Rigdon Company leases 50 acres of land to Christmas Tree Inter-national on January 1, 2016. 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 is 12%.
• The cost of the land to Rigdon 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?