What is the significance of the term 'fair market value' at the end of a lease?

The significance of 'fair market value' at the end of a lease primarily involves determining the potential buyout cost of the leased asset once the lease term expires. This value reflects what the asset would be worth in the open market at the time of lease termination. This valuation becomes crucial for both the lessor (the owner of the asset) and the lessee (the person or entity leasing the asset) because it can influence decisions regarding the asset's acquisition at lease termination.

For the lessee, understanding the fair market value helps in assessing whether purchasing the asset at that value makes financial sense compared to option alternatives, such as leasing a new asset. It serves as a baseline for negotiations should the lessee wish to buy the asset at the end of the lease. Knowing this value can also affect the overall cost-effectiveness of the leasing arrangement throughout its duration.

In contrast, while considerations related to depreciation, initial pricing, and obligations of the lessee are important aspects of leasing agreements, they do not directly relate to the intrinsic function of fair market value at the termination stage of a lease.