Determining Types of Leases
Response to the following problem:
Rigdon Company leases 50 acres of land to Christmas Tree International on January 1, 2010. The provisions of the lease are as follows:
The lease is noncancelable and has a term of 25 years. The annual rentals are $10,000, payable at the end of each year. The lease contains no bargain purchase option and the land reverts to Rigdon at the end of the lease. The incremental borrowing rate of Christmas Tree International is 12%.
The cost of the land to Rigdon Company is $60,000. The fair value is $78,431.39. The lessor incurs no material initial direct costs. The collectibility of the rentals is reasonably assured, and there are no important uncertainties surrounding the amount of unreimbursable costs yet to be incurred by the lessor.
Required
1. Determine the classification of this lease for both the lessor and the lessee.
2. Why are the final two criteria (lease term 75% of economic life and present value of lease payments 90% of fair value) not applicable when classifying a lease of land?