Case Study: Big Bear Power Public Utility Company

Good Essays
Haley Battista, John Conroy, Katie Early, John MacGovern
Professor Holder-Webb
AC 306
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
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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 …show more content…
According to ASC 840-10-25-4, “lease payments that depend on an existing index or rate, such as the consumer price index or the prime interest rate, shall be included in minimum lease payments based on the index or rate existing at lease inception; any increases or decreases in lease payments that result from subsequent changes in the index or rate are contingent rentals and thus affect the determination of income as accruable.” This means that the CPI of 4% will be used to calculate the rent payments after the first year. So, to calculate the first years rent, you first need to know how much of the legal fees discussed in Provision One are being amortized per month. We got this by dividing the $1,000,000 over the life of the lease, 120 months, to get $8,333.33 per month. This is added to the first years monthly rent of $83,333.33 for a total rent per month of $91,666.66. The second years initial monthly rent will increase by 4% according to the CPI, bringing the base rent to $86,666.67 for a total monthly rent (including amortization of legal fees) of

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