Question: The Abilene Company has agreed to pay $100,000 per year for seven years to lease an airplane.
Assume that legal title will not be exchanged and no purchase option is mentioned in the contract. Further assume
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that the life of the plane is judged to be ten years and that the amount to be paid does not approximate the
fair value of the item. The contract is signed on December 31, Year One, with the first annual payment made
immediately. This agreement does not appear to meet any of the four criteria for a capital lease. What financial
accounting is appropriate for an operating lease?
Answer: None of the four criteria for a capital lease is being met in this transaction:
1. Legal ownership is not conveyed to the lessee.
2. No bargain purchase option is included in the contract.
3. The life of the lease is less than 75 percent of the life of asset (7 years/10 years or 70 percent).
4. Payments do not approximate the acquisition value of the asset.
Thus, this lease is recorded as an operating lease. The first annual payment was made immediately to cover the