Question

Callaway Golf Co. leases telecommunication equipment from Photon Company. Assume the following data for equipment lease form Photon Company. The lease term is 5 years and requires equal rental payments of $31,000 at the beginning of each year. The equipment has a fair value at the commencement of the lease of $150,000, an estimated useful life of 8 years, and a guaranteed residual value at the end of the lease of $15,500. Photon set the annual rental to earn a rate of return of 6%, and this fact is known to Callaway. The lease does not transfer title or contain a bargain purchase option and is not a specialized asset. How should Callaway classify this lease?

Answer 1

Answer:

This lease is  regarded and classified  as Capital lease.

Explanation:

This lease is  regarded and classified  as Capital lease.

Here, Callaway Golf Co. is the body financing the leased asset but the right ownership is with Photon Company.

Now; the present value of future payment is calculated as:

Present value of future payment =[PVA 6%,5 × Annual payment ]+[PVF 6%,5 × Residual value]

=[4.46511 × 31000] +[0.74726 × 15500]

= 138418.27+ 11582.53

= 150000

However the present value of minimum lease payment is equal or more than 90% fair market value ,as such we therefore conclude that this  lease is a capital lease.