What is a ‘Bargain Purchase Option’
A bargain purchase option is a clause in a lease agreement that allows the lessee to purchase the leased asset at the end of the lease period at a price substantially below its fair market value. The bargain purchase option is one of four criteria under the Financial Accounting Standards Board (FASB) Statement No. 13, any one of which, if satisfied, would require the lease to be classified as a capital or financing lease that must be disclosed on the lessee’s balance sheet. The objective of this classification is to prevent off-balance sheet financing by the lessee.
BREAKING DOWN ‘Bargain Purchase Option’
FASB defines a bargain purchase option as a provision that allows a lessee to purchase the leased property “for a price which is sufficiently lower” than the expected fair value at the date that the option can be exercised. As an example, assume that the value of an asset at the end of the lease period is estimated at $100,000, but the lease agreement has an option that enables the lessee to purchase it for $70,000. This would be considered a bargain purchase option and would require the lessee to treat the lease as a capital lease.
Accounting for a Lease with Bargain Purchase Option
There are significant differences in the accounting treatment of capital leases versus operating leases. If a lease has a bargain purchase option, the lessee must record the asset as a capital lease in an amount equal to the present value of all minimum lease payments over the lease term. During the lease term, each minimum lease payment should be allocated between a reduction of the lease obligation and interest expense. Capital leases and their accumulated amortization must be disclosed on the balance sheet or in the notes to the consolidated financial statements.