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Lease classification

substantially all of the fair value of the underlying asset. Accordingly, Lessee Corp has obtained control
of the underlying asset, which is economically similar to Lessor Corp selling the asset to Lessee Corp.

See Example 4-7 for an illustration of the initial recognition and measurement of this type of lease.

EXAMPLE 3-24

Lease classification – real estate lease with a purchase option (lessor)

Lessor Corp enters into a property (land and building) lease with Lessee Corp. The following table
summarizes information about the lease and the leased asset.

Lease term 10 years

Renewal option Five 5-year renewal options
If exercised, the annual lease payments are reset to then
current market rents.

Economic life 40 years

Fair value of the property $5,000,000

Lessor Corp’s carrying value of the
leased property $5,000,000

Purchase option Lessee Corp has an option to purchase the property at the end
of the lease term for $3,000,000.

Annual lease payments The first annual payment is $500,000, with increases of 3%
per year thereafter.

Payment date Annually on January 1

Incentive Lessor Corp gives Lessee Corp a $200,000 incentive for
entering into the lease (payable at the beginning of year 2),
which is to be used for normal tenant improvements.

Rate implicit in the lease Approximately 9.04%

Other □ Title to the property does not automatically transfer to
Lessee 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 Lessor Corp

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