Transcript Document

DEFINITION:
Agreement conveying the right to use property,
plant or equipment for stated periods of time.
Is the OWNER of the property.
Is the RENTER of the property.
Capital vs. Operating Leases.
Capital Lease
Transfers essentially ALL risk/rewards of ownership to
the lessee:
•Lessee gets property on B/S as asset
•Debt is recorded as a liability.
•The asset is even depreciated.
Operating Lease
Does not essentially transfer all risks/rewards to lessee.
•Do not report on B/S.
•Rents are charged as they become due.
•This is OFF-BALANCE SHEET FINANCING.
THIS IS
WHAT FIRMS
WANT!!
1-1-08: Receipt of first payment
Cash…………….. $4,800
Unearned Revenue……… $4,800
12/31/08 EOY ADJS
Grafix Inc. (LESSEE) leases a computer from
Comfast Inc. (LESSOR) for 2-years beginning
January 1, 2008. Grafix will pay Comfast $4,800/
yr, payable in advance on January 1 of each year.
Comfast is responsible for ownership costs,
(i.e., maintenance, property tax & insurance).
Lessee incurs only one risk (payment of rents)
and one benefit (temporary use of asset). Lessor’s
cost was $30,000, 10 year life and st line
depreciation with no salvage).
Unearned Rev… $4,800
Rent Revenue…. $4,800
Depreciation Expense.. $3,000
Accumulated Dep… $3,000
LessOR depreciates the asset because
they didn’t relinquish ownership.
1-1-08: First payment
Prepaid rent………… $4,800
Cash……………..$4,800
12/31/08 EOY ADJS
Grafix Inc. (LESSEE) leases a computer from
Comfast Inc. (LESSOR) for 2-years beginning
January 1, 2008. Grafix will pay Comfast $4,800/
yr, payable in advance on January 1 of each year.
Comfast is responsible for ownership costs,
(i.e., maintenance, property tax & insurance).
Lessee incurs only one risk (payment of rents)
and one benefit (temporary use of asset). Lessor’s
cost was $30,000, 10 year life and st line
depreciation with no salvage).
Rent Expense………. $4,800
Prepaid………………$4,800
If a lease meets ANY ONE of the following 4 criteria at the
inception of the lease, the lease is a CAPITAL LEASE.
*
TRANSFER OF OWNERSHIP.
Explicitly states a transfer of ownership at EOL without
payment of additional compensation.
*
BARGAIN PURCHASE OPTION (BPO).
• LEASE TERM EQUAL TO 75% OR MORE OF THE
ASSETS REMAINING USEFUL SERVICE LIFE.
• MINIMUM LEASE PAYMENTS (pv) ARE AT LEAST
90% OF THE ASSETS MARKET VALUE.
CAPTIAL LEASE IS RECORDED AT:
The LOWER of:
VS.
Example:
•January 1, 2008 LESSOR CO. and LESSEE CO. sign a 3-year, non-cancelable
lease for an asset with an estimated economic life of 3 years.
•There are no collection uncertainties and the lessor’s performance is
complete.
•There are (3) lease payments worth $36,556 each. They are payable on
January 1 of 2008, 2009 and 2010.
•The fair value of the asset at inception of the lease is $100,000 (which is
also the carrying value on the lessor’s books).
•The lease DOES NOT contain a renewal or Bargain Purchase Option (BPO)
and the asset reverts to the lessor at the end of the three year period.
•Lessee and Lessor depreciation on a ST LINE basis for book purposes.
Residual value (salvage) is –0-.
* The lessee’s incremental borrowing rate is 10%
*
*
The accounting year ends on December 31 for each party.
The Lessor’s IMPLICIT interest rate is 10%.
YES
•Lease term is equal to 75% or > of the assets remaining
useful life.
3/3 = 100%
•Minimum lease payments (PV) are at least 90% of the assets
market value.
$36,556 x 2.73554 = $100,000
FMV = $100,000
$100,000/$100,000 = 100%
TO RECORD THE LEASE
Leased Asset………….. $100,000
Lease Liability………$100,000
TO RECORD THE FIRST PAYMENT ON THE FIRST DAY
Lease Liability……… $36,556
Cash………………..$36,556
Date
Payment
Interest 10%
LL adj
1/1/08
$100,000
1/1/08
$36,556
1/1/09
$36,556
$6,344
$36,556
$3,323
1/1/10
LL Bal.
