Chapter 18, Problem 2JC

Judgment Case 2: Lease Classification

On January 1, 2019, Lessee Company leased a piece of machinery from Lessor Bank. The machinery could also be used by other parties. The 14-year lease requires payments of $250,000 due at the beginning of each year. The lease agreement does not transfer ownership of the machinery nor does it contain a purchase option. Lessor Bank anticipates that the asset will have a residual value at the end of the lease term, but this value is not guaranteed by Lessee or a third party. The machinery has a fair value of $2,628,000 and an estimated life of 19 years. Lessor Bank's implicit rate is 7% and is known by Lessee Company.

Do you think Lessee should classify this as an operating lease or a finance lease? Explain your answer.