As I understand, leases are capital leases if there is a bargain purchase option to purchase to allow leasee to purchase the leased asset significantly lower than fair value of the asset… Talk 4 Free, an internet phone company, has recently signed a 4-year lease for $12 million of equipment. The lease payments are $2.5 million annually. The estimated life of the equipment is 6 years. After 4 years, they will have the option to purchase the equipment for $4 million. The lease would most correctly be classified as a(n): A) capital lease. B) sales-type lease. C) direct-financing lease. D) operating lease. Your answer: A was incorrect. The correct answer was D) operating lease. The lease fails to meet any of the criteria necessary to be classified as a capital lease. Sales-type and direct-financing leases are types of capital leases so the lease also fails to meet the criteria for these types of leases. Therefore we must classify the lease as an operating lease. Is it an operating lease because after four years, you can pay 4 million dollars for the equipment which is fair value (assuming SL depreciation) and therefore not a “significant discount” to fair value? Thanks.
Well, yes. That and because it doesn’t meet any of the other conditions to be a capital lease either.