leases
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Leases. PV Computations Classification of Leases. Acct 414 – Fall 2008 – Prof. Teresa Gordon. 1e. BPO - Lease 1E. Inception date: 1/1/12 Lessor: Troy Tractors Inc. Fair value of combine at 1/1/02: $50,000 Cost to manufacture combine: $40,000 - PowerPoint PPT PresentationTRANSCRIPT
PV ComputationsClassification of Leases
Acct 414 – Fall 2008 – Prof. Teresa Gordon
1. Inception date: 1/1/122. Lessor: Troy Tractors
Inc.3. Fair value of combine
at 1/1/02: $50,0004. Cost to manufacture
combine: $40,0005. Estimated fair value at
end of lease is $10,0006. Fixed non-cancelable
lease term: 5 years.
7. First payment due on 12/31/12
8. Lessee: Farview Farms9. Incremental borrowing
rate (lessee): 12%10.Implicit interest rate
(lessor’s desired rate of return): 12%
11.Option to buy at end of lease term for $5,000
12.Estimated useful life of combine: 8 years
1e
Note that the last payment willinclude the $5,000 BPO
1e
$50,000 * 12%
$13,083 - $6,000
$50,000 - $7,083
1e
An ordinary annuity situation – the first line includes interest
1e
1. Inception date: 1/1/12
2. Lessor: Troy Tractors Inc.
3. Fair value of combine at 1/1/12: $50,000
4. Estimated fair value at end of lease is $10,000
5. First payment due on 1/1/12
6. Lessee: Farview Farms
7. Fixed non-cancelable lease term: 6 years.
8. Option to buy at end of lease term for $2,000
9. Estimated useful life of combine: 8 years
10. Desired rate of return for lessor and incremental borrowing rate for lessee: 12%
11. The cost to manufacture the tractor is $40,000.
1f
What amount should the payment be given that the lessor requires a 12% return?
1. Inception date: 1/1/122. Lessor: Troy Tractors
Inc.3. Fair value of combine at
1/1/12: $50,0004. Estimated fair value at
end of lease is $10,0005. First payment due on
1/1/126. Lessee: Farview Farms7. Fixed non-cancelable
lease term: 6 years
8. Option to buy at end of lease term for $2,000
9. Estimated useful life of combine: 8 years
10. Desired rate of return for lessor and incremental borrowing rate for lessee: 12%
11. The cost to manufacture the tractor is $40,000.
12. Payment = 10,638
Now, classify the lease
1f
Note that the first payment is ALL principalsince no interest has yet been incurred
39,362 * 12%
10,638 - 4,723
39,362 - 5,915
This is an annuity due situation – the first payment is 100% principal.
1f
Note that there is interest on the BPO
This is an annuity due situation – the first payment is 100% principal.
1f
IFRS vs. US GAAPIAS 17 vs. FAS 13 as amended many times
But there’s more!
Note that IFRS has no “bright
line” rules
Leased assets are of a specialized nature and are only usable by the lessee unless substantial costs are incurred to modify (nothing comparable in US GAAP)
Upon early termination of lease, lessee is responsible for lessor’s losses
Any gains & losses due to fluctuations in fair value of leased asset are attributed to the lessee
Lessee has option to renew for below market cost
IFRS US GAAP
For Lessor Operating lease Operating lease
Finance lease Direct Financing Lease
Finance lease Sales-type leaseFinance lease Leveraged lease
For Lessee Operating lease Operating lease
Finance lease Capital lease
1. Inception of the lease: January 1, 2012
2. Term: 3 years 3. Implicit interest rate
(known to lessee) 10% 4. Fair value of asset
$100,000 5. Incremental
borrowing rate: 12% 6. No collection or cost
uncertainties for lessor
7. First payment due 1/1/12
8. Estimated useful life of asset: 5 years
9. Lessor retains ownership of asset at end of lease
10. Cost of asset $100,000
11. Payments of $36,556 per year
2
1. Inception of the lease: January 1, 2012
2. Term: 3 years 3. Implicit interest rate
10% (NOT known to lessee but could be estimated)
4. Fair value of asset $100,000
5. Incremental borrowing rate: 12%
6. No collection or cost uncertainties for lessor
7. First payment due 1/1/12
8. Estimated useful life of asset: 5 years
9. Lessor retains ownership of asset at end of lease
10. Cost of asset $100,000
11. Payments of $36,556 per year
2a
What if the lessor’s rate were NOT known to lessee? What would be the PVMLP?
