Problem 15-3 Direct financing and sales-type lease; lessee and lessor [LO15-3, 1
ID: 2727862 • Letter: P
Question
Problem 15-3 Direct financing and sales-type lease; lessee and lessor [LO15-3, 15-5, 15-6] Rand Medical manufactures lithotripters. Lithotripsy uses shock waves instead of surgery to eliminate kidney stones. Physicians' Leasing purchased a lithotripter from Rand for $2,040,000 and leased it to Mid-South Urologists Group, Inc., on January 1, 2016. Lease Description: Quarterly lease payments $ 133,126 —beginning of each period Lease term 5 years (20 quarters) No residual value; no BPO Economic life of lithotripter 5 years Implicit interest rate and lessee's incremental borrowing rate 12 % Fair value of asset $ 2,040,000 Collectibility of the lease payments is reasonably assured, and there are no lessor costs yet to be incurred. Required: 1. How should this lease be classified by Mid-South Urologists Group and by Physicians' Leasing?
Explanation / Answer
Solution
Capital lease to lessee or Mid-South Urologists group ; Direct financing lease to lessor or physicians' Leasing
Since the present value of minimum lease payments (same for both the lessor and the lessee) is greater than 90% of the fair value of the asset, the 90% recovery criterion is met.
Calculation of the Present Value of Minimum Lease Payments
Present value of periodic lease payments
$133,126 x 15.32380** = $2039996
(rounded)
** present value of an annuity due of $1: n=20, i=3%
The 75% of useful life criterion is met also. Both additional lessor conditions are met for a capital lease. There is no dealer’s profit because the fair value equals the lessor’s cost.