Question

Sandhill Corp. is a manufacturer of truck trailers. On January 1, 2021, Sandhill Corp. leases 9 trailers to Blue Company under a 5-year noncancelable lease agreement. The following information about the lease and the trailers is provided:

1.		Equal annual payments that are due on January 1 each year provide Sandhill Corp. with an 11% return on net investment.
2.		Titles to the trailers pass to Blue at the end of the lease.
3.		The fair value of each trailer is $51,600. The cost of each trailer to Sandhill Corp. is $46,500. Each trailer has an expected useful life of nine years.
4.		Collectibility of the lease payments is probable. What type of lease is this for the lessor?

Answer 1

Solution

Sandhill Company

What type of lease is this for the lessor:

Lessor, Sandhill Company needs to classify the lease as either finance lease or operating lease.

The lease is a finance lease for lessor.

Reasons and explanation:

Transfer of risks and rewards. – title to the trailers passes to Blue Company at the end of the lease. Hence, Sandhill would treat the lease as finance or capital lease.

The criteria to classify lease as finance lease –

At least one of the following conditions must be met –

1. Title transfers to lessee at the end of the lease term.

2. The terms allow lessee to purchase the leased asset at a price lower than the fair price.

3. Lease terms is 75% or more of the economic life of asset.

4. Lease term where the present value of minimum payments equal to fair value of leased asset.

From the above criteria,

The first one is satisfied as the title to the trailers is transferred to the lessee at the end of the lease.