On January 1, 2008, Dexter, Inc. signs a 10-year noncancelable lease agreement to lease a storage building from Garr 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 end of each year.
(b) The fair value of the building on January 1, 2008 is $3,000,000; however, the book value to Garr is $2,500,000.
(c) The building has an estimated economic life of 10 years, with no residual value. Dexter 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) Dexter's incremental borrowing rate is 11% per year. Garr Warehouse Co. set the annual rental to ensure a 10% rate of return. The implicit rate of the lessor is known by Dexter, 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 lease qualifies as a capital lease from the lessee's viewpoint because it meets several criteria for capital lease classification: the lease term is equal to the economic life of the asset (10 years), title transfers to the lessee at the end of the lease term, and the lessee knows the implicit rate set by the lessor, which is indicative of a financing arrangement.