Classifying Leases

On January $1,$ Lessee Company leases equipment with a fair value of $$2,000$ from Lessor Company for $3$ years, with no renewal options. The estimated life of the equipment is $5$ years and there is no purchase option at the end of the lease term. The annual lease payment is $$700,$ which includes a $$50$ charge for an annual maintenance contract. The first payment is due immediately. Lessee Company$$s incremental borrowing rate is $6\%$ and the lessee is not readily able to determine the lessor$$s implicit interest rate. Title to the equipment remains with the lessor at lease end and the lessee does not guarantee the residual value at lease end.

a$.$ Determine the classification of the lease for Lessee Company. Answer $1$

Finance Lease

b$.$ Determine the classification of the lease for Lessor Company. Answer $2$

Sales$-$Type Lease

Option One Lease Classification Criteria Criterion Met? Analysis

$1.$ Ownership transfer Answer $3$

No

$2.$ Purchase option Answer $4$

No

$3.$ Lease term length Answer $5$

No

Answer $6$

$3$

year lease term is

$60$

of the asset$$s useful life of Answer $7$

$5$

years.

$4.$ Present value of lease payments Answer $8$

Yes

PV of lease payments of Answer $9$

$1,983$

is

$99\mathrm{.}2$

of the asset's fair value of Answer $10$

$2,000$

$.$

$5.$ No alternative use Answer $11$

No