What if we follow IFRS?
1. Term: 3 years 3. Implicit interest rate
(known to lessee) 10% 5. Fair value of asset
$130,000 7. Incremental
borrowing rate: 12% 9. Estimated useful life
of asset: 5 years11.Purchase option at
end of lease: $2,500
2. Payments of $________________
4. Est. fair value of asset at end of lease $2,500
6. Cost of asset $100,000
8. First payment due 1/1/12 (at inception)
10.No collection or cost uncertainties for lessor
4a
1. Term: 3 years 3. Implicit interest rate
=10% (known to lessee)
5. Fair value of asset $130,000
7. Incremental borrowing rate: 12%
9. Estimated useful life of asset: 5 years
11.Purchase option at end of lease: $2,500
2. Payments of $46,836 4. Est. fair value of asset
at end of lease $2,500 6. Cost of asset
$100,000 8. First payment due
1/1/12 (at inception)10.No collection or cost
uncertainties for lessor
4A
Classify lease under US GAAP and IFRS
1. Term: 3 years 3. Implicit interest rate
=10% (NOT known to lessee but could be estimated)
5. Fair value of asset $130,000
7. Incremental borrowing rate: 12%
9. Estimated useful life of asset: 5 years
11.Purchase option at end of lease: $2,500
2. Payments of $46,836
4. Est. fair value of asset at end of lease $2,500
6. Cost of asset $100,000
8. First payment due 1/1/12 (at inception)
10.No collection or cost uncertainties for lessor
4B
What if the lessor’s implicit rate is NOT known to lessee? Find the PVMLP.
1. Term: 3 years 3. mplicit interest rate
(NOT known to lessee) 10%
5. Fair value of asset $130,000
7. Incremental borrowing rate: 12%
9. Estimated useful life of asset: 5 years
11.Purchase option at end of lease: $2,500
2. Payments of $46,836 4. Est. fair value of asset
at end of lease $5,000 6. Cost of asset
$100,000 8. First payment due
1/1/12 (at inception)10.No collection or cost
uncertainties for lessor
4c
What if the fair value of the asset is $5,000 at end of the lease? Find the PVMLP.
Initial Direct CostsResidual Values
Type of LeaseAccounting Treatment for Initial Direct Costs
OperatingRecorded as an asset and amortized over the lease term*
Direct Financing (US)Finance (IFRS)
Recorded as part of investment in lease and amortized over lease term by reducing interest revenue (find new implicit rate)*
Sales-type Lease (US)Finance if lessor is manufacturer or dealer (IFRS)
Immediately recognized as cost of goods sold (reduces profit or increases loss on sale of leased asset)
Remember that the UnGRV is part of lessor’s receivable and therefore is included in the amortization table!
