Question

Each the four independent situations below describes a lease requiring annual lease payments of $30,000. Situation 1 Situation 2 Situation 3 Situation 4 Lease term (years) 4 4 4 4 Asset's useful life (years) 6 6 5 6 Asset's fair value $132,000 $123,000 $129,000 $117,000 Bargain purchase option? No No Yes No Annual lease payments Beg. of yr. End of yr. Beg. of yr. End of yr. Lessor's implicit rate (known by lessee) 5% 5% 7% 6% Lessee's incremental borrowing rate 5% 5% 5% 5% Required: For each situation, determine the appropriate lease classification by the lessee and indicate why.

Answer 1

End of yr А B C D Statement showing classification of lease Particulars Situation 1 Situation 2 Situation 3 Situation 4 Usefull life of asset (Yrs) 6 6 5 6 Lease Term (years) 4 4 4 4 Annual Lease Payment $30,000.00 $30,000.00 $30,000.00 $30,000.00 Payment term Beg.of yr Beg.of yr End of yr Asset Fair Value $132,000.00 $123,000.00 $129,000.00 $117,000.00 Bargain purchase option? No No Yes No Lessor implicit rate 5% 5% 7% 6% Lessee Borrowing rate 5% 5% 5% 5% Classification of Lease would be as follows Annual Lease payment (1) $30,000.00 $30,000.00 $30,000.00 $30,000.00 Discount rate 5% 5% 5% 5% PVAF @5%,For 4 Years (2) 3.7232 3.546 3.7232 3.546 PV of Lease payments (1)*(2) 111696 106380 111696 106696 Lease term as a % of life (lease term/life of asset) 67% 67% 80% 67% % of Lease payments PV of lease payments/fair valu 84.62% 86.49% 86.59% 91.19% Classification of Lease Operating Lease Operating Lease Capital Lease Capital Lease Because,condition Coditions for Because,option Because ,PV of of Capital lease is Capital lease is for purchase of Lease payment is Not satisfied not satisfied asset is available More than 90% of Assets fair value Form16 Sheeti

119 End of yr А B C D Statement showing classification of lease Particulars Situation 1 Situation 2 Situation 3 Situation 4 Usefull life of asset (Yrs) 6 6 5 6 Lease Term (years) 4 4 4 4 Annual Lease Payment $30,000.00 $30,000.00 $30,000.00 $30,000.00 Payment term Beg.of yr End of yr Beg.of yr Asset Fair Value $132,000.00 $123,000.00 $129,000.00 $117,000.00 Bargain purchase option? No No Yes No Lessor implicit rate 5% 5% 7% 6% Lessee Borrowing rate 5% 5% 5% 5% 1 Classification of Lease would be as follows 2 Annual Lease payment (1) $30,000.00 $30,000.00 $30,000.00 $30,000.00 3 Discount rate 5% 5% 5% 5% 4 PVAF @5%,For 4 Years (2) 3.7232 3.546 3.7232 3.546 5 PV of Lease payments (1) * (2) 111696 106380 111696 106696 6 Lease term as a % of life 7 (lease term/life of asset) 67% 67% 80% 67% 8 % of Lease payments 9 PV of lease payments/fair valu 84.62% 86.49% 86.59% 91.19% o Classification of Lease Operating Lease Operating Lease Capital Lease Capital Lease Because,condition Coditions for Because,option Because ,PV of 2 of Capital lease is Capital lease is for purchase of Lease payment is Not satisfied not satisfied asset is available More than 90% of Assets fair value Form16 Sheeti 1 4