Question

A lessor has signed a non-cancelable 5-year lease of a warehouse with a lessee:

• The lessor believes that the lessee will make all 5 of the beginning-of-the-year rentals of $62,018 each, i.e., the lessor believes collection of the rentals is probable.

• The structure has an estimated useful life of 40 years, and at the end of the lease, it will be returned to the lessor, who plans to maintain it for storage of idled machinery.

• The warehouse has a fair value of $800,000, and unknown to the lessee, the cost of the property to the lessor was $500,000.

• The lease contains a residual guarantee of $700,000, and unknown to the lessor, the lessee does not expect the residual value to exceed $650,000.

• In setting the terms of the lease, the lessor used a 6% rate of return, although that fact is not known to the lessee, whose borrowing rate is 8% and who is unable to determine the lessor’s implicit rate.

Required—Identify the type of lease the above contract represents to the lessor by applying each of the five lease classification criteria of FASB ASC 842.

Answer 1