Indicate which of the following leases would be a capital (financing) lease and
ID: 2470543 • Letter: I
Question
Indicate which of the following leases would be a capital (financing) lease and which would be an operating lease: 1. Rental of a warehouse for $10,000 per month, renewable annually. 2. Rental of a crane for $9,000 per month on a 6-year lease, with an option to buy for $10,000 at the end of the 6 years when its fair value is $150,000. 3. Rental of an automobile on a 6-month lease for $500 per month. The auto will be returned to the dealer after the 6 months. 4. Rental of a computer for $500 per month on a 5-year lease. At the end of 5 years, the computer is expected to have a fair market value of zero. 5. Rental of 10 forklifts for $1,400 per month on an 8-year lease. The value of the forklifts at the end of 8 years is uncertain, but the total economic life is not expected to be more than 10 years.Explanation / Answer
A lease should be recorded as a capital lease if any of the following four criteria is contained in the lease agreement.
The ownership of lease asset will be transferred to the leasee by the end of the lease term.
At the end of the lease term, the leasee can purchase the lease asset from the lessor a price that is less than the market price of the asset.
The lease term encompasses at least 75% of the useful life of the lease asset and the lease cannot be cancelled during this time period.
The present value of the minimum lease payments required under the lease is at least 90% of the fair value of the asset at the inception of the lease.
If the lease agreement does not contain any of the above criteria it should be recorded as an operating lease.
On the basis of the above information, it can be easily decided which of the given leases are capital lease and which ones are operating lease.
1. Operating lease - None of the four criteria of capital lease is fulfilled.
2. Capital lease - At the end of the lease term, the leasee can purchase the lease asset from the lessor a price that is less than the market price of the asset.
3. Operating lease - None of the four criteria of capital lease is fulfilled.
4. Operating lease - None of the four criteria of capital lease is fulfilled.
5. Capital lease - The lease term encompasses 75% of the useful life of the lease asset