Bisk Chapter 8 ppt

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					Bisk Chapter 8 – Leases
• Lessor - lease payment are made by lessee
  to Lessor
  – Lessor holds a title / PPSA secured interest in
    the asset leased
• Lessee - entity entering into the lease to
  acquire use of the asset and lease debt
                Lease Term
• Fixed or stated term
  – Normally stated in months
  – At the end of the term the asset will be returned
    to the Lessor unless there is a purchase option
      Minimum Lease Payments
•   The initial term I.e. 60 months
•   Minimum rental payments
•   Includes penalty for failure to renew
•   Guarantees on residual value
•   Not included is executory costs
            Executory costs
• Insurance
• R&M
• Taxes
• Required to be paid during term of the
• Failure to pay executory cost is a breech of
             Present Values
• Incremental borrowing rate
• Implicit interest rate during terms of lease
  remains constant
• Discount rate that would result in the
  transfer of title at the end of the lease =
  implicit interest rate
• Must know cash price of asset to determine
  implicit interest rate.
            Residual Value
• Estimate FMV at the end of the lease
• To be profitable for Lessor – residual values
  must be certain.
• If residual values are uncertain – the Lessor
  will loose money, i.e. GM / Ford out of
  lease business now
• Guaranteed (option) and unguaranteed
• Unguaranteed residual values are not part of
  minimum lease payments
• Guaranteed RV is included in MLP (if –
  then scenario - deficiencies)
• Exit or disposal plan
• SFAS requires recognition of lease
  termination costs in period when obligations
  to others exist, not necessarily commencing
  in the period of commitment to a plan.
               Capital lease
• One or more lease criteria are met
  – Transfer of property at end to lessee
  – Bargain purchase option
  – 75% or more is estimated life of lease property
    is used during the lease
  – PV of MLP (excluding executory costs) = 90%
    FMV of asset at inception
            Operating Lease
• Sales type or direct financing
  (manufacturers use as method of making
  – Capital lease for lessee
  – Collect ability is reasonably predictable
  – No important uncertainties on unreimbursable
    costs yet to be incurred by Lessor
  – Sale of assets on installment basis
                Exhibit 2

• Capital Lease Criteria page 6-5
            Operating Leases
• Definition – none of 4 criteria are met
• Profit on leased assets
   – MLP+ amortization of bonus = rental revenue
   – Less:
      • Deprecation
      • Amortization of initial direct cost
      • Executory costs
      = Operating Profit
                          OH 3
Wall leased office premises to Fox for a 5 year term – Jan 1,
 2008. Under the terms of the lease rent for the 1 yr is $8,
 000; yr 2 to 5 is $12,500 per annum. As an inducement
 Wall granted Fox the first 6 months rent free. In its current
 year Dec 31 income statement what amt should be reported
 as Wall’s rental income?
  – A. $12,000
  – B. $11,600
  – C. $10,800
  – D. $8,000
        Lessee's Capital Lease
• Initial recording
  – Capitalize asset and record debt at present
  – Current and long term portions m/b recognized
  – Depreciate / amortize asset over useful life
                       OH - 5
Dec 30, 2008, Haber leased a new machine with FMV
  $700,000 from Gregg. The following data applies:
   – Lease term                                    10 years
   – Annual rental pmts at end of each yr          $100,000
   – Estimated useful life                         12 years
   – Implicit interest rate                        10%
   – PV $1 annuity in advance for 10 periods at 10%
   – PV $1 annuity in arrears for 10 periods at 10% 6.15
   Haber should record a lease liability of ?
OH-07 (MC #46)
Oak Co. leased equipment for its entire 9-year estimated life,
agreeing to pay $50,000 at the start of the lease term on December
31, year 1, and $50,000 annually on each December 31 for the next
eight years. The present value on December 31, year 1, of the nine
lease payments over the lease term, using the rate implicit in the
lease which Oak knows to be 100/0, was $316,500. The December
31, year 1 present value of the lease payments using Oak's
incremental borrowing rate of 12% was $298,500. Oak made a
timely second lease payment. What amount should Oak report as
capital lease liability in its December 31, year 2 balance sheet?
a.          $350,000
b.         $243,150
c.          $228,320
d.          $0
1.Enter payment; interest rate
2. Note the last month and scan to that month. What is the
4. Compare the balance to the purchase option price, this
difference is your equity in the car
5. Repeat the calculation if you took a loan out instead.
6. Compare the two schedules and pick the best option. General a
loan is cheaper

Excel Worksheet format – >>> go to example
           OH – 8 Amortization Schedule

•   Capital lease obligation at inception
•   Less any immediate minimum lease payment
•   Capital lease obligation at beginning of period
•   Times appropriate discount rate
•   = Interest expense

• Less minimum lease payment
• = Reduction of capital lease obligation
                        OH-09 (MC #24)

Howe Co. leased equipment to Kew Corp. on January 2, year
  1, for an 8-year period expiring December 31, year 8.
  Equal payments under the lease are $600,000 and are due
  annually on January 2. The first payment was made on
  January 2, year 1. The list selling price of the equipment is
  $3,520,000 and its carrying cost on Howe's books is
  $2,800,000. The lease is appropriately accounted for as a
  sales-type lease. The present value of the lease payments at
  an imputed interest rate of 12% (Howe's incremental
  borrowing rate) is $3,300,000. What amount of profit on
  the sale should Howe report for the year ended December
  31, year 1?
         Cont…. Oh 9

• a.   $720,000
• b.   $500,000
• c.   $ 90,000
  d.     $0
       OH – 10 Amortization Schedule

Gross investment in capital lease
Less any immediate minimum lease payment
= Gross investment in lease at beginning of period
Less unamortized unearned income
= Carrying amount of obligation
Times interest rate implicit in lease
= Interest income
                      OH - 11

Glade Co. leases computer equipment to customers
  under direct-financing leases. The equipment has
  no residual value at the end of the lease, and the
  leases do not contain bargain purchase options.
  Glade wishes to earn 8% interest on a 5-year lease
  of equipment with a fair value of $323,400. The
  present value of an annuity due of $1 at 8% for
  five years is 4.312. What is the total amount of
  interest revenue that Glade will earn over the life
  of the lease?
         OH –11 cont…

• a.   $ 51,600
• b.   $ 75,000
• c.   $129,360
  d.     $139,450
                          OH -12

On June 30 of the current year, Lang Co. sold equipment with
   an estimated useful life of eleven years and immediately
   leased it back for ten years. The equipment's carrying
   amount was $450,000; the sales price was $430,000; and
   the present value of the lease payments, which is equal to
   the fair value of the equipment, was $465,000. In its June
   30 current year balance sheet, what amount should Lang
   report as deferred loss?
a.           A. $35,000
b.           B. $20,000
c.           C. $15,000
        D. $0
                                OH - 13
On July 1, year 1, South Co. entered into a 10-year operating lease for a
   ware-house facility. The annual minimum lease payments are
   $100,000. In addition to the base rent, South pays a monthly allocation
   of the building's operating expenses, which amounted to $20,000 for
   the year ended June 30, year 2. In the notes to South's June 30, year 2
   financial statements, what amounts of subsequent years' lease
   payments should be disclosed?
a.          a $100,000 per annum for each of the next five years
   and $500,000 in the aggregate
b.         b $120,000 per annum for each of the next five years
   and $600,000 in the aggregate
c.         c $100,000 per annum for each of the next five years
   and $900,000 in the aggregate
d.         d $120,000 per annum for each of the next five years
   and $1,080,000 in the aggregate
The end ch 8

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