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Lease - Essay Example

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The Company has entered into a 10 year lease agreement with Goliath Co for a combustion turbine on December 15, 2004 which has become operational since January 1, 2005. This…
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Download file to see previous pages... he FSAB standards, the lease agreement is for the use of the combustion turbine which could qualify as a capital lease because it is an agreement for the use of a piece of property that could be classified as an asset. The first item to be assessed is the legal fees arising in connection with the lease, i.e., $500K to Stipe, Berry, Mills and Buck, together with $1 million in legal fees incurred by Goliath Co. These expenses would fall under the category of external expenses that are not incurred on a sustained basis, but rather are a one-off expense. They do not fall under the category of a recurring expense and moreover, the total value of the payments as mentioned above, is unlikely to add up to a sum that is greater than 90% of the fair value of the leased asset, i.e., the combustion turbine. This expense can however be included in the Balance sheet of the Company as an establishment expense, which would fall under the category of a one-time expense for setting up the lease. The advantage of this method is that it could contribute towards the payment of lower taxes to be paid on incomes gained from the leased property during the first year of lease.
In regard to the second provision, the lease is a capital lease that would fall under the category of a direct financing lease, because lease payments are being made by a bank and Goliath Company which is leasing out the asset does not gain any share in the profits of Big Bear. The default provision in the lease requires a penalty payment from Big Bear if there is a “material adverse change” in its financial condition. Although this term is not specifically defined under the agreement, nevertheless the direct inference would be construed as any change in financial circumstances that lead to Big Bear being unable to make its payments. The inclusion of a penalty payment is a fairly standard provision within a lease document, but the instigating factor is a default in the bank’s credit arrangement. This ...Download file to see next pagesRead More
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