Intermediate Accounting 2 answeres - Essay Example

(Maxwel, 2010) The lease receivable will be revealed as an asset on the balance sheet, and the interest revenue is recognized over the term of the lease, as paid. Normally, the company will record its sale on its books, removing the asset from its books and replacing it with a receivable from the lease. During the lease term, the lessor receives interest income. The cash inflow equals the lease payments and the cash outflow is equal to the book value of the asset. (Paul, 2007) Legally, the lease expenses are usually treated as operating expense and the operating lease is not revealed as part of the capital of the firm.

When a lease is classified as a sales type lease, the present value of the lease expenses is treated as debt, and interest is imputed on this amount and shown as part of the income statement. Changing from operating leases to sales type leases increases the debt shown on the balance sheet significantly. (Paul, 2007).It is therefore wise for the company to use operating lease since there would be no increase in debt. The operating lease payments in future years, which are revealed in the footnotes to the financial statements for US firms, should be discounted back at a rate that should reflect their status as unsecured and fairly risky debt.

As an approximation, using the firm’s current pre-tax cost of debt as the discount rate yields a good estimate of the value of operating leases. Note that capital leases are accounted for similarly in financial statements, but the significant difference is that the present value of capital lease payments is computed using the cost of debt at the time of the capital lease commitment, and is not adjusted as market rates change. Using straight line method Depreciation = (Cost - Residual value) / Useful life/salvage value.

Suppose the cost of airplane is p, then the salvage value of x and y under 15 and 25 years