Blue Incorporated leases a piece of equipment to Larkspur Corporation on January 1, 2020. The lease agreement called for annual rental payments of $4,569 at the beginning of each year of the 4-year lease. The equipment has an economic useful life of 6 years, a fair value of $24,300, a book value of $19,300, and both parties expect a residual value of $8,250 at the end of the lease term, though this amount is not guaranteed. Blue set the lease payments with the intent of earning a 4% return, and Larkspur is aware of this rate. There is no bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a specialized nature.

Required:

Determine the nature of the lease to both Blue and Larkspur.

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18 March, 15:18

Blue Incorporated leases a piece of equipment to Larkspur Corporation on January 1, 2020. The lease agreement called for annual rental payments of $4,569 at the beginning of each year of the 4-year lease. The equipment has an economic useful life of 6 years, a fair value of $24,300, a book value of $19,300, and both parties expect a residual value of $8,250 at the end of the lease term, though this amount is not guaranteed. Blue set the lease payments with the intent of earning a 4% return, and Larkspur is aware of this rate. There is no bargain purchase option, ownership of the lease does not transfer at the end of the lease term, and the asset is not of a specialized nature.

Required:

Determine the nature of the lease to both Blue and Larkspur.

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Layne Horne · Answer 1

This is a capital lease to Larkspur Corporation since the lease term is greater than75% of the economic life of the leased asset. The lease term is 67% (4 : 6) of the asset's economic life.

This is a capital lease to Blue Incorporated because the collectibility of the lease payments is reasonably predictable, there are no important uncertainties surrounding the costs yet to be incurred by the lessor, and the lease term is greater than 75% of the asset's economic life. Since the fair value ($24,300) of the equipment exceeds the lessor's cost ($19,300) the lease is a sales-type lease.