Exhibit 21-5 The Chicago, Inc.entered into a five-year lease with the Urbana Company on January 1, 2010.Chicago, the lessor, will require that five equal annual payments of $25, 000 be made at the beginning of each year.The first payment will be made on January 1, 2010.The lease contains a bargain purchase option price of $12, 000, which the lessee may exercise on December 31, 2014.The lessee pays all executory costs.The cost of the leased property and its normal selling price are $95, 000 and $118, 236, respectively.Collectibility of the future lease payments is reasonably assured, and the lessor does not expect to incur any future costs related to the lease.Present value factors for a 7% interest rate are as follows:
$\begin{array}{llr}
\text { Present value of $ \$ 1 $ for $ n=1 $} &0.934579\
\text { Present value of $ \$ 1 $ for $ n=5 $ } &0.712986\
\text { Present value of an ordinary annuity for $ n=5 $ } &4.100197\
\text { Present value of an annuity due for $ n=5 $ } &4.387211\

\end{array}$

- Refer to Exhibit 21-5.If Chicago requires a 7% annual return, the lease should be classified as a(n)
A)operating lease
B)direct financing lease
C)sales-type lease
D)leveraged lease

Question

Exhibit 21-5 The Chicago, Inc.entered into a five-year lease with the Urbana Company on January 1, 2010.Chicago, the lessor, will require that five equal annual payments of $25, 000 be made at the beginning of each year.The first payment will be made on January 1, 2010.The lease contains a bargain purchase option price of $12, 000, which the lessee may exercise on December 31, 2014.The lessee pays all executory costs.The cost of the leased property and its normal selling price are $95, 000 and $118, 236, respectively.Collectibility of the future lease payments is reasonably assured, and the lessor does not expect to incur any future costs related to the lease.Present value factors for a 7% interest rate are as follows:
$\begin{array}{llr}
  \text {  Present value of \( \$ 1 $ for $ n=1 $} &0.934579\
 \text { Present value of $ \$ 1 $ for $ n=5 $ } &0.712986\
 \text { Present value of an ordinary annuity for $ n=5 $ } &4.100197\
 \text { Present value of an annuity due for $ n=5 $ } &4.387211\

\end{array}\)

- Refer to Exhibit 21-5.If Chicago requires a 7% annual return, the lease should be classified as a(n)
A)operating lease
B)direct financing lease
C)sales-type lease
D)leveraged lease

Quizplus · Accepted Answer

To determine the classification of the lease, we need to compare the present value of the lease payments to the cost of the leased property.

Using the present value factor for a 7% interest rate, we can calculate the present value of the lease payments as follows:

PV = $25,000 x 3.387 = $84,675

The cost of the leased property is $95,000, which is higher than the present value of the lease payments. Therefore, this lease qualifies as a sales-type lease, since the lessor will earn a profit on the lease.

Additionally, the bargain purchase option price of $12,000 allows the lessee to purchase the leased property at a price lower than its normal selling price. This further supports the classification of a sales-type lease.

Exhibit 21-5 the Chicago, Inc - Refer to Exhibit 21-5