There is no transfer of ownership or bargain purchase option
, and the term of the lease is for 73% of the asset's remaining useful life (11 out of 15 years).
2 The lease contains a bargain purchase option
. A bargain purchase option
is a "provision allowing the lessee, at his option, to purchase the leased property for a price which is sufficiently lower than the expected fair value of the property at the date the option becomes exercisable that exercise of the option appears, at the inception of the lease, to be reasonably assured."
At the end of the lease term, the lease calls for a bargain purchase option
by the lessee for a nominal amount.
In the U.S., the criteria for determining whether a lease should be capitalized are: (1) the transfer of ownership at the end of the lease term, (2) a bargain purchase option
that can be exercised by the lessee, (3) a lease term that is equal to or greater than 75 percent of the estimated useful life of the leased asset, or (4) the present value of the lease payments being equal to or greater than 90 percent of the fair market value of the leased asset
The lease does not contain a bargain purchase option
* The lease must not contain a bargain purchase option
This month's column continues with an explanation of a capital lease that includes a bargain purchase option
Under the R&R approach, assets are 1) the receivable calculated as the present value of the estimated lease payments--the minimum lease payment for the lessor does not include any guaranteed residual value when the lessee is not entitled to the residual profits on the residual and does not include any bargain purchase option
, only the lessee's required lease payments are included--using the rate the lessor charges the lessee (generally, the implicit rate in the lease for equipment leases), and 2) the residual derived by subtracting the receivable from the book value of the underlying leased asset, plus any profit and deferred profit.
* A bargain purchase option
is included, exercisable before the end of the lease term.
Bargain Purchase The lease contains a The lease contains a Option bargain purchase option
. bargain purchase option
In leases of land only, however, only a transfer of title or the existence of a bargain purchase option
(criteria (1) or (2) above) would qualify the lease as a capital lease, because, in these cases, ownership of the land is expected to pass to the lessee.
There is much more to be discussed including financial statement reporting and disclosures, and we have not yet considered bargain purchase options
, residual value or sale-leaseback arrangements.