Question

1. On January 1, 2021, Sans Serif Publishers leased printing equipment from First Lease Corp. First Lease Corp purchased the equipment from CompuDec Corporation at a cost of $479,079. · The lease agreement specifies six annual payments of $90,000 beginning January 1, 2021, the beginning of the lease, and at each December 31 from 2021 through 2025. • The six-year lease term ending December 31, 2026, is two years less than the expected useful life . There is no obligation for the lessor to buy the asset at the end of the lease period but they may buy it at the value identified by a registered valuer at that time. The interest rate in these financing arrangements is 10%. Determine if this is a finance or operating lease. Explain your answer, including calculations.

Answer 1

A lease will be classified as a Financing lease if it meets one or more of the following criteria.

• The lease transfers ownership of the leased property to the lessee by the lessor at the end of the lease term.
• The lease contains a bargain purchase option
• The lease term is for a period which contains at least 75% of the Assets asset's economic life.
• The present value of the lease Rentals exceed 90% of the fair market value of the leased Asset.

We apply these test to classify the lease whether it is operatin or financing….

1. It is not mentioned that property will transfer or not the asset at the end of lease period.
2. There is no obligation to purchase the asset at the end of lease period.
3. Assets economic life 8 year (6+2) which is 6/8*100= 75%
4. Present value of lease rentals 90000+90000* PVAF(10%,5yr)

= 90000+90000*3.791

= 90000+341171

=431171

Which is (431171/479079)100 = 89.9999% almost 90%

Conclusion the above lease is a financing lease because it qualifies two condition of given condition.