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;fairvalueofassetatMay1,2017,$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.)

(b) Discuss the nature of this lease to Lennox Company.

Short answer

Answer

The lease includes a bargain purchase option.

Step-by-step solution

Meaning of BPO

A BPO offers the lessee the option to purchase the leased asset at a price that is much lower than the estimated fair value of the asset and appears relatively certain to exercise the option.

Discussing the nature of the lease to Lennox Company

A bargain-purchase option is included in the lease agreement. From the perspective of the lessor, the lease qualifies as a finance-type lease. The lease is classified as a sales-type lease since the initial amount of the lease receivable (net investment) (which in this case equals the present value of the minimum lease payments, $81,000) exceeds the lessor's cost ($65,000).