Question

I know the answer is choice b. is the lessee in a capital lease. I was told the lease term was 7 years, but how can that be possible. The amount of years between Dec 31, 2015 to Dec 31, 2021 is 6 years. 6 years doesn't satisfy the 75% of useful life rule. (6/9=66.67% which is not greater than 75%) , is there any other way to distinguish this as a capital lease? explain please? thanks.

  On December 31, 2015, Reagan Inc. signed a lease for some equipment having a nine-year useful life

with Silver Leasing Co. The lease payments are made by Reagan annually, beginning at signing date.
Title does not transfer to the lessee, so the equipment will be returned to the lessor on December 31,
2021. There is no bargain purchase option, and Reagan guarantees a residual value to the lessor on
termination of the lease.
Reagan lease amortization schedule appears below:

Dec 31	Payments	Interest	Decrease Balance	Balance
2015				$519,115
2015	$90,000		$90,000	$429,115
2016	$90,000	$17,165	$72,835	$356,280
2017	$90,000	$14,251	$75,749	$280,531
2018	$90,000	$11,211	$78,779	$201,752
2019	$90,000	$8,070	$81,930	$119,822
2020	$90,000	$4,793	$85,207	$34,615
2021	$36,000	$1,385	$34,615	$0

In this situation, Reagan:
a. is the lessee in a sales-type lease.
b. is the lessee in a capital lease.
c. is the lessor in a capital lease.
d. is the lessor in a sales-type lease.

Answer 1

Solution:

A lease that meets one of the following criteria is classified as capital lease:

1. The lease transfer the ownership of the property at the end of lease term.

2. The lease contains a bargain purchase option

3. The lease term is equal to 75% or more of the estimated economic life of the leased property.

4. The present value of minimum lease payment is atleast 90% of fair value of leased property to the lessor.

In the given scenario, Lease term is 67% of economic life of property and does not transfer ownership and bargain purchase option at the end of lease term.

However if present value of minimum lease payment is 90% of fair value of asset then only it can be considered as a capital lease.

This is only other way,to distinguish this as a capital lease. Please check wheterh fair value of assets is available and present value of minimum lease payment is 90% or more of fair value, then Reagan is the lessee in a capital lease"