$0
$36,556
$30,212
$33,233
$63,444
$33,232
$0
TO RECOGNIZE INTEREST EXPENSE FOR 1/1/09
Interest Expense………… $6,344
Lease Liability………….$6,344
TO RECORD DEPRECIATION EXPENSE
($100,000 - $0 SALVAGE) / 3 YEARS = $33,333
Depreciation Expense……….. $33,333
Accumulated Depreciation……… $33,333
THE LESSOR MUST NOT ONLY MEET (1) OF THE FOUR PREVIOUSLY
MENTIONED CAPITAL LEASE CRITERIA BUT ALSO BOTH OF THE
CRITERIA LISTED BELOW:
COLLECTIBILITY OF THE MINIMUM LEASE PAYMENTS IS
REASONABLY ASSURED.
NO IMPORTANT UNCERTAINTIES SURROUND THE AMOUNT
OF ANY REIMBURSEABLE COSTS YET TO BE INCURRED BY
THE LESSOR UNDER THE LEASE.
The Lessor classifies capital leases in one of two ways:
Does NOT provide a gross profit to the lessor
at the time the lease is signed.
Lessor earns profits from interest revenue during lease
Value of the leased asset equals its MARKET VALUE
at the inception date.
•The lessor uses this to compute rent
payments.
Example from above: Now continued for the LESSOR.
*
This is a DIRECT FINANCING lease.
FMV = $100,000 which equals the cost on the lessor’s books.
We know the rent payments are $36,556, but how was this established?
FMV OR PV
OF MIN LEASE PAYMENTS = RENT X FACTOR
FMV OR PV
2.7354
OF$100,000
MIN LEASE PAYMENTS = RENT X FACTOR
(10%, 3 YRS ANN DUE;
T 6-5)
$36,556
TO RECORD The RECEIVABLE at 1/1/08
Lease Receivable… $100,000
Asset…………… $100,000
RECORD The FIRST PAYMENT ON The DAY The LEASE IS SIGNED at 1/1/08
Cash……….. $36,556
Lease Receivable…….. $36,556
RECORD The SECOND RECEIPT OF CASH at 1/1/09
Cash…….. $36,556
Earned Interest Rev $6,344
Lease Receivable….. $30,212
Provides a GROSS PROFIT to the lessor at the
inception of the lease.
Value of leased asset is greater (or less than) the
lessor’s cost (or carrying).
Lessor wants to earn a profit on the sale of the leased asset and interest
during the period.
Example continued:
Assume that the FMV of the asset at inception of this lease is $100,000
and that the carrying value on the lessor’s books is $80,000.
DEALER’S PROFIT
$100,000 FMV - $80,000 carrying = $20,000 profit
RECORD The LEASE INCEPTION
same as before
Lease Receivable… $100,000
COGs…………. $80,000
Inventory....................... $80,000
Sales Revenue………. $100,000
From here other entries are the same..
FMV of asset
In Sales Type leases there is a DIFFERENCE in accounting for Guaranteed
vs. Unguaranteed Residual Values. THE
WAY PROFIT IS RECORDED
GUARANTEED RV is considered part of the sale.
UNGUARANTEED RV is not considered part of the sale.
•inserting any residual value into the previous example would change
too many things so we’ll use the book example to illustrate this.
Basically since an UN-guaranteed salvage value can’t be considered part of a sale
its PRESENT VALUE needs to be subtracted from the SALES and the COG. But
that actually leaves the GP unchanged.
Assume estimated RV is $5,000 with a PV of $3,104.60
Assume leased equipment has an $85,000 cost to the dealer.
Rent payments are $23,237.09
FMV of asset at time of leasing $100,000
PV of minimum lease payments = (R x f) + (RV x f)
$100,000 = ($23,237.09 x 4.16986) + ($5,000 x .62092)
Basically since an UN-guaranteed salvage value can’t be considered part of a sale
its PRESENT VALUE needs to be subtracted from the SALES and the COG. But
that actually leaves the GP unchanged.
Assume estimated RV is $5,000 with a PV of $3,104.60
Assume leased equipment has an $85,000 cost to the dealer.
Rent payments are $23,237.09
Guaranteed Residual Value
Lease Receivable.. $100,000
COG...................... $ 85,000
Sales Rev.......... $100,000
Inventory.......... $85,000
Sales...........$100,000
COG...........$ 85,000
-------------------------GP.............. $15,000
FMV of asset at time of leasing $100,000
Unguaranteed Residual Value
Lease Receivable.... $100,000
COG........................ $81,895.40
(85K – 3,104.60)
Sales Rev............. $96,895.40
(100K – 3,104.60 PV of RV)
Inventory............ $85,000
Sales...........$96,895.40
COG...........$ 81,895.40
-------------------------GP.............. $15,000
Assume the BPO is $10,000, exerciseable at the end of the three year lease.
(BACK TO OUR ORIGINAL EXAMPLE)
The residual value is now $15,000, at the BPO date. At the end of the 4th year
its –0-.
