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Definition: Bargain Purchase Option
Bargain purchase option is an option available in a lease contract that gives the lessee (user of the asset) to purchase the leased asset from the lessor (owner of the asset) at a purchase price which is significantly lower than the market price of the leased asset. But this option requires the lessee to classify such lease as capital lease or finance lease.
For ex: If the market value of leased machinery is Rs. one lakh. But at the end of lease period lessee has the option to purchase that machinery at Rs. Fifty thousand only. Then, such option is known as bargain purchase option.
This type of option indicates that some of the rental payments have contributed towards part of principal repayment of loan.
Accounting basically recognizes only two types of lease operating lease and finance lease. Operating lease is neither recorded as an asset nor as a liability. It is only considered as a part of expense. However, capital or finance lease needs to be recorded on both sides of the financial statements i.e., as an asset as well as a liability. Statement of Financial Accounting Standard (FAS) No. 13 is the main standard for the purpose of lease accounting. According to this standard as well as according to Sarbanes Oxley Act of 2002, if lessee has bargain purchase option in the lease agreement then he needs to classify such lease as a capital lease. Sarbanes Oxley Act in 2002 has been introduced to improve financial disclosures as well as protect the interest of the shareholders from accounting frauds that the world has witnessed in the early 2000s due to failure of Enron and other giants.
The main objective of providing such option is to reduce the “off balance sheet” financing on part of the lessee.