A company desires to replace its current plant equipment with new equipment that costs $10000000. One possibility would be for the company to issue $10000000 of bonds and use the proceeds to purchase the equipment. Another possibility is to acquire the use of the equipment by signing a long-term capital lease with a leasing company. Describe and compare the financial statement effects of these two alternatives.

The bond alternative will result in the balance sheet presentation of an asset (Equipment) and a long-term liability (Bonds Payable), which probably will have a corresponding liability valuation account (Premium or Discount on Bonds Payable). The income statement will show the interest expense from the payment of interest to the bondholder and the depreciation expense for the equipment.

The leasing alternative will result in the balance sheet presentation of a Leased Asset, recorded at the present value of the cash payments for the lease. The portion of the Lease Liability expected to be paid in the next year is reported as a current liability while the remainder is classified as a long-term liability. The income statement will show the interest expense, which is the financing cost, and since the lessee has essentially purchased the asset, the income statement will also show the depreciation expense.