QuestionAugust 24, 2025

2. BE21-1 Callaway Golf Co lesses telecommunication equipment. Assume the following data for equip- mentleased from 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 inception of the lease of 138,000 an estimated useful life of 8 years, and no residual value. Callaway pays all executory costs directly to third parties. Photon set the annual rental to earn a rate of return of 10% and this fact is known to Callaway. The lease does not transfer title or contain a bargain-purchase option. How should Callaway classify this lease?

2. BE21-1 Callaway Golf Co lesses telecommunication equipment. Assume the following data for equip- mentleased from 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 inception of the lease of 138,000 an estimated useful life of 8 years, and no residual value. Callaway pays all executory costs directly to third parties. Photon set the annual rental to earn a rate of return of 10% and this fact is known to Callaway. The lease does not transfer title or contain a bargain-purchase option. How should Callaway classify this lease?
2. BE21-1 Callaway Golf Co lesses telecommunication equipment. Assume the following data for equip- mentleased from 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 inception of the lease of 138,000 an estimated useful life of 8 years, and no residual value. Callaway pays all executory costs directly to third parties. Photon set the annual rental to earn a rate of return of 10% and this fact is known to Callaway. The lease does not transfer title or contain a bargain-purchase option. How should Callaway classify this lease?

Solution
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Answer

Callaway should classify this lease as an operating lease. Explanation 1. Determine Lease Classification Criteria A lease is classified as a finance lease if it meets any of the following criteria: transfer of ownership, bargain purchase option, lease term for major part of economic life, present value of lease payments equals or exceeds fair value, or specialized nature. 2. Evaluate Transfer of Ownership and Bargain Purchase Option The lease does not transfer ownership nor contain a bargain-purchase option. 3. Assess Lease Term vs. Economic Life Lease term is 5 years; economic life is 8 years. 5/8 = 62.5\%, which is less than the "major part" threshold (typically 75%). 4. Calculate Present Value of Lease Payments Use **Present Value of Annuity Formula**: PV = R \times \left(1 - (1 + r)^{-n}\right) / r. R = 31,000, r = 10\%, n = 5. Since payments are at the beginning, adjust by multiplying by (1 + r). PV = 31,000 \times \left(1 - (1 + 0.10)^{-5}\right) / 0.10 \times (1 + 0.10). 5. Compare Present Value to Fair Value Calculate PV: PV = 31,000 \times 3.79079 \times 1.10 = 129,000.69. 129,000.69 < 138,000, so PV does not equal or exceed fair value. 6. Conclusion on Lease Classification None of the finance lease criteria are met.

Explanation

1. Determine Lease Classification Criteria<br /> A lease is classified as a finance lease if it meets any of the following criteria: transfer of ownership, bargain purchase option, lease term for major part of economic life, present value of lease payments equals or exceeds fair value, or specialized nature.<br /><br />2. Evaluate Transfer of Ownership and Bargain Purchase Option<br /> The lease does not transfer ownership nor contain a bargain-purchase option.<br /><br />3. Assess Lease Term vs. Economic Life<br /> Lease term is 5 years; economic life is 8 years. $5/8 = 62.5\%$, which is less than the "major part" threshold (typically 75%).<br /><br />4. Calculate Present Value of Lease Payments<br /> Use **Present Value of Annuity Formula**: $PV = R \times \left(1 - (1 + r)^{-n}\right) / r$.<br /> $R = 31,000$, $r = 10\%$, $n = 5$. Since payments are at the beginning, adjust by multiplying by $(1 + r)$.<br /> $PV = 31,000 \times \left(1 - (1 + 0.10)^{-5}\right) / 0.10 \times (1 + 0.10)$.<br /><br />5. Compare Present Value to Fair Value<br /> Calculate $PV$: $PV = 31,000 \times 3.79079 \times 1.10 = 129,000.69$.<br /> $129,000.69 < 138,000$, so PV does not equal or exceed fair value.<br /><br />6. Conclusion on Lease Classification<br /> None of the finance lease criteria are met.
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