Big Bear Power is a public utility company that leases a combustion turbine from Goliath Co for a 10-year non-cancelable term. The lease agreement is signed on December 15, 2004 and Big Bear’s right to use the turbine begins on January 1, 2005. They have the following three transactions that need to be analyzed under ASC 840, Accounting for Leases, to determine whether costs or potential costs associated with the provision should be included in minimum lease payments: 1. Fees paid in connection with negotiating lease agreement and legal fees. Big Bear pays Stipe, Berry, Mills and Buck LLP, its external legal counsel $500,000 in connection with negotiating the lease agreement and $1,000,000 of legal fees incurred by Golaiath Co.
2. Penalty payment caused by default under the primary credit arrangement. If Big Bear, due to a material adverse change in its financial condition, defaults under the credit agreement it is stated in the default provision in the lease that a penalty payment will be required. 3. The lease agreement stipulates that Big Bear will pay minimum rent in an amount equal to the $1 million increased by the same percentage as the increase in the Consumer Price Index (CPI) from January 1 of the prior year until January 1 of each respective year. The CPI as of the inception was 4%.
Identification of Questions & Alternatives
The following questions and alternatives have been identified with respect to whether the items are included in the minimum lease payments: 1. Should the payment to the external legal counsel of $500,000 in connection with negotiating the lease agreement be included in the minimum lease payment or not? Should the payment of $1,000,000 of legal fees incurred by Goliath Co. be included in the minimum lease payment or not?
2. Should a penalty payment due to default on the credit agreement be included in minimum lease payment?
3. Should the consumer price index be included in the...