On January 1, 2010, Carey, Inc., entered into a noncancellable agreement, agreei

Question

On January 1, 2010, Carey, Inc., entered into a noncancellable agreement, agreeing to pay $3,500 at the end of each year for four years to acquire a new computer system having a market value of $10,200. The expected useful life of the computer is also four years, and the computer will be depreciated on a straight line basis with no salvage value. The interest rate used by the lessor to determine the annual payments was 14 %. Under the terms of the lease, Carey, inc., has an option to purchase the computer for $1 on January 1, 2014.

Explain why Carey inc. should account for the lease as a capital lease rather then an operating lease.

Explanation / Answer

A capital lease allows you to carry an item on your books as if you own it, so any of the reasons for ownership would qualify.

One good reason for opting for a capital lease is that at the end of the term, you may purchase the item for little more than what you've already invested. This is good, if the equipment is well-maintained and could last well beyond its useful life.

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