ExpertHard1 markMultiple Choice
CPA · Question 35 · Area III: Select Transactions
Granite Corp. leases equipment under a 6-year lease with the following terms:<br/>- Annual lease payments: $50,000 (paid at year-end)<br/>- Granite's incremental borrowing rate: 7%<br/>- Lease term: 6 years<br/>- Equipment's estimated useful life: 10 years<br/>- Equipment's fair value: $350,000<br/>- Present value of lease payments: $238,130<br/><br/>How should Granite classify this lease under ASC 842?
Granite Corp. leases equipment under a 6-year lease with the following terms:<br/>- Annual lease payments: $50,000 (paid at year-end)<br/>- Granite's incremental borrowing rate: 7%<br/>- Lease term: 6 years<br/>- Equipment's estimated useful life: 10 years<br/>- Equipment's fair value: $350,000<br/>- Present value of lease payments: $238,130<br/><br/>How should Granite classify this lease under ASC 842?
Answer options:
A.
Finance lease
B.
Operating lease
C.
Cannot determine without additional information
D.
Short-term lease
How to approach this question
Apply the five ASC 842 finance lease criteria: (1) ownership transfer, (2) purchase option, (3) lease term ≥75% of useful life, (4) PV of payments ≥90% of fair value, (5) specialized asset. If any criterion is met, it's a finance lease; otherwise, it's operating.
Full Answer
B.Operating lease✓ Correct
Under ASC 842-10-25-2, a lease is classified as finance if it meets any of five criteria. This lease fails the key tests: lease term (60% of useful life) < 75% threshold, and PV of payments (68% of fair value) < 90% threshold. No ownership transfer or purchase option is mentioned, so it's an operating lease.
Common mistakes
Miscalculating the percentages, applying old ASC 840 criteria, or not understanding that failing all tests results in operating classification
Practice the full CPA FAR Practice Exam 2
50 questions · hints · full answers · grading
More questions from this exam
Q01Madison Inc. reported the following for Year 1:<br/>- Net income: $200,000<br/>- Depreciation exp...HardQ02Apex Corp. owns a manufacturing facility with the following data at year-end:<br/>- Net carrying ...HardQ03On January 1, Year 1, Corbin Co. enters a 5-year lease for equipment. Annual lease payments of $1...HardQ04Riverview City received a $300,000 grant from the state government restricted exclusively for roa...HardQ05Summit Corp. has the following book-to-tax differences at December 31, Year 1 (enacted tax rate: ...Hard