Question

In order for a lease to be classified as a direct financing lease, the lease must meet the following criteria: select one:

a. ownership of the leased asset transfers to the lessee at the end of the lease term.
b. it is reasonably certain that the lessee will exercise a purchase option.
c. the lease term is a major part of the estimated life of the leased asset.
d. the present value of the lease payments plus the residual guaranteed by a third party equals or exceeds substantially all of the fair value of the leased asset.
e. the leased asset has no alternative use at the conclusion of the lease.
f. all of the above.
g. none of the above.

Answer 1

The correct answer is (d) the present value of the lease payments plus the residual guaranteed by a third party equals or exceeds substantially all of the fair value of the leased asset. This criterion is necessary for a lease to be classified as a direct financing lease.

Step-by-step explanation:

In order for a lease to be classified as a direct financing lease, certain criteria must be met. The correct criterion that must be met is (d) the present value of the lease payments plus the residual guaranteed by a third party equals or exceeds substantially all of the fair value of the leased asset. This suggests that the upfront and residual value of the payments by the lessee cover most of the leased asset's value, allowing the lessor to recover the investment and earn a profit. In contrast, a transfer of ownership or a reasonable certainty that the lessee will exercise a purchase option relates to a capital lease.


The lease term being a major part of the estimated life of the leased asset, the leased asset having no alternative use, or a third party guarantee are also considerations but do not exclusively classify a lease as a direct financing lease.