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Lease classification

Lessee Corp should classify the lease as a finance lease because, at lease commencement, the fixed
price purchase option available to Lessee Corp at the end of the initial lease term (i.e., after 10 years) is
reasonably certain to be exercised by Lessee Corp. As a result, Lessee Corp has effectively obtained
control of the underlying asset. The lease also has payments equal to substantially all of the fair value
of the underlying asset.

See Example 4-3 for an illustration of the initial recognition and measurement of this type of lease.

3.5.2 Operating leases

EXAMPLE 3-20

Lease classification – automobile lease (lessee)

Lessee Corp leases an automobile from Lessor Corp. The following table summarizes information
about the lease and the leased asset.

Lease term 3 years, no renewal option

Economic life of the automobile 6 years

Purchase option Lessee Corp has the option to purchase the automobile at fair
market value upon expiration of the lease.

Monthly lease payments $500

Payment date Beginning of the month

Lessee Corp’s incremental 6%
borrowing rate
The rate Lessor Corp charges Lessee Corp in the lease is not
readily determinable by Lessee Corp.

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

□ The fair value of the automobile is $30,000; Lessee Corp
does not guarantee the residual value of the automobile at
the end of the lease term
□ Lessee Corp pays for all maintenance of the automobile
separate from the lease
□ There are no initial direct costs incurred by Lessee Corp

□ Lessor Corp does not provide any incentives

How should Lessee Corp classify the lease?

3-45