What type of lease is determined by the fair market value of the equipment?

In this scenario, the type of lease that is primarily influenced by the fair market value of the equipment is an operating lease. An operating lease typically involves renting equipment for a shorter period of time when compared to its economic life. The lease payments are often lower because the lessee does not take on the full risk of ownership, and at the end of the lease term, the equipment is returned to the lessor.

The fair market value plays a significant role in determining the lease payments and the structure of an operating lease. Since an operating lease does not meet the capitalization criteria set out in accounting standards, it remains off the balance sheet, treating the payments as rental expenses without capitalizing the asset.

In contrast, a capital lease generally results in the lessee recording the asset and corresponding liability on their balance sheet, typically because the lease conveys ownership-like benefits (such as an option to purchase the asset at the end of the lease). Financial leases are similar to capital leases but may have slightly different accounting treatment. A conditional sale is a transaction that is not classified as a lease but as a sale with a financing component, further distancing it from the concept of fair market valuation in the leasing context.

Understanding these distinctions clarifies why the operating lease is the type