### CFA Practice Question

Which of the following is (are) true?

I. If the lease term exceeds 90% of the economic life, it's a capital lease.
II. If the present value of the MLPs exceeds 75% of the fair value, it is a capital lease.
III. The present value must be calculated at the lessee's incremental borrowing rate.
IV. If the lease does not transfer ownership at the end of the term, it's an operating lease.
A. I & II
B. I only
C. III and IV.
Explanation: Note: In such questions, be very careful about the semantics.
Under GAAP, if the lease term exceeds 75% of the economic value of the property, then it must be classified as a capital lease. Since I satisfies this, it is true.
For II to be true, the "75%" should be replaced by "90%."
The discount rate to be used for present value is the lower of the lessee's incremental borrowing rate and the implicit interest rate of the lessor.
Finally, even if IV is violated, the lease could still be a capital lease provided at least one of the remaining 3 conditions specified by GAAP is satisfied.

### User Contributed Comments9

User Comment
jamiejamie I is wrong, should be 75% II is wrong, should be 90% III is correct IV is misleading, but false, since one of the other conditions could apply to make it a capital lease even if the ownership was not transferred over. the answer is thus, D, only III is correct! B??? What?
shasha all wrong, buddies! jamiejamie gave good explanation on I,II and IV, for III, the analystnotes' explanation is correct. so none is true.
daddylew the answer is definitely B. option I is correct, since 90% > 75% of the asset's economic life. it doesn't match the exact definition in the textbook, but under GAAP, option I would HAVE to be classified as a capital lease.
tianhan good question!
schelsea Yes jamiejamie, if it is more than 75%, it is a capital lease.
The question is tricky by asking "if it exceeds 90%, it is a capital lease"
But I is correct because 90% exceeds 75%. All semantics!
Clude This is just a trick. You getting this wrong doesn't mean you don't understand how to recognize cap lease vs. op lease...
aragarwal amazing trick question!!!..phew..
GBolt93 Yes I is correct for the reasons given. I.e. it's not the definition of the criteria, but it still meets it. III is false because it should be the lessor's borrowing rate not the lessee's.
fobucina This is just plain unadulterated BS...