Use the following information for questions 54 through 59. (Annuity tables on page 21-25.)
On January 1, 2015, Yancey, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Holt Warehouse Company. Collectibility of lease payments is reasonably predictable and no important uncertainties surround the amount of costs yet to be incurred by the lessor. The following information pertains to this lease agreement.
(a) The agreement requires equal rental payments at the beginning each year.
(b) The fair value of the building on January 1, 2015 is $4,000,000; however, the book value to Holt is $3,300,000.
(c) The building has an estimated economic life of 10 years, with no residual value. Yancey depreciates similar buildings on the straight-line method.
(d) At the termination of the lease, the title to the building will be transferred to the lessee.
(e) Yancey's incremental borrowing rate is 11% per year. Holt Warehouse Co. set the annual rental to insure a 10% rate of return. The implicit rate of the lessor is known by Yancey, Inc.
(f) The yearly rental payment includes $10,000 of executory costs related to taxes on the property.
-From the lessee's viewpoint, what type of lease exists in this case?
A) Sales-type lease
B) Sale-leaseback
C) Capital lease
D) Operating lease

Question

Quizplus · Accepted Answer

This is a capital lease because it meets one of the four criteria under ASC 840-10-25-1, which are:

1. The lease transfers ownership of the property to the lessee by the end of the lease term.
2. The lease contains a bargain purchase option for the property.
3. The lease term is equal to 75% or more of the estimated economic life of the property.
4. The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90% of the fair value of the property.

In this case, the lease transfers ownership of the building to Yancey at the end of the lease term, which means it meets the first criteria and qualifies as a capital lease.

Use the Following Information for Questions 54 Through 59