Question

United Ltd leases mechanical robots which work mechanically without original thought to a variety of business customers under long-term direct finance leases. United’s implicit rate under these arrangements is 10%.

United leased a robot it purchased for $30,900 to a local publisher, Dickens Ltd, on Dec 31, 2020. The lease contract specified the first annual payment $8,000 was payable on Jan 1, 2021, the commencement of the lease, and each Jan 1 through 2023. The publisher had the option to purchases the robot on Dec 31, 2023, the end of the lease term, for $12,000 when it was expected to have a market value of $19,000. The robot had a useful life of 5 years. Both used the straight-line method for depreciation and their financial year ended Dec 31.

1. What criterion is met so as to classify the lease as a finance lease?

Answer 1

The criterion met to classify the lease as a finance lease is that the lease term covers the major part of the economic life of the asset.

Step-by-step explanation:

The criterion that is met to classify the lease as a finance lease is that the lease term covers the major part of the economic life of the asset. In this case, the robot has a useful life of 5 years, and the lease contract spans from Dec 31, 2020, to Dec 31, 2023, which is a period of 4 years. This fulfills the criterion for the lease to be classified as a finance lease.