Asked by Olayinka Afelumo on May 12, 2024
Verified
Refer to Exhibit 21-5.If Chicago requires a 7% annual return, the lease should be classified as a(n)
A) operating lease
B) direct financing lease
C) sales-type lease
D) leveraged lease
Bargain Purchase Option
An option in a lease agreement that allows the lessee to purchase the leased asset at a price significantly lower than its expected fair market value at the end of the lease term.
Executory Costs
Expenses related to ongoing maintenance and administration of a lease that are neither fixed nor included in the lease payments.
Annual Payments
Yearly amounts paid or received over the term of a financial instrument or agreement.
- Understand the criteria for classifying leases as operating, direct financing, or sales-type leases.
Verified Answer
FA
Fabiola ArguihoMay 17, 2024
Final Answer :
C
Explanation :
To determine the classification of the lease, we need to compare the present value of the lease payments to the cost of the leased property.
Using the present value factor for a 7% interest rate, we can calculate the present value of the lease payments as follows:
PV = $25,000 x 3.387 = $84,675
The cost of the leased property is $95,000, which is higher than the present value of the lease payments. Therefore, this lease qualifies as a sales-type lease, since the lessor will earn a profit on the lease.
Additionally, the bargain purchase option price of $12,000 allows the lessee to purchase the leased property at a price lower than its normal selling price. This further supports the classification of a sales-type lease.
Using the present value factor for a 7% interest rate, we can calculate the present value of the lease payments as follows:
PV = $25,000 x 3.387 = $84,675
The cost of the leased property is $95,000, which is higher than the present value of the lease payments. Therefore, this lease qualifies as a sales-type lease, since the lessor will earn a profit on the lease.
Additionally, the bargain purchase option price of $12,000 allows the lessee to purchase the leased property at a price lower than its normal selling price. This further supports the classification of a sales-type lease.
Learning Objectives
- Understand the criteria for classifying leases as operating, direct financing, or sales-type leases.