Question

The following facts pertain to a non-cancelable lease agreement between Lennox Leasing Company and Gill Company, a lessee.

Inception date: May 1, 2017

Annual lease payment due at the beginning of each year, beginning with May 1, 2017: \(18,829.49

Bargain-purchase option price at end of lease term: \)4,000.00

Lease term: 5 years

Economic life of leased equipment: 10 years

Lessor’s cost: \(65,000.00; fair value of asset at May 1, 2017, \)81,000.00

Lessor’s implicit rate: 10%; lessee’s incremental borrowing rate 10%

The lessee assumes responsibility for all executory costs.

Instructions

(Round all numbers to the nearest cent.)

(a) Discuss the nature of this lease to Gill Company.

Short answer

Answer

The lease agreement has a bargain-purchase option.

Step-by-step solution

Meaning of Lease Agreement

A lease agreement is referred to as a contract in which one party transfers ownership of a real estate to another party for a certain period of time, subject to certain conditions, in exchange for something of value.

Discussing the nature of the lease

From the lessee's perspective, the lease agreement has a bargain-purchase option and so fits the criteria to be categorized as a finance lease. Furthermore, the present value of the minimum lease payments is practically all (more than 90%) of the asset's fair value.