Question

Alice Foyle, M.D. (lessee), has a noncancelable 20-year lease with Brownback Realty, Inc. (lessor) for the use of a medical building. Taxes, insurance, and maintenance are paid by the lessee in addition to the fixed annual payments, of which the present value is equal to the fair value of the leased property. At the end of the lease period, title becomes the lessee’s at a nominal price. Considering the terms of the lease described above, comment on the nature of the lease transaction and the accounting treatment that should be accorded it by the lessee.

Answer 1

As per the accounting standards, a lease is said to be finance lease, if any of the follwing conditions are satisfied in lease agreement:

a. The present value of the minimum lease payments is 90% or more than the fair value of the leased asset.

b. The asset is leased for 75% or more times the economic life of the asset.

c. At th end of the lease, lessee has the option to purchase the asset at a nominal price.

In the given case, present value of lease payments is equal to the fair value of the asset & at the end of the lease period title becomes of the lessee's for nominal price and therefore, such an agreement is a finance lease of the lessee & lessor.

Under finance lease, lessee will record leased asset as an asset in his books of account at the present value of lease payments and at the same time will create a liability of same amount of lease relating to the lease payments to be made.

Journal Entry

Leased Asset............DR.

TO Lease Liability