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(Solved) Question 1 (25 points): After graduation, you began work at a moderately large, but rapidly growing, tech company in the bay area. The company's...


i have a question regarding the new accounting lease standards. the question is attached below.

Question 1 (25 points):
After graduation, you began work at a moderately large, but rapidly growing, tech company in
the bay area. The company’s primary sales are generated by providing computational data
services and storage to customers via the internet. Previously it leased most of its hardware
and data warehouses from a variety of providers such as Amazon and accounted for them using
operating lease treatment. However, with the change in accounting principles, executive
management is carefully considering how to consider several important leases which are most
material to the company. Since you are fresh out of school, and know
the new accounting standards, you’re brought in to provide your thoughts. The company will
have assets
of $150,000,000 and liabilities of $80,000,000 prior to any changes in how leases are
accounting for. They determine that there are leases with a present value of $30,000,000 that
the company will now need to bring onto its balance sheet. The company has debt covenants
that require it to keep a debt-to-equity ratio of 1.50 or it will go into technical default and pay a
massive amount of fees. If this happens, most of the top management and finance department
would be fired, and your job will very likely be at risk. Your boss approaches you and says, “You
know, about $7.5 million of those leases are going to expire pretty
soon. I think it’s ‘highly likely’ that these leases will end in nine months and never be renewed,
because we plan to upgrade to new equipment. But when that time comes, we can renegotiate
the contract with our lessors and decide to renew for another couple of years because the new
hardware just isn’t ready. That way we can use the short-cut method for those leases in the
meanwhile and it’ll give us enough time
to sort things out with our lenders and avoid technical default.”
Discuss and examine the impact of the change in accounting standards on the company’s
financials.
After doing so, consider how to respond to your boss and how the different choices you have
will impact various stakeholders.

 


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