Capital Leases, 05 Overview and Background, deals with the classification of capital leases as per the guidance give in subtopic 840-10 (FASB, N.d.). There are now four different criteria that can classify a lease which are as follows:

1) Explicit transfer of ownership at the end of the lease term

2) Bargain…