Jonathan Corporation enters into a lease contract as lessor on January 1, 2008, to lease an airplane to Nelly Airlines. Term of the contract is eight years, noncancelable, and payments are at the end of each year. The information below relates to this lease agreement.
- Nelly Airlines has the option to purchase the airplane for $13,500,000. The fair value at time the lease expires is expected to be $22,500,000.
- The airplane cost to Jonathan Corporation is $57,000,000, the useful life is estimated for 40 years with no salvage value at the end of that time (due to technological obsolescence).
- Nelly Airlines will pay all executory costs related to the airplane.
- Annual year-end lease payments of $8,649,638 allow Jonathan Corporation to earn an 8% return on its investment.
- Collectibility of the payments is reasonably predictable, and there are no important uncertainties surrounding the costs yet to be incurred by Jonathan Corporation.
InstructionsWhat type of lease is this? Discuss.
Solution
The lease is a direct-financing type lease from the perspective of lessor or a capital lease from the perspective of lessee. The lease contains a bargain purchase option which satisfies one of the criteria for classification as a direct-financing lease. The option to buy for $13,500,000 at the termination of the lease when the asset is expected to have a fair value of $22,500,000 constitutes a bargain purchase option. Additionally, the payments are collectible, and there are no uncertainties as to future lessor costs.
