Question

On December 31, 2019, Kingbird Corporation signed a 5-year, non-cancelable lease for a machine. The terms of the lease called for Kingbird to make annual payments of $7,924 at the beginning of each year of the lease, starting December 31, 2019. The machine has an estimated useful life of 6 years and a $5,200 unguaranteed residual value. The machine reverts back to the lessor at the end of the lease term. Kingbird uses the straight-line method of depreciation for all of its plant assets. Kingbird’s incremental borrowing rate is 2%, and the lessor’s implicit rate is unknown.

Required:
What type of lease is this?

Answer 1

The lease is operating lease.

Step-by-step explanation:

There are two types of leases:

Operating lease and Finance lease.

For qualifying a lease as a finance lease certain conditions must be met,

1. The lessee will get the ownership of the asset

2. Lessee may have bargain purchase option at the end of lease term

3. Asset is leased for majority of its life.

In the given case the asset is leased for majority of the life of asset but the ownership of asset is not transferred at the end of the lease term. The conditions for qualifying lease as a finance lease are not met.