Lease Case – American Airlines, British Airways

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CASE INFORMATION
RK Corp, a publically traded NASDAQ company (symbol ARK), is a manufacturer of electrical
automobiles. Based in Chicago, the company has been operating since 1996. The company sells their
electric automobiles to auto manufacturers as well as the retail market on a worldwide basis. Its
major clients are Ford, General Motors and Toyota. Ark has captured about 10 percent of the world market
of the electrical automobile sales. Its stock sells at 25 US Dollars per share, and its 52-week price range is
between 19.75 and 27.15 US Dollars, with a market cap of 10.6 billion dollars.
Their financial statements presented below for the year ending December 31, 2011 has been prepared using
GAAP (Tables 1 and Table 2). The controller would like to see the effect of IFRS treatment of leases on
the financial statements, and you have been assigned this task. In particular, the controller would like to
see the impact GAAP and IFRS differences have on balance sheet, income statement and selected financial
ratios. The company would like to adapt IFRS by as early as next year as it is considering a new stock issue
in the Tokyo Stock Exchange, which requires IFRS compliance.
ADDITIONAL INFORMATION
Ark entered into a lease on January 1, 2011 with the following terms:

1. Ark leased specialized machinery manufactured by the lessor, Bell Corp., which will enable Ark to
   manufacture their electric cars in a much more efficient manner. This machinery does not have a
   resale market and was made specifically for Ark to meet itsspecifications.
2. The lease term is for 3 years with a minimum lease payment of $10,000. Payment is due on
   December 31 of each year, with the first payment due on December 31, 2011. At the end of year 3,
   Ark has the option of leasing the equipment for one additional year for $2,500. At the end of the
   lease term, ownership reverts to the lessor. There is no option to buy the equipment.
3. The lessee will pay all executor costs.
4. The estimated useful life of the lease is 49 months (4 and 1/12 years.)
5. The fair market value of the equipment is $30,000.
6. The implicit rate of Bell Corp. is 6 percent, and the lessee, Ark, knowsthis.
7. The incremental borrowing rate of Ark is 7 percent.
   QUESTIONS
   1- Differentiate between an operating lease and a capital/ financing Lease for GAAP financial
   reporting purposes.
   2- Under GAAP, has this been treated as a capital lease / financing Lease for Ark or an operating
   lease?
   3- Under IFRS, should this lease be classified as an operating or a financing lease?
   4- Describe the different reporting results between GAAP and IFRS and review the necessary
   adjusting entries to conform the financial statements to IFRS compliance for Year 1 (see below).
   5- Prepare an income statement under IFRS for year 1. Assume that the net income remains the same
   under IFRS as it does for GAAP and any difference is reconciled in the tax expense and tax payable
   accounts.

Sample Solution

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