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19 January, 19:47

Corinth Co. leased nonspecialized equipment to Athens Corporation for an eight-year period, at which time possession of the equipment will revert back to Corinth. The equipment cost Corinth $16 million and has an expected useful life of 12 years. Its normal sales price is $22.4 million. The present value of the lease payments for both the lessor and lessee is $20.6 million. The first payment was made at the beginning of the lease. How should Athens classify this lease? Why?

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  1. 19 January, 23:37
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    Capital lease

    Explanation:

    1. How should Athens classify this lease?

    Capital lease

    2. Why?

    The reason is that the fair the 90% of the fair value of the asset is less than the present value of the lease payment as shown below:

    The present value of the lease payments = $20.6 million

    The 90% of the fair value of the asset = 90% * $22.4 million = $20.16 million

    Since, the $20.16 million which is the 90% of the fair value of the asset is less than the present value of the lease payment of $20.16 million, the lease is a capital lease.
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