Operating/Capitalize lease.

Scooter has leased equipment for a period of 10 years with the following provisions: * Lease payments \$5,000 per year * Current value of equipment \$45,000 * Estimated useful life of equipment 15 years * Salvage value no salvage value after 15 years At the end of ten years, Scooter has the option to buy the equipment for \$15,000. The discount rate is 10 percent. Scooter should: A) treat this lease as an operating lease. B) capitalize this lease because the present value of the lease payments exceeds 90% of its fair market value. C) capitalize this lease because the lease term is less than 75% of the economic life of the equipment. D) capitalize this lease because it involves a bargain purchase.

B and C aren’t true and if I remember correctly, since there is an option to purchase at the end of the lease you should capitalize the lease. Although, there may be a some criteria about the purchase that the option must meet.

A. Does not meet any of the requirements of a capital lease.

The purchase option thing is only if you are getting the asset at a discount to fair market value I believe, and this doesn’t appear to be the case. I’d lean towards A. but I could be wrong.

After 10 years, the asset would be worth \$15,000. It would not be a bargain purhcase option, it would be a purchase at book value.

I thought there was some criteria for the purchase. Thanks for reminding me. I did think it was quite a coincidence that the PV of lease payments were about 30K leaving the balance of the asset at about 15K.

Niblita75 - how do you get 30K for PV, I was getting 39K??

N = 10 I/YR = 10 PV = ??? PMT = -5000 FV = 0 PV = 30, 722.84 and thats in end mode. I tried it in begin mode to see if that was it but I just get around 33k. Maybe you are using 15 for n?

Thanks Niblita, I was using 15K for FV, stupid me.

A

That means, if the purchase option price equals the book value, then it’s not “bargain” price and thus can’t be classified as Cap Lease? By the way, what should be the difference between bk value and purchase price that would allow it to be classified as Cap Lease? Thanks in advace.

I’m not sure if there is a set price difference to in the bargain purchase option to make it a cap lease. Maybe someone else will know that. In this question, if the purchase option was for \$5000 or even \$10,000 it would probably be a cap lease.

Definitely A. It doesn’t meet any of the criteria, and as mentioned above, the BPO price = Value of machine in 10 yrs.

Hey Guys! Does anyone has an idea about the price for which this equipement would be a bargain option? I mean after 10 years, it will be worth 15000\$, so if the lessee has ths option to get it for 12000\$ for example, will this be a bargain option? Thanks a lot. Malek.

Malek, Yes it would become a BPO.

If it’s worthy of \$15K then, and you have a option to purchase it for \$12K, it surely is an bargain option and hence could be classified as a capital lease… - Dinesh S