Question

Morey Corporation leases a tractor from Equity Leasing with a five-year non-cancelable lease on January 1, 20X1 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. Morey has an excellent credit rating.

5. 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(n)

Answer 1

For Morey (the lessee ), the lease will be treated as Capital Lease because of the following reasons:-

1.) The present value of lease payments are equal to fair value of leased assets , which satisfy the condition for present value of lease payments is greater than or equal to 90% of the assets fair market value.

2.) The term of lease is 5 years and useful lfe is 6 years , which means lease term is 83.33% ( 5/6) of useful life of the assets, which also satisfy the condition of the term of lease is greater than or equal to 75% of the useful life of the asset.