ExpertHard1 markMultiple Choice
CPA · Question 14 · Area 2: Select Accounts
On January 1, Year 1, Lessee Corp enters a 10-year lease for a building. Annual payments are $50,000 due at the beginning of each year. The building's useful life is 15 years. The lease grants Lessee an option to purchase the building for $10,000 at the end of the lease, which is significantly below the expected fair value of $200,000. The implicit rate is 5%. How should Lessee classify this lease and amortize the Right-of-Use (ROU) asset?
On January 1, Year 1, Lessee Corp enters a 10-year lease for a building. Annual payments are $50,000 due at the beginning of each year. The building's useful life is 15 years. The lease grants Lessee an option to purchase the building for $10,000 at the end of the lease, which is significantly below the expected fair value of $200,000. The implicit rate is 5%. How should Lessee classify this lease and amortize the Right-of-Use (ROU) asset?
Answer options:
A.
Operating Lease; Amortize over 10 years.
B.
Finance Lease; Amortize over 15 years.
C.
Finance Lease; Amortize over 10 years.
D.
Operating Lease; Amortize over 15 years.
How to approach this question
1. Classify Lease (OWNES criteria). Option to purchase = Finance. 2. Determine Amortization period. If ownership transfers or option exercised -> Useful Life. Otherwise -> Shorter of Lease Term or Useful Life.
Full Answer
B.Finance Lease; Amortize over 15 years.✓ Correct
B
The option to purchase at a significant discount (reasonably certain) makes this a Finance Lease. Since the lessee is expected to acquire the asset, the ROU asset is amortized over the useful life of the asset (15 years), not the lease term.
Common mistakes
Amortizing over the lease term (10 years) despite the purchase option.
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