John Smith just founded the Hospital for Toys and Puppets. The hospital is an in

Question

John Smith just founded the Hospital for Toys and Puppets. The hospital is an independent non-profit entity. It does not pay any taxes. The Board of Trustees is evaluating whether the hospital should buy or lease an fMRI machine. If they purchase the machine, they expect to pay $1.2 million, and will depreciate the machine on a straightline basis over its 10-year economic life. There are no plans to sell the machine after 10 years. If they lease the machine, they expect to pay $140,000 at the beginning of each year for a period of 10 years. Additionally, they expect to pay a security deposit of $250,000 at the beginning of the lease, which will be returned at the expiration of the lease at the end of the 10th year. The hospital's cost of debt is rd = 7.0%.

Pick the combination that best completes these sentences:

Nonprofit accounting differs slightly from accounting for public corporations, but there are many similarities. Based on FAS 13, we would expect that this lease _____________________ need to be recorded on the balance sheet because it is a(n) ____________________________ lease.

a. would not; operating

b. would not; capital

c. would; operating

d. would; capital

Explanation / Answer

We know that a capital lease shows up on the balance sheet while an operating lease doesn't. Now a lease a characterized as an capital lease if the period of the lease encompasses at least 75% of the useful life of the asset.

From the above question it is clear that the life of the machine is 10 years and the lease period is also for 10 years. So the lease should be characterized as an capital lease. Hence the answer should be "d. would, capital"

Please revert to me in case of any queries :)

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