Assume we are dealing with the DIRECT FINANCING type lease.
annual rent is now
FMV = RENT (FACTOR) + BPO (FACTOR)
$100,000 = Rent (2.73554)
+ $10,000 (.75131)
$33,809
DEPRECIATION TIMETABLES ALSO CHANGE WITH BPOS
•The lease depreciates over the EXPECTED USEFUL LIFE not
the life of the lease, since they are expected to own it at the EOL.
When the lessee agrees to makeup any deficiency in the stated amount realized for
an asset at the end of the lease.
A RESIDUAL VALUE IMPACTS The AMOUNT OF The ANNUAL
RENT WHETHER ITS GUARANTEED OR NOT
Originally we calculated the rent as follows:
$100,000 = Rent x 2.7354 (10%, 3yrs)
Now if we assume there is also a $10,000 residual value
$100,000 = (rent x 2.7354) + ($10,000 x .75132)
RENT = $33,809
RENT = $36,556
What the guaranteed or unguaranteed status of the salvage does impact is the
amount of the MINIMUM LEASE PAYMENTS in terms of finding an
amount for the capitalized asset.
is capitalized.
is not capitalized.
Returning to the original example, now consider the following changes:
•The actual residual value at the EOL is $9,000 (rather than the $10K
expected earlier).
•The salvage value is FULLY guaranteed (lessee must pay $10,000
cash if necessary).
•The $10,000 estimated salvage value has resulted in annual
payments of $33,809.
What amount does the lessee capitalize?
($33,809 x 2.73554) + ($10,000 x .75131) = $100,000
ENTRY TO RECORD The LEASE
Leased asset…… $100,000
Lease liability……. $100,000
Date
1/1/08
1/1/08
1/1/09
1/1/10
12/31/10
Lease pay
Interest 10%
LL adj
$33,809
$33,809
$33,809
$0
$6,619
$3,900
$909
$33,809
$27,190
$29,909
LL bal
$100,000
$ 66,191
$ 39,001
$9,092
$10,001
•The last year builds interest and then the residual value remains in
the lease liability.
ENTRY FOR FIRST RENT PAYMENT
SECOND PAYMENT
Lease liability……. $33,809
Cash…………..$33,809
Interest expense.. $6,619
Lease Liability… $27,190
Cash…………..$33,809
($100,000 - $10,000)/3 = $30,000
ENTRY FOR
1ST
DEPRECIATION
Life of LEASE, asset reverts to lessor
Depreciation expense…… $30,000
Accumulated Depreciation…..$30,000
TERMINATION OF The LEASE Actual residual is $9,000
LOSS on lease.. $1,000
Accum Dep….. $90,000 (remove)
Lease liability… $10,000 (remove)
Cash……….. $1,000 (pay)
Leased asset… $100,000 (remove)
The LESSOR’s accounting is the same, with a guaranteed or an unguaranteed
residual value.
The INCEPTION OF The LEASE
Lease receivable:
$100,000 = (rent x 2.7354) + ($10,000 x .75132)
Lease Receivable…… $100,000
Asset……… $100,000
RECEIPT OF The FIRST RENT (DAY LEASE IS SIGNED)
Cash…….. $33,809
Lease Receivable……. $33,809
RECEIPT OF SECOND RENT (ONE YEAR LATER)
Cash……. $33,809
Interest Revenue…. $6,619
Lease Receivable….. $27,190
TERMINATION OF The LEASE
Asset…….. $9,000 (get it back)
Cash………. $1000 (receive guaranteed payment)
Lease receivable……. $10,000
Lessee capitalizes ONLY the lease payments (NOT the salvage)
Assume there is now a $10,000 un-guaranteed salvage value at the EOL.
Note:
The rent payment will STILL be $33,809 because the salvage
reduces it whether its guaranteed or not.
$100,000 = (RENT x 2.73554) + $10,000 (.75131)
The AMOUNT CAPITALIZED FOR The LEASED ASSET IS:
$33,809 (2.73554) = $92,487
DON’T capitalize salvage
Leased asset… $92,487
Lease liability……$92,487
Remember, whether the salvage value is guaranteed or not, it is ALWAYS
deducted in order to compute the AMOUNT of the rent payment.
Recall, however, that the lessee will not capitalize the amount of the
salvage because they do not promise to pay it.
The LESSOR HOWEVER WILL CAPITALIZE The SALVAGE VALUE
AS IT COMES TO HIM/HER AT The EOL REGARDLESS OF WHETHER
ITS GUARANTEED OR NOT (AT LEAST IN THEORY IT DOES).
LEASE RECEIVABLE RECORDED
$100,000 = (rent x 2.7354) + ($10,000 x .75132)
Lease Receivable.. $100,000
Asset……. $100,000