Reference no: EM132756483

On January 1, 2001, Kruder Products, as lessee, leases a machine used in its operations. Kruder uses straight-line depreciation for all of its equipments. The annual lease payment of $10,000 is due on Dec 31 of 2001, 2002 and 2003. The machine reverts to the lessor at the end of three years. The lessor can either sell the machine or lease it to another firm for the remainder of its expected total useful life of five years. The interest rate appropriate for Kruder Products is 12 percent annually. The market value of the machine at the inception of the lease is $30,000.

Problem 1. Is this lease an operating lease or a capital lease?

Problem 2. Assume this lease qualifies as an operating lease. What are the expenses recorded for the lease in 2001, 2002 and 2003?

Problem 3. Assume this lease qualifies as a capital lease. What are the expenses recorded for the lease in 2001?

Problem 4. Which of the above methods, i.e., operating vs. capital lease results in a higher ROA (return on assets=income/average assets) in 2002? Which method results in a higher leverage (liability/shareholder's equity) in 2002? Why?

Problem 5. Which of the above methods, i.e., operating vs. capital lease results in a higher Cash Flow from Operations in 2001? Why?