Question

Poe Inc. enters into a lease agreement as lessor on January 1, 2020, to lease a check-in kiosk to Nat Airlines. The normal selling price is $991,355. The term of the noncancelable lease is ten

years and payments are required at the beginning of each year. The following information relates to this agreement:

1. Nat Airlines has the option to purchase the kiosk for $5,000 when the lease expires at which time the fair value is expected to be $30,000.
2. The airplane has an estimated useful life of twenty years, and a residual value of $30,000 at the end of that time.
3. Nat Airlines will pay all executory costs related to the leased airplane.
4. Annual beginning-of-year lease payments of $120,000 allow Poe to earn a 5% return on its investment. Poe has determined that the collectibility of the lease payments is probable.
5. The kiosk reverts to Poe at the termination of the lease, is not a specialized asset, and has an alternative use.

What type of lease is this to Poe Inc.? Discuss and explain clearly by listing 6 points.

Answer 1

This is a Capital lease.

1. Lessor transfer the ownership to lessee after lease term.

In the given case after lease term of 10 years asset transfer to lessee

2. Option to purchase the asset at a discounted price at the end of the term.

In the given case option for transfer given in $5,000 for an asset having fair value of $30,000

3. The life of lease is greater than or equal to 75% of asset life.

In the given case assets life is 12 years and 75% is 9 years, So 10 years lease is more than 75% of asset life.

4. All day to day / Operational expenses bear by the lessee.

In this case all executory expense are bear by lessee (Airline)

5. The present value of the minimum lease payments (MLP) is equal to or greater than 90% of the fair market value of leased property.

In this case total lease payment are equal to present value after discounting lease payment @ 5%. Further collectibility of the lease payments is probable.

6. The assets under the lease are specialized so that only the lessee is able to utilize them without major changes being made to the assets.

In this case test of specilised asset failed as anyone can be use this asset. It is not specially design for lessee.

But in the basis of first five points it is clear that this is a Capital Leases