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
Clover Manufacturing enters into a 5-year lease agreement with Rose Equipment Leasing for a specialized industrial press. The lease stipulates annual payments of $50,000. At the end of the lease term, Clover has the option to purchase the press for $20,000, even though the estimated fair market value of the equipment at that time is expected to be around $80,000. Given the significant difference between the purchase option price and the expected market value, it is highly likely that Clover will exercise the option to acquire the press. This bargain purchase option gives Clover the benefit of long-term ownership of the asset at a heavily discounted price, effectively incentivizing them to plan for the purchase. The presence of this clause also classifies the lease as a finance lease under accounting standards, as it transfers substantially all the risks and rewards of ownership to Clover.