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Lease classification

Discount rate Since both the lease payments required during the lease and
the purchase option price are fixed, Lessee Corp can combine
these cash flows with its estimate of the property’s fair value
to determine that the interest rate Lessee Corp incurs during
the lease is 9.04%. However, because Lessee Corp cannot be
sure of Lessor Corp’s estimate of fair value or whether Lessor
Corp realized any investment tax credits with respect to the
property, this rate is not the rate implicit in the lease.
Consequently, Lessee Corp compares the rate to other
evidence of its borrowing rates in similar circumstances, and
concludes that this rate is a reasonable estimate of its
incremental borrowing rate.

Other □ Title to the property remains with Lessor Corp upon lease
expiration

□ Lessee Corp does not guarantee the residual value of the
real estate asset

□ Lessee Corp pays for all maintenance, taxes, and
insurance on the property separate from the lease

□ There are no initial direct costs incurred by Lessee Corp

How should Lessee Corp classify the lease?

Lessee Corp should assess the lease classification using the criteria outlined in ASC 842-10-25-2 and
ASC 842-10-25-3.

Criteria Analysis

Transfer of ownership Ownership of the asset does not transfer to
Lessee Corp by the end of the lease term.

Purchase option which the lessee is reasonably The lease contains an option to purchase the
certain to exercise property for $3,000,000, which is below the
fair value of the real estate asset at lease
commencement and its expected value at the
date of exercise. Options to purchase real estate
at a price below commencement date fair value
are generally considered to be reasonably
certain of exercise since real estate generally
appreciates in value; therefore, a significant
economic incentive to exercise the purchase
option exists.

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