Pepper, Inc. agrees to lease equipment from the Blue Corporation for 10 years at $25,000 at the end of each year. The equipment has a fair value of $175,000 and an estimated useful life of 10 years. The lease includes a guaranteed residual value of $10,000. In addition to the lease payments, Pepper will pay $5,000 per year for a maintenance agreement. Pepper can finance this lease with its bank at a 12% rate. The lessors implicit lease rate, known to the lessee, is 10%. The lessor and the lessee use ASC 840 guidelines for lease accounting.

Present value interest factors are:

10% 12%

PV factor of $1 for 10 periods 0.38554 0.32197

PV factor for ordinary annuity for 10 periods 6.14457 5.65022

The Pepper lease is a/an:

Multiple Choice

A operating lease because the lease value is less than 90% of the fair value of the asset.

B capital lease because the lease value is 90% of the fair value of the asset.

C operating lease because the asset reverts to Blue at the end of the lease.

D capital lease because the lease term is more than 75% of the life of the asset.