just not getting this question! I have tried to understand it, not sure if it's the wording, but no matter how much I read it over I can't quite grasp it.

Dec. 31, 2005, Comp A leased equipment from Comp B Equipment Rental. Pertinent lease transaction data follows:
- the estimated 7yr useful equipment life coincides with the lease term.
- the first of the 7 equal annual $200,000 lease payments was paid on Dec 31, 2005
- Comp B's implicit interest rate of 12% is known to Comp A.
- Comp A's incremental borrowing rate is 14%
present values of annuity of 1 in advance for 7 periods are 5.11 at 12% and 4.89 at 14%

Comp A should record the equipment on the books at:
a) $1,400,000
b) $1,022,000
c) $978,000
d) $0

THANKS!

This is a capital lease as the life of the lease is equal to or greater than 75% of the economic life of the asset (in your case 100%).

Under a capital lease, the lessee does not record rent as an expense. Instead, the rent is reclassified as interest and obligation payments, similarly to a mortgage (with the interest calculated each rental period on the outstanding obligation balance). At the same time, the asset is depreciated. If the lease has an ownership transfer or bargain purchase option, the depreciable life is the asset's economic life; otherwise, the depreciable life is the lease term. Over the life of the lease, the interest and depreciation combined will be equal to the rent payments.

FAS 13 will detail how to solve this problem.