Acct 414SOLUTIONProf. Teresa Gordon

LEASE EXAMPLE #2

Lessee: No title transfer, no BPO, LT < 75%. Interest rate = 10% (annuity due) but PVMLP < 90% of FMV (see computations below) so it is a capital lease for the lessee.

Lessor: Direct Financing lease because (1) PVMLP > 90% of FMV, (2) no cost or collection uncertainties for lessor (satisfied the 2 extra rules) and (3) FMV = cost of asset (lessor does not have a gain or loss)

PVMLP computations:

Since we know the implicit interest rate, we use the lower of the two rates:

i=10%, n=3, pmt=36,556,
PVIF-OA =2.4869 * 1.10 = PVIF-AD

Therefore, PVMLP = 2.4869 * 1.10 * 36,556 = 100,002

(Approximately fair value with a bit of a rounding difference)

What if the lessee did NOT know the implicit interest rate? What would the PVMLP be?

Example 2 - using incremental borrowing rate:

i=12%, n=3, pmt=36,556,
PVIF-OA =2.4018 * 1.12 = PVIF-AD

2.4018 * 1.12 * 36,556 = 98,336 = PVMLP

Note that this would be a capital lease even if PVMLP were not > 90,000 since it met the 75% of economic life test!

However, we would need to construct a different amortization table for the lessee.

Amortization Table

Date / Lease Payment / Interest / Principal / Balance
1/01/02 / 100,000
0 / 1/01/02 / 36,556 / 0 / 36,556 / 63,444
1 / 1/01/03 / 36,556 / 6,344 / 30,212 / 33,232
2 / 1/01/04 / 36,556 / 3,323 / 33,233 / 0

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Acct. 414 – Spring 2006HOMEWORK ASSIGNMENT

n / Lease 2
FMV = / 100,000
90,000 / 90% FMV
3 / Lease Term
3 / Economic Life
100.00% / LT as % Eco. Life
MLP Lessee / Comments
0 / 36,556
1 / 36,556
2 / 36,556
3
4
5
6
10.00% / Lessee's discount rate
A / Lessee's PVMLP:
100,000 / Annuity Due
Lease 2 / Type of Lease:
B / FOR LESSEE: / Why?
Capital / LT >75% Eco Life
Lessor Cash Flows / Comments
0 / (63,444)
1 / 36,556
2 / 36,556
3
4
5
6
10.00% / Guess
C / 10.000% / Implicit Rate
MLP Lessor / Comments
0 / 36,556
1 / 36,556
2 / 36,556
3
4
5
6
D / Lessor's PVMLP =
100,000 / Annuity Due
Lease 2 / Type of Lease:
E / FOR LESSOR: / Why?
Dir Fin / LT >75% Eco