The Shifting Sands Company has negotiated to lease a piece of equipment. The equipment has a useful life of 10 years. The lease is non-cancellable but there is only a minor penalty if the lessee returns the equipment before the expiry of the lease. The lease terms provide that the lease is over five years and the present value of the minimum lease payments is 60% of the fair value of the asset at the commencement of the lease. Shifting Sands records the lease payments as an expense in the statement of comprehensive income. Based on this information, which of the following statements is correct?
A) Assets and liabilities are understated as the lease should be a finance lease.
B) Assets and liabilities are not affected as the lease is an operating lease.
C) The non-cancellable nature of the lease determines that it should be a finance lease.
D) There is insufficient information to determine whether the lease is a finance or an operating lease.

Question

Quizplus · Accepted Answer

The lease is classified as an operating lease because the present value of the minimum lease payments is less than 90% of the fair value of the asset, and the lease term is less than 75% of the asset's useful life.

The Shifting Sands Company Has Negotiated to Lease a Piece