On January 1, Year 7, Quan Restaurant is planning to enter as the lessee into the two lease agreements described below.Each lease is noncancelable, and Quan does not receive title to either leased property during or at the end of the lease term.All payments required under these agreements are due on January 1 each year.

\begin{array}{lll}\text { Lessor } & \text { Hadowav Inc. } & \text { Cutter Electronics }\\\text { Type of property } & \text { Oven } & \text { Computer } \\\text { Yearly rental (not including executory costs) } & \$ 15,000 & \$ 4,000 \\\text { Lease term } & 10 \text { years } & 3 \text { years } \\\text { Economic life } & 15 \text { years } & 5 \text { years } \\\text { Purchase option } & \text { None } & \$ 3,000\\\text { Renewal option } & \text { None } & \text { None } \\\text { Fair market value at inception of lease } & \$ 125,000 & \$ 10,200 \\\text { Unguaranteed residual value } & \text { None } & \$ 2,000 \\\text { Lessee's incremental borrowing rate } & 10 \% & 10 \%\\\text { Executory costs paid by } & \text { Lessee } & \text { Lessor } \\\text { Annual executory costs } & \$ 800 & \$ 500 \\\text { Present value factor at 10\% (of an annuity due) } & 6.76 & 2.74\end{array}

(CMA adapted, Dec 93 #28) Refer to the Quan Restaurant example.Quan Restaurant should treat the lease agreement with Cutter Electronics as a(n)
A)operating lease, charging $3,400 in rental expense and $500 in executory costs to annual operations.
B)operating lease, charging $4,000 in rental expense and $500 in executory costs to annual operations.
C)operating lease, charging $3,500 in rental expense and $500 in executory costs to annual operations.
D)capital lease.
E)operating lease, charging $3,500 in rental expense and $400 in executory costs to annual operations.

A _____ Is a Financial Contract in Which the Borrower

Multiple Choice

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