Question

Corinth Co. leased nonspecialized equipment to Athens Corporation for an eight-year period, at which time possession of the equipment will revert back to Corinth. The equipment cost Corinth $16 million and has an expected useful life of 12 years. Its normal sales price is $22.4 million. The present value of the lease payments for both the lessor and lessee is $20.6 million. The first payment was made at the beginning of the lease. How should Athens classify this lease? Why?

Answer 1

Capital lease

Step-by-step explanation:

1. How should Athens classify this lease?

Capital lease

2. Why?

The reason is that the fair the 90% of the fair value of the asset is less than the present value of the lease payment as shown below:

The present value of the lease payments = $20.6 million

The 90% of the fair value of the asset = 90% * $22.4 million = $20.16 million

Since, the $20.16 million which is the 90% of the fair value of the asset is less than the present value of the lease payment of $20.16 million, the lease is a capital lease.