Bargain purchase option definition
/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 for substantially less than its fair market value as of the termination date of the lease. The purchase price is set sufficiently low that there is a reasonable expectation that the lessee will exercise the option and purchase the leased asset.
When this option is present, the lessee is usually required to treat the lease arrangement as a finance lease, where the lessee recognizes the leased asset on its own balance sheet.
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Example of a Bargain Purchase Option
A company leases production equipment for five years. The lease agreement allows the company to purchase the equipment for $20,000 at the end of the lease term. At lease commencement, management expects the equipment to have a fair value of approximately $55,000 after five years. Because the option price is substantially below the expected fair value, the company is reasonably certain to exercise the option. The bargain purchase option therefore affects the lease classification and the measurement of the related lease obligation.
Bargain Purchase Option FAQs
How is the bargain purchase option price determined?
The bargain purchase option price is established in the lease agreement at an amount sufficiently below the asset’s expected fair value when the option becomes exercisable. The discounted price makes exercise reasonably certain, effectively allowing the lessee to acquire the asset for less than its anticipated market value.