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Case xx Required: How should Keith Motors, Inc. account for the contractual arrangement?

Case xx

Required: How should Keith Motors, Inc. account for the contractual arrangement?  Provide 2 alternatives 

Joyce Hubert, an individual investor, owns 100% of Greensburg Properties, LLC (Greensburg Properties), and 60% of Keith Motors, Inc. (Keith Motors), a private company in process of going public – see proposed structure below.

Keith Motors is a manufacturer of windmill motors, and leases a building for its manufacturing facility from Greensburg Properties.

Joyce Hubert capitalized Greensburg Properties with $30,000 of equity and a $970,000 loan from Midwest Bank. The debt is a 10-year fixed-rate loan. The loan terms provide that Midwest Bank will have recourse to the assets of Greensburg Properties and to the personal assets of Ms. Hubert if the loan is not paid. Greensburg Properties owns no assets other than the manufacturing building leased to Keith Motors.

You are employed as the accounting team for Keith Motors and you have determined that the lease does not meet any of the four criteria in ASC 840-10-25-1, and that it does not meet both of the criteria in ASC 840-10-25-42. Accordingly, it appears that the lease meets the classification as an operating lease and not as a capital lease, in accordance with ASC 840, Accounting for Leases. The lease contains no explicit guarantees of the residual value of the building or any fixed-price purchase options. At inception, the terms of the lease were consistent with fair market rentals. The lease is the only contractual relationship between Keith Motors and Greensburg Properties.

PROPOSED PUBLIC OFFERING FOR KEITH MOTORS, INC.

Joyce Hubert

Noncontrolling Shareholders

100%

Personal Bank Guarantee Loan

Midwest Bank

60% 40%

Operating Lease

Greensburg Properties LLC

Keith Motors, Inc.

Required: How should Keith Motors, Inc. account for the contractual arrangement? 

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