Bargain Renewal Option

Definition of Bargain Renewal Option

A Bargain Renewal Option is a provision in a lease agreement that allows the lessee to renew the lease term at a rate that is exceptionally favorable compared to the fair market rental rate. This option is often set at a considerably low rate, making it an attractive offer for the lessee. This feature can impact the classification of a lease, potentially resulting in its categorization as a capital lease instead of an operating lease.

Examples

Office Space Lease: A company leasing office space at $10 per square foot per year has an option to renew the lease for an additional term at $5 per square foot per year, while the market rate is $12 per square foot.
Equipment Lease: A manufacturing company leases machinery with an option to renew the lease at 50% of the prevailing market rate. As the lease end approaches, the actual market rate is $10,000 annually, but the bargain renewal option allows renewing at $5,000 per year.

Frequently Asked Questions (FAQs)

What is the impact of a bargain renewal option on lease classification?

A Bargain Renewal Option can cause a lease to be classified as a Capital Lease rather than an Operating Lease due to the potential financial benefit to the lessee.

How does a bargain renewal option benefit the lessee?

It provides an opportunity to continue using the leased asset at a significantly lower cost than prevailing market rates, offering substantial savings.

Can a bargain renewal option be negotiated out of a lease?

Yes, both parties can renegotiate the lease terms, and the inclusion or exclusion of a bargain renewal option can be part of these discussions.

Capital Lease: A lease considered to have the economic characteristics of asset ownership.
Operating Lease: A lease whose duration is significantly shorter than the life of the asset, where the ownership stays with the lessor.
Lessee: The party that obtains the right to use an asset under a lease agreement.
Lessor: The party that grants the right to use an asset under a lease agreement.
Lease Agreement: A contract in which the lessor agrees to allow the lessee to use an asset in exchange for periodic payments.

Online References

Suggested Books for Further Studies

“Accounting for Leases: A book exploring all the facets of lease accounting, including bargain renewal options.
“Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield: Delve into lease accounting and its classifications.
“Financial Accounting” by Robert Libby, Patricia A. Libby, and Frank Hodge: Comprehensive coverage on accounting principles, including lease agreements.

Accounting Basics: “Bargain Renewal Option” Fundamentals Quiz

### What is a bargain renewal option in a lease agreement? - [ ] Allows the lessee to purchase the asset at market value. - [ ] Allows the lessor to change the lease terms at will. - [ ] Obliges the lessee to renew the lease at a high rate. - [x] Allows the lessee to renew the lease at a rate significantly below market value. > **Explanation:** A bargain renewal option allows the lessee to extend the lease term at a rate that is significantly favorable compared to the market rental rate. ### What could be a consequence of a lease containing a bargain renewal option? - [ ] The lease automatically becomes an operating lease. - [x] The lease may be classified as a capital lease. - [ ] The lessee loses the right to use the asset. - [ ] The lessor cannot earn rent on the asset. > **Explanation:** A lease with a bargain renewal option may be classified as a capital lease because of the financial benefit it provides to the lessee. ### What is the primary benefit for the lessee of a bargain renewal option? - [ ] Higher future lease payments - [ x ] Cost savings due to lower renewal rates - [ ] More ownership rights over the asset - [ ] Binding purchase agreement for the asset > **Explanation:** The main benefit for the lessee is the cost savings that come with renewing the lease at a rate significantly below the market value. ### True or False: A bargain renewal option can be negotiated out of a lease between the parties involved. - [ x ] True - [ ] False > **Explanation:** The inclusion or exclusion of a bargain renewal option can be negotiated mutually between the lessee and the lessor. ### Which of the following terms would a lease possibly fall under with a bargain renewal option? - [x] Capital Lease - [ ] Operating Lease - [ ] Charter Lease - [ ] Service Lease > **Explanation:** A lease with a bargain renewal option may likely be classified as a capital lease because it generally bears the economic characteristics of asset ownership. ### Can a bargain renewal option impact the financial statements of a company? - [ x ] Yes, especially in the context of lease classification. - [ ] No, it has no impact on financial statements. - [ ] Only if the lease is for equipment. - [ ] Only if the lease term is over five years. > **Explanation:** Yes, the classification of a lease as either an operating or capital lease can have significant implications on a company's financial statements. ### Which entity benefits from the inclusion of a bargain renewal option in a lease? - [ ] The lessor specifically - [x] The lessee specifically - [ ] Both parties mutually - [ ] Neither party > **Explanation:** The lessee benefits more due to the potential cost savings afforded by the favorable renewal rate. ### What aspect predominantly affects the concept of a "Bargain Renewal Option"? - [x ] The financial savings compared to market rate - [ ] The length of the new lease term - [ ] The type of asset being leased - [ ] The original lease term > **Explanation:** The financial savings achieved by renewing the lease at a substantially below-market rate is the key feature of a bargain renewal option. ### Is a bargain renewal option more likely found in leases for residential real estate or commercial equipment? - [ ] Residential real estate - [ x ] Commercial equipment - [ ] Both equally - [ ] Neither > **Explanation:** Bargain renewal options are more common in commercial leases, particularly for equipment, where long-term usage and cost savings are critical. ### What type of lease does NOT usually include a bargain renewal option? - [ x ] Short-term operating lease - [ ] Long-term capital lease - [ ] Commercial equipment lease - [ ] Industrial property lease > **Explanation:** A short-term operating lease generally does not include a bargain renewal option since it usually doesn't aim for long-term asset use and cost savings.

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