Morey Corporation leases a tractor from Equity Leasing with a five-year non-cancelable lease on January 1, 2014 under the following terms:
1. Five payments of $26,379.74 (a 9% implicit rate, known to Morey) due at the end each year.
2. The payments were calculated based on the fair value (which is also the book value for Equity) of the tractor.
3. The lease is nonrenewable and the tractor reverts to Equity at the end of the lease term.
4. The tractor has a six-year economic life.
5. Morey has an excellent credit rating.
6. Equity offers no warranty on the tractor other than the manufacturer's two-year warranty that is handled directly with the manufacturer.
-For Morey,this lease is treated as a/an
A)operating lease.
B)capital lease.
C)direct financing capital lease.
D)sales-type capital lease.

Question

Quizplus · Accepted Answer

This lease should be treated as a capital lease for Morey. The lease term is for five years, which is greater than 75% of the six-year economic life of the tractor, indicating that the lease term is for a major part of the life of the asset. Additionally, the lease payments are based on the fair value (book value) of the tractor, and the implicit rate is known to Morey. This makes it likely that the present value of the lease payments is approximately equal to or exceeds 90% of the fair value of the tractor, which is another criterion for classification as a capital lease. Finally, the lease is nonrenewable and the tractor reverts to Equity at the end of the lease term, which indicates that there is a transfer of ownership from the lessor to the lessee at the end of the lease term.

Morey Corporation Leases a Tractor from Equity Leasing with a Five-Year