1. Term: 4 years2. Payments of
$83,0993. Implicit interest
rate (known to lessee) 10%
4. Lessor retains ownership of asset at end of lease
5. Fair value of asset $300,000
6. Cost of asset $250,000
7. Incremental borrowing rate: 12%
8. First payment due 1/1/129. Estimated useful life of
asset: 5 years10.No collection or cost
uncertainties for lessor11.Est. fair value of asset at
end of lease: $15,00012.The residual value is
guaranteed by a third party at a cost of $500 (initial direct cost)
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Lessor Date Lease Payment Interest Principal Balance 01/01/12 300,000 0 01/01/12 83,099 0 83,099 216,901 1 01/01/13 83,099 21,690 61,409 155,492 2 01/01/14 83,099 15,549 67,550 87,942 3 01/01/15 83,099 8,794 74,305 13,638
01/01/16 15,000 1,362 13,638 0
6Lessee
DateLease
PaymentInterest Principal Balance
01/01/12 289,754 0 01/01/12 83,099 0 83,099 206,655 1 01/01/13 83,099 20,665 62,434 144,221 2 01/01/14 83,099 14,422 68,677 75,545 3 01/01/15 83,099 7,554 75,545 0
1. Term: 3 years 3. Implicit interest rate
(NOT known to lessee) 10%
5. Fair value of asset $100,000
7. Incremental borrowing rate: 14%
9. Estimated useful life of asset: 5 years
11. Est. fair value of asset at end of lease: $10,000
2. Payments of $33,809 4. Lessor retains
ownership of asset at end of lease
6. Cost of asset $100,000
8. First payment due 10/1/12
10. No collection or cost uncertainties for lessor
12. The residual value is NOT guaranteed by lessee
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Lease TermRenewal PeriodsExecutory Costs
IFRS has the same “rule” about the end of the lease term
1. Term: 4 years 3. Interest rate used to
compute payments = 12% 5. Fair value of asset $200,000 7. Incremental borrowing rate:
14% 9. Estimated useful life of asset:
6 years11. Est. fair value of asset at
end of lease: $10,00013. Initial direct costs to arrange
lease: $3,000
2. Payments of $61,924 4. Cost of asset $200,000 6. First payment due 6/1/12 8. No collection or cost
uncertainties for lessor10. The payments include
$5,000 for insurance.12. The lessee can
purchase asset for $10,000 at end of lease, otherwise, asset is returned to lessor.
11
11
DateLease
PaymentInterest Principal Balance
6/01/02 203,000
0 6/01/02 56,924
1 6/01/03 56,924
2 6/01/04 56,924
3 6/01/05 56,924
4 6/01/06 10,000
11
DateLease
Payment Interest Principal Balance
10/1/2002 10.86% 203,000
0 10/1/2002 56,924 0 56,924 146,076
1 10/1/2003 56,924 15,858 41,066 105,010
2 10/1/2004 56,924 11,400 45,524 59,486
3 10/1/2005 56,924 6,458 50,466 9,020
4 10/1/2006 10,000 980 9,020 0
1. Term: 4 years with possible renewal (see #12)
2. Implicit interest rate (NOT known to lessee) 10%
3. Fair value of asset $200,000
4. Incremental borrowing rate: 14%
5. Estimated useful life of asset: 6 years
6. The residual value is NOT guaranteed by lessee, asset is expected to be worth $25,000 at end of 4 years, and $15,000 at end of 5 years.
7. Payments of $49,523 8. Lessor retains ownership of
asset at end of lease 9. Cost of asset $200,000 10.First payment due 1/1/1211.No collection or cost
uncertainties for lessor12.At the end of the lease, HGJB
can renew for one more year at same annual amount of $49,523. This is certainly no bargain. There is a $15,000 penalty for non-renewal of the lease. However, this amount is probably not large enough to assure that HGJB will renew.
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1.Term: 4 years, with possible renewal (see #11)
3. Implicit interest rate (NOT known to lessee) 10%
5. Fair value of asset $260,000
7. Incremental borrowing rate: 12%
9. Estimated useful life of asset: 6 years
11. Lease can be renewed for one more year at $17,000. The actual value is probably $25,000.
13. There are no guarantees of residual value
2. Payments of $68,565 4 . Lessor retains title to
the asset at end of lease 6. Cost of asset $200,000 8. First payment due
1/1/1210. No collection or cost
uncertainties for lessor12. Est. fair value of asset
at end of original lease term is $35,000. It should be worth $15,000 at the end of 5 years.
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