Accounting For Classification Of The Lease Agreement With Developer Inc.

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Re: Accounting for classification of the lease agreement with Developer Inc.
Tech Startup Inc. (“Lessee”) is entering into a contract with Developer Inc. (“Landlord”) the rent Landlord’s newly constructed office building located at 15 Tech Drive in San Francisco, CA. The lease term is 10 years, and the estimated life of the building is 40 years. Lessee will occupy all 12 floors of the building. At the end of the lease term, Lessee has the option to purchase the property for $16.25 million. The fair value of the building at the time is expected to be $17 million. Monthly, Lessee will be required to pay $50,000 to occupy the building, plus a monthly supplemental rental cost based on Lessee’s sales (1% of sales). From experience, …show more content…

To classify the arrangement, ASC 840-10-25-29 states that “If at its inception a lease meets any of the four lease classification criteria in paragraph 840-10-25-1, the lease shall be classified by the lessee as a capital lease.” On the contrary, if none of the criteria is meet, the lease should be classified as an operating lease (ASC 840-10-25-30)

ASC 840-10-25-1 presents the criteria the Lessee will consider as part of classifying the lease. Each criterion will be analyzed separately to determine if it meets the classification as a capital lease. ASC 840-10-25-1a states:
Transfer of ownership. The lease transfers ownership of the property to the lessee by the end of the lease term. This criterion is met in situations in which the lease agreement provides for the transfer of title at or shortly after the end of the lease term in exchange for the payment of a nominal fee, for example, the minimum required by statutory regulation to transfer title.
It is unclear from the criteria if the purchase option established in the lease will meet the transfer of ownership criterion(a). However, ASC 840-10-25-50 details that such purchase option does not satisfy the transfer of ownership criterion, therefore, criterion (a) is not met.
ASC 840-10-25-1b states “Bargain purchase option. The lease contains a bargain purchase option.” To conclude if criterion (b) is met, ASC

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