Ford signs a non-cancelable 8-year equipment lease with Ray. The lease has an implicit rate of return of 10% to Ray, the lessor. This rate is known to Ford. Rays incremental borrowing rate is 8.5%. Ford has a 9% incremental borrowing rate. Ray believes that the equipment has a 10-year service life but has reason to suspect that a major overhaul might be required in the fifth to seventh year. Since this is the first year of the equipments production, Ray warrants equipment for eight full years anyway. The lessor and the lessee use ASC 840 guidance for lease accounting.

Assuming that the lease is a capital lease for Ray, which one of the following interest rates will Ray use to record this lease?

Multiple Choice

A Use 8.5% because it is the lessors incremental borrowing rate.

B Use 9.0% because it is the lessees incremental borrowing rate.

c Use 10.0% because it is the implicit lease rate of return to the lessor.

D Use 8.5% because it is the lesser of the implicit rate and Rays incremental borrowing rate.