Haley Battista, John Conroy, Katie Early, John MacGovern
February 5, 2013
Big Bear Power public utility company is leasing a combustion turbine from Goliath Co. Big Bear signed a 10-year noncancelable lease on December 15, 2010. The lease begins on January 1, 2011. There are three provisions to this lease that need to be analyzed to tell if they should be included in the minimum lease payments.
For provision one, Big Bear pays $500,000 to an external legal counsel to negotiate the lease agreement. This $500,000 that Big Bear paid in connection with negotiating the lease agreement would not be included in the minimum lease payment. These legal fees would be expensed by Big Bear. This payment is considered to be and incremental direct cost because it is being paid to an independent third party in connection with originating the lease agreement. The $1 million that Big Bear is required to pay in legal fees incurred by Goliath would be included in the minimum lease payment. According to ASC 840-10-25-6 (e), minimum lease payments include, “Fees that are paid by the lessee to the owners of the special-purpose entity for structuring the lease transaction.” The legal fees incurred by Goliath, the lessee, are costs that were incurred structuring the lease, so this means that Big Bear should include the $1 million in its minimum lease payment. This cost is considered to be an initial direct cost, according to ASC 840-20-35-2, which states, “Deferred initial direct costs shall be allocated by the lessor over the lease term in proportion to the recognition of rental income.” the cost of these fees shall be allocated over the life of the lease. We show this calculation in provision three.
Provision two states that Big Bear would be required to pay a penalty if their bank declares a default under its primary credit arrangement. Big Bear will be considered in default under the credit arrangement if there is a material adverse change in...
Please join StudyMode to read the full document