Question

Teal Corporation has signed a 5-year lease for machinery with a cost of $195,000. The asset has an economical life of 9 years with zero salvage value. Annual minimum lease payments made at the end of year are $32,000 and the discount rate is 6%. There is no bargain purchase option available on the lease.

Identify whether the machinery should be treated as an operating or capital lease assuming Teal follows ASPE.

The machinery should be treated as a(n) .

Answer 1

The machinery should be treated as operating lease.

There are four criterias to determine whether a lease is capital lease or operating lease. Any one of the four criterias should be met to calssify a lease as capital lease.

1. A transfer of ownership of the asset at the end of the term.

2. An option to purchase the asset at the end of the lease term at a discounted price.

3. Term of the lease is equal to or greater than 75% of the asset's useful life.

4. Present value of lease payments is equal to or greater than 90% of the asset's fair market value.

Since none of these criterias are not satisfied it is not a capital lease.

There is no indication of trasnfer of ownership in the question.

It is directly stated in the question itself that there is no bargain purchase option.

Term of the lease is only upto 55.5% of the asset's useful life. 5 / 9 = 55.5%

Since there is no market value for the asset present value of lease payments will never be equal to or greater than 90% of the market value.