The lessor must classify a sale-and-leaseback arrangement as a(n)
a. Operating lease or a finance lease
b. Operating lease or a sales-type lease
c. Direct financing lease or a sales-type lease
d. Direct financing lease or an operating lease
The correct answer and explanation is :
The correct answer is:
a. Operating lease or a finance lease
Explanation:
A sale-and-leaseback arrangement is a transaction where the owner of an asset (the seller-lessee) sells an asset to another party (the buyer-lessor) and then leases the same asset back from the buyer. This allows the seller-lessee to retain the use of the asset while receiving the proceeds from the sale. For the lessor, this arrangement involves leasing the asset to the lessee after purchasing it.
When a lessor enters into a sale-and-leaseback arrangement, they must classify the lease under two possible categories based on the terms of the lease: operating lease or finance lease.
Operating Lease:
An operating lease is a lease where the lessor retains the risks and rewards of ownership. The lessor is responsible for maintenance, insurance, and other responsibilities associated with ownership, while the lessee only uses the asset for a specified period. In a sale-and-leaseback arrangement, if the lease agreement does not transfer significant risks and rewards of ownership to the lessee, it will be classified as an operating lease. This could happen if the lease term is relatively short, and there are options like renewal or purchase at a nominal price, which indicate that the lessor will likely retain ownership after the lease.
Finance Lease:
A finance lease (or capital lease) is one where the risks and rewards of ownership are effectively transferred to the lessee. In this case, the lease term is typically long enough to cover most of the asset’s useful life, or there may be an option for the lessee to purchase the asset at a bargain price at the end of the lease. If the terms of the sale-and-leaseback arrangement suggest that the lessor has transferred these risks and rewards to the lessee (for instance, if the lease term is long, or there is a bargain purchase option), the lease would be classified as a finance lease.
Therefore, a sale-and-leaseback arrangement must be classified as either an operating lease or a finance lease depending on the specific terms of the agreement.