Your firm is considering leasing a new radiographic device. The lease lasts for 3 years. The lease calls for 4 payments of $25,000 per year with the first payment occurring immediately. The computer would cost $140,000 to buy and would be straight-line depreciated to a zero salvage value over 3 years. The actual salvage value is negligible because of technological obsolescence. The firm can borrow at a rate of 12%. The corporate tax rate is 40%. This lease would be classified as a(n):
A) operating lease because the asset will be obsolete.
B) operating lease because there is no amortization.
C) leveraged lease because it is being financed.
D) capital lease because the lease life is greater than 75% of the economic life.
E) sale and leaseback because the company gets full use of the asset.

Question

Quizplus · Accepted Answer

Based on the given information, the lease qualifies as a capital lease because it meets at least one of the four criteria outlined in FASB ASC 840-10-25-1: the lease term of 3 years is greater than 75% of the asset’s economic life, which is also 3 years (assuming the asset’s useful life is the same as its depreciable life). Additionally, the lease payments cover the majority (more than 90%) of the fair value of the asset, which is another criterion for a capital lease. As a capital lease, the asset and related lease obligations would be recorded on the lessee’s balance sheet, and depreciation expense and interest expense would be recognized on the income statement.

Your Firm Is Considering Leasing a New Radiographic Device