Question

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 lessor’s 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.

Answer 1

solution :

OPTION D is the correct option (capital lease because the lease term is more than 75% of the life of the asset)

explanation :

By the tip of every year contract material of the blue organization for 10 years at $25,000 the lessor of lessee's financing payment or lessor's absolute rate will be utilized for PV of yearly lease amounts
Discount Does 10%
Yearly lease amount is $25.000 Annuity portion for 10 years @10%=6.14457
the instant cost of lease amounts = 25.000 x6.14457
=153614.25
Lease contract will be minor of asset fair price or PV of yearly lease amounts,
Secured remaining cost=10.000
Immediate cost Interest part @10% for 10 years,= 0.38554
The present value of remaining value,10.000x 0.38554
= 3855.4
Complete present cost =153614 .25+3855.4
=$157469.65
Beneath ASC 840, the law state's that the lease Is to be recognized a property lease Is the price of stated lease Is 75% or more extra of the fair cost of the asset Therefore, the result Is capital lease because the lease term Is higher than 75% of the life of the asset .