Question

On January 1, Plugs Company, a lessee, entered into three non-cancelable leases for new equipment, Lease L, Lease M, and Lease N. None of the three leases transfers ownership of the equipment to Plugs at the end of the lease term. For each of the three leases, the present value at the beginning of the lease term of the lease payments is 75% of the fair value of the equipment. The following information is specific to each lease.

· Lease L does not contain a bargain purchase option. The lease term is equal to 80% of the estimated economic life of the equipment.

· Lease M contains a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.

· Lease N does not contain a bargain purchase option. The lease term is equal to 50% of the estimated economic life of the equipment.

Required:

1. Please show the calculation(s)/discussion of the test you use to answer the following questions:

a. What type of lease is Lease L for the lessee?

b. What type of lease is Lease M for the lessee?

c. What type of lease is Lease N for the lessee?

Answer 1

	Situations normally lead a lease to finance lease are :
A	Lease transfers the ownership of the asset to the lessee by the end of the term.
B	Lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than
	thr fair value at the date the option becomes exercisable such that at the inception of the lease,
	it is reasonably certain that the option will be exercised.(bargain option purchase price)
C	Lease term is for the major part of the economic life of the asset even if title is not tranferred.
	(A threshold limit of 75% or more of economic life)
D	the present value of the lease payments and any residual value guaranteed by the lessee equals
	or exceeds substantially all of the fair value of the asset (90% of the total original cost of the equipment).
E	Leased asset is of specialized nature and only lessee can use it
	a)Lease L is a Finance Lease as it complies Point Number C that is lease term is for more than 75%
	of the economic life.
	b)Lease M is also a Finance Lease as it complies Point Number B .Here the lessee has bargain option
	purchase price.
	c)Lease N is an Operating Lease as it doesn’t comply with any of the above points(A-E).