Question 1 Crane Co. processes jam and sells it to the public. Crane leases equi

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Question 1 Crane Co. processes jam and sells it to the public. Crane leases equipment used in its production processes from Larkspur, Inc. This year, Crane leases a new piece of equipment from Larkspur. The lease term is 5 years and requires equal rental payments of $18,000 at the beginning of each year. In addition, there is a renewal option to allow Crane to keep the equipment one extra year for a payment at the end of the fifth year of $14,000 (which Crane is reasonably certain it will exercise). The equipment has a fair value at the commencement of the lease of $87,146 and an estimated useful life of 7 years. Larkspur set the annual rental to earn a rate of return of 8%, and this fact is known to Crane. The lease does not transfer title, does not contain a bargain purchase option, and the equipment is not of a specialized nature. Click here to view the factor table. How should Crane classify this lease? Crane should classify the lease as a/an lease. Question Attempts: o of 1 used SAVE FOR LATERSUBMIT ANSWER SUBMIT ANSWER

Explanation / Answer

Definition of Lease: A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.

Finance Lease: A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.

Operating Lease: An operating lease is a lease other than a finance lease.

Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are:

a. the lease transfers ownership of the asset to the lessee by the end of the lease term;

b. the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that
the option will be exercised;

c. the lease term is for the major part of the economic life of the asset even if title is not transferred;

d. at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and

e. the leased assets are of such a specialised nature that only the lessee can use them without major modifications.

Indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease are:

i. if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee;

ii. gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for example, in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and

iii. the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.

Since in this question useful life of the asset is 7 years and lease period is 5 year hence lease term is for the major part of the economic life of the asset even if title is not transferred; will be classifies as finance lease.

Also present value of minimum lease payment amounts tis equal to the fair value of the leased asset hence will be classifies as finance lease.

Even though bargain purchase option is not there and equipment doesnt have speciliazed nature it will be classified as finance lease because condition (c) and (d) listed above has been met.

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