On January 1, 2018, Jones AutoWorld, Inc. leases an SUV to Mains Company. The lease term is 4 years with no renewal options and the economic life of the SUV is 7 years. The fair value of the automobile is $65,000 and Jones' cost or carrying value is also $65,000. There are no lease incentives. The lease calls for monthly payments of $800 at the end of each month. Mains incurs initial direct costs of $2,400 on January 1, 2018. The implicit rate in the lease is 5%. There is no transfer of ownership at the end of the lease term. Lease payment collection is probable.
To determine whether Jones, the lessor, should classify the lease as operating, direct financing, or sales-type, we assess both Group I and Group II criteria. Complete the below table and draw a conclusion about how the lease should be classified.
$\begin{array}{|l|l|c|}
\hline\text{ Group I Criteria } &\text{ Met?}&\text { Explanation } \
\hline \text{Transfer of ownership? }& \
\hline\text{ Purchase option likely to be exercised? }& \
\hline \text{Lease term major part of economic life?} & \
\hline \text{Present value substantial part of fair value? }& \
\hline\text{ Asset is specialized? }& \
\hline & \
\hline \text{Group II Criteria} & \
\hline\text{ Present value including third-party guarantees} & \
\text{substantially all of fair value? }& \
\hline\text{ Lease payment collection probable?} &\
\hline
\end{array}$

Question

On January 1, 2018, Jones AutoWorld, Inc. leases an SUV to Mains Company. The lease term is 4 years with no renewal options and the economic life of the SUV is 7 years. The fair value of the automobile is $65,000 and Jones' cost or carrying value is also $65,000. There are no lease incentives. The lease calls for monthly payments of $800 at the end of each month. Mains incurs initial direct costs of $2,400 on January 1, 2018. The implicit rate in the lease is 5%. There is no transfer of ownership at the end of the lease term. Lease payment collection is probable.
To determine whether Jones, the lessor, should classify the lease as operating, direct financing, or sales-type, we assess both Group I and Group II criteria. Complete the below table and draw a conclusion about how the lease should be classified.
 $\begin{array}{|l|l|c|}
\hline\text{ Group I Criteria } &\text{ Met?}&\text { Explanation } \
\hline \text{Transfer of ownership? }& \
\hline\text{ Purchase option likely to be exercised? }& \
\hline \text{Lease term major part of economic life?} & \
\hline \text{Present value substantial part of fair value? }& \
\hline\text{ Asset is specialized? }& \
\hline & \
\hline \text{Group II Criteria} & \
\hline\text{ Present value including third-party guarantees} & \
\text{substantially all of fair value? }& \
\hline\text{ Lease payment collection probable?} &\
\hline
\end{array}$

Quizplus · Accepted Answer

The Answer of On January 1, 2018, Jones AutoWorld, Inc. leases an SUV to Mains Company. The lease term is 4 years with no renewal options and the economic life of the SUV is 7 years. The fair value of the automobile is $65,000 and Jones' cost or carrying value is also $65,000. There are no lease incentives. The lease calls for monthly payments of $800 at the end of each month. Mains incurs initial direct costs of $2,400 on January 1, 2018. The implicit rate in the lease is 5%. There is no transfer of ownership at the end of the lease term. Lease payment collection is probable.
To determine whether Jones, the lessor, should classify the lease as operating, direct financing, or sales-type, we assess both Group I and Group II criteria. Complete the below table and draw a conclusion about how the lease should be classified.
 $\begin{array}{|l|l|c|}
\hline\text{ Group I Criteria } &\text{ Met?}&\text { Explanation } \
\hline \text{Transfer of ownership? }& \
\hline\text{ Purchase option likely to be exercised? }& \
\hline \text{Lease term major part of economic life?} & \
\hline \text{Present value substantial part of fair value? }& \
\hline\text{ Asset is specialized? }& \
\hline & \
\hline \text{Group II Criteria} & \
\hline\text{ Present value including third-party guarantees} & \
\text{substantially all of fair value? }& \
\hline\text{ Lease payment collection probable?} &\
\hline
\end{array}$