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SELECTED SOLUTIONS

By Darrell Price,2014-01-07 06:40
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SELECTED SOLUTIONS

Acct. 414 Fall 2006 SOLUTION

    Lease Example #4a

    On January 1, 2012, Powell Trucking and Cummingham Diesel sign a lease with the following terms:

     1. Term: 3 years 2. Payments of $________________

     3. Implicit interest rate (known to lessee) 10% 4. Est. fair value of asset at end of lease $2,500

     5. Fair value of asset $130,000 6. Cost of asset $100,000

     7. Incremental borrowing rate: 12% 8. First payment due 1/1/12 (at inception)

     9. Estimated useful life of asset: 5 years 10. No collection or cost uncertainties for lessor

    11. Purchase option at end of lease: $2,500

    Determine the payment that the lessor should request:

    Lease 4a involves finding the payment that a lessor should charge when they will get the asset back from lessee at end

    of the lease. The value of the returned asset is called the “unguaranteed residual value” if there is no specific guarantee of the value of the asset.

    To find the payment points to remember:

    a. Use lessor’s implicit rate, b. Must decide whether the lessee will exercise the purchase option (asset is not returned) or if the asset will

    be returned to the lessor (residual value)

    Using financial calculator: N=3, i=10%, PV= -130,000 (always FMV and not cost of asset), FV=2,500 (not a BPO but asset will be

    returned at end of lease since there is no title transfer and no BPO), solve for PMT annuity due

    PMT = 46,836 (on calculator)

Decision process:

    1 No title transfer

2 Purchase option = $2,500

    Is this a bargain? NO because it is only projected to be worth $2500 at end of lease

3 LT = 3/5 = 60% of economic life

4 90% of FMV = $117,000.

    Find PVMLP lessee and lessor use same interest rate since 10% is less than 12%: PVMLP = 128,122 [n=3, i=10%, pmt=46,836, FV=0, annuity due (BGN)] Therefore capital lease for lessee

FOR LESSOR must compute PVMLP since no TT, BPO, and LT=60%

    N=3, i=10%, PMT=46,836, FV=0(not a bargain), PVMLP=$128,122.

    No collection or cost uncertainties for lessor (item 10)

    There is a dealer’s profit (difference between item 5 and item 6

THEREFORE: Sales type lease for lessor

    [Note that PVMLP is same for lessee and lessor even though they are using the same interest rate the reason is the

    unguaranteed residual value of $2,500 which is NEVER part of the MLP even though UnGRV must be considered

    when the lessor sets the lease payments]

    Acct. 414 Fall 2006 SOLUTION

     PRACTICE VARIATION same as 4c but lessee knows

    the implicit interest rate. Lease 4b - What if the lessor’s implicit rate is NOT known to lessee? Find the PVMLP. Lease #4d Amortization Table Lessor N=3 (annuity due) Date Payment Interest Principal Balance i=12% 1/01/12 130,000 Pmt=46,836 1/01/12 46,836 0 46,836 83,164 FV=0 (purchase option is not a bargain) 1/01/13 46,836 8,316 38,520 44,644 PVMLP=125,991 (with calculator) 1/01/14 46,836 4,464 42,372 2,273 Still capital lease because >90% of 130,000 = $117,000 1/01/15 2,500 227 2,273 0 143,008 13,008 130,000 0 What if lessee says their incremental borrowing rate is 20%? Sales Type with BPO Still a capital lease (PVMLP=$118,391) but for a lease LESSOR with a longer life, a higher interest rate MIGHT cause the 1/2/2012 PVMLP test to fail even though the LESSOR met the Net Lease Receivable $ 83,164 90% rule! Cash 46,836

     Sales $130,000 Lease 4c

     Computations using Excel

    n Lease 4 COGS $100,000 FMV = 130,000 Inventory $100,000 117,000 90% FMV 3 Lease Term 12/31/12 5 Economic Life Net Lease Receivable $ 8,316 60.00% LT as % Eco. Life MLP Lessee Comments Interest Revenue $ 8,316 0 46,836 1 46,836 1/2/2005 at end of lease receipt of BPO 2 46,836 Cash $ 2,500 3 2,500 BPO Net Lease Receivable $ 2,500 4 10.00% Lessee's discount rate A Lessee's PVMLP: 130,000 Annuity Due LESSEE assumes the lessee knows the implicit interest Lease 4 Type of Lease: rate and is therefore using the same amortization table as B FOR LESSEE: Why? the lessor (see above) Capital BPO 1/2/2012

     Equipment (PVMLP) $130,000 Lessor Cash Flows Comments Lease Liability. $ 83,164 0 (83,164) Cash 46,836 1 46,836 2 46,836 12/31/12 (Use 5 year life) 3 2,500 BPO 4 Depreciation Expense $ 26,000 10.00% Guess Acc'd. Depreciation $ 26,000 C 10.000% Implicit Rate MLP Lessor Comments Interest Expense $ 8,316 0 46,836 Lease Liability. $ 8,316 1 46,836 2 46,836

    3 2,500 BPO 1/2/2005 at end of lease payment of BPO 4 Lease Liability $ 2,500 D Lessor's PVMLP = Cash $ 2,500 130,000 Annuity Due Lease 4 Type of Lease: E FOR LESSOR: Why?

     Sales Type BPO Profit, no cost or collection uncertainties

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