On January 1, 2010, Magnum Company leased equipment for 8 years. The agreement required annual payments of $65,000 at the end of each year. The cost value and the fair value of the lease equipment were $100,000 and
$291,675.90, respectively. The estimated residual value of the lease equipment was $35,000 at the end of the lease, which was not guaranteed by the lessee. The estimated economic life of the leased equipment was 10 years. The lease payments were determined at an amount such that the lessor earned a 15% annual rate of return over the lease period. The leased equipment was returned to the lessor at the end of the lease. Based on the given information, how should the lease be classified?

Question

Quizplus · Accepted Answer

The lease should be classified as a sales-type lease because the fair value of the leased equipment ($291,675.90) is significantly higher than its cost value ($100,000), indicating that the lessor is making a profit on the sale of the equipment. Additionally, the lease term (8 years) is a major part of the equipment's economic life (10 years), and the present value of the lease payments is likely to cover substantially all of the fair value of the leased equipment.

On January 1, 2010, Magnum Company Leased Equipment for 8