Under FASB 13, a high present value of minimum lease payments relative to fair market value indicates which classification?

Under FASB 13, a high present value of minimum lease payments relative to fair market value indicates which classification?

• A. Operating lease
• B. Capital lease
• C. Service lease
• D. Financial lease

Answer: (B)

When the present value of minimum lease payments is very high relative to the asset’s fair value, the arrangement is treated as financing rather than simple renting. Under FASB 13, if that present value is at least about 90% of the asset’s fair value, the lease is classified as a capital lease (finance lease). That classification means the lessee records the asset and a corresponding lease liability on the balance sheet, depreciates the asset, and recognizes interest expense on the liability over the lease term. In contrast, operating leases do not capitalize the asset or liability, and payments are expensed as they come. A service lease isn’t accounted for as a lease under this framework. So the high PV relative to fair value points to a capital lease.

When the present value of minimum lease payments is very high relative to the asset’s fair value, the arrangement is treated as financing rather than simple renting. Under FASB 13, if that present value is at least about 90% of the asset’s fair value, the lease is classified as a capital lease (finance lease). That classification means the lessee records the asset and a corresponding lease liability on the balance sheet, depreciates the asset, and recognizes interest expense on the liability over the lease term. In contrast, operating leases do not capitalize the asset or liability, and payments are expensed as they come. A service lease isn’t accounted for as a lease under this framework. So the high PV relative to fair value points to a capital lease.