Question

Walker Company is a manufacturer and lessor of computer equipment. What should be the nature of its lease arrangements with lessees if the company wishes to account for its lease transactions as sales-type leases?

Short answer

One or more requirements must be met for the nature of the lease arrangement, such as lease transfer, bargain purchase option, lease term, and present value equal to more than 90%.

Step-by-step solution

Meaning of Lease Agreement

Lease agreements have a bargaining option. Lease payments are typically estimated as collectables, and there is no significant uncertainty about the lessor’s future expenses. As a result, from the lessor's perspective, the lease qualifies as a capital lease.

Explaining the nature of the lease arrangements

If a manufacturer's or dealer's profit (or loss) exists at the start of the lease and the lease fits one or more of the four parameters specified below, Walker Company may use the sale-type lease strategy.

1. The lessee receives ownership of the property;
2. The lease includes a bargain-purchase option;
3. The lease term is equal to or greater than 75% of the leased asset's estimated economic life; and
4. The present value of the minimum lease payment (excluding executive costs) is equal to or greater than 90% of the leased asset's fair value.

Both of the following requirements must also be met:

1. The collectability of the payments due from the lessee is reasonably foreseeable, and
2. There is no significant uncertainty about the amount of the reimbursable expense to be incurred by the lessee.