Piper Corporation recently signed a lease for equipment from Photon Inc. The lease term is five years and requires equal rental payments of $32,000

Piper Corporation recently signed a lease for equipment from Photon Inc. The lease term is five years and requires equal rental payments of $32,000 at the beginning of each year. The equipment has a fair value at the lease’s inception of $140,000, an estimated useful life of eight years, and no residual value. Piper pays all executory costs directly to third parties. Photon set the annual rental to earn a rate of return of 8%, and this fact is known to Piper. The lease does not transfer title or contain a bargain purchase option. How should Piper classify this lease using private enterprise GAAP?

The lease does not meet the transfer of ownership test, (the bargain purchase test), or the economic life test [(5 years ÷ 8 years) < 75%] used for PE GAAP. However, it does pass the recovery of investment test. The present value of the minimum lease payments ($32,000 X 4.31213 = $137,988) (or using the alternatives below) is greater than 90% of the FMV of the asset (90% X $140,000 = $126,000). Therefore, Piper should classify the lease as a capital lease.

Excel formula =PV(rate,nper,pmt,fv,type)

Using a financial calculator:
PV	$  ?	Yields $137,988
I	8%
N	5
PMT	$   (32,000)
FV	$ 0
Type	1