Download 1) Determine if each lease is an operating or a capital lease. 2) For

1) Determine if each lease is an operating or a capital lease. 2) For each capital lease, identify the
factor or factors that qualify the lease as a capital lease. Include the appropriate calculations to
support your conclusions.
XYZ current borrowing rate is 10%.
All lease payments are made in advance at the beginning of each quarter.
A lease is considered capital lease if any one of the condition is met
(a) the lease life exceeds 75% of the life of the asset
(b) there is a transfer of ownership to the lessee at the end of the lease term
(c) there is an option to purchase the asset at a "bargain price" at the end of the lease term.
(d) the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of
the fair market value of the asset.
I5-4: The XYZ Company entered into the following leasing arrangements, as the lessee, during the
current year: A. XYZ leased a copy machine for 3 years. The fair market value of the machine at the
inception of the lease was $17,500 and XYZ agreed to pay a quarterly lease payment of $1,475. At the
end of the lease the remaining life is estimated to be 2 years and XYZ has the option to purchase the
copy machine for its then estimated fair market value of $5,000.
This is not a capital lease since none of the criteria are met, it would be treated as an
operating lease
(a) the lease life exceeds 75% of the life of the asset
Lease life is 60% of the total life (3/5)
(b) there is a transfer of ownership to the lessee at the end of the lease term
There is not transfer of ownership at end of lease term
(c) there is an option to purchase the asset at a "bargain price" at the end of the lease term.
Machine can be purchased at fair price and not bargain price
(d) the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of
the fair market value of the asset.
PV of lease payment = 1475*PVIFA(12periods, 2.5%) = $15,508.46 which is less than 90% of the
value
B. XYZ leased a mid-range computer for 4 years. The fair market value of the computer at the inception
of the lease was $139,000 and XYZ agreed to pay a quarterly lease payment of $9,000. At the end of the
lease the remaining life is estimated to be 2 years. XYZ has no option to purchase the computer at any
time during the lease term.
This is not a capital lease since none of the criteria are met, it would be treated as an
operating lease
(a) the lease life exceeds 75% of the life of the asset
Lease life is 66.67% of the total life (4/6)
(b) there is a transfer of ownership to the lessee at the end of the lease term
There is not transfer of ownership at end of lease term
(c) there is an option to purchase the asset at a "bargain price" at the end of the lease term.
No option to purchase at bargain price
(d) the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of
the fair market value of the asset.
PV of lease payment = 9000*PVIFA(16 periods, 2.5%) = $120,432.4 which is less than 90% of the
value
C. XYZ leased a new car for 2 years for its president’s use. The fair market value of the car at the
inception of the lease was $65,000 and XYZ agreed to pay a quarterly lease payment of $5,750. At the
end of the lease the remaining life is estimated to be 4 years. XYZ has no option to purchase the car at
any time during the lease term.
This is not a capital lease since none of the criteria are met, it would be treated as an
operating lease
(a) the lease life exceeds 75% of the life of the asset
Lease life is 33.63% of the total life (2/6)
(b) there is a transfer of ownership to the lessee at the end of the lease term
There is no transfer of ownership at end of lease term
(c) there is an option to purchase the asset at a "bargain price" at the end of the lease term.
No option to purchase at bargain price
(d) the present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of
the fair market value of the asset.
PV of lease payment = 5750*PVIFA(8 periods, 2.5%) = $42259 which is less than 90% of the value
D. XYZ leased a delivery truck for 5 years. The fair market value of the truck at the inception of the lease
was $84,000 and XYZ agreed to pay a quarterly lease payment of $4,500. At the end of the lease the fair
market value of the truck is estimated to be $24,000 and the truck’s remaining economic life is
estimated to be 2 years. XYZ has the option to purchase the truck at the end of the lease for $10,000.
This is a capital lease since there is an option to purchase truck fot $10000 less than the fair
market value (Bargain Purchase)
E. XYZ leased a collation machine for 6 years. The fair market value of the machine at the inception of
the lease was $142,000 and XYZ agreed to pay a quarterly lease payment of $6,750. At the end of the
lease, the ownership of the machine transfers to XYZ.
This is a capital lease since at the end of lease the ownership of the machine would be transfered
to XYZ.
F. XYZ leased a widget production machine for 7 years. The fair market value of the machine at the
inception of the lease was $246,000 and XYZ agreed to pay a quarterly lease payment of $11,000. XYZ
has no option to purchase the machine at any time during the lease term.
This is a capital lease since the present value of the lease payments, discounted at an appropriate
discount rate, exceeds 90% of the fair market value of the asset.
PV of Lease payment = 11000*PVIFA(2.5%,28) = 225,104 which is 92% of the current value
(225104/246000 = 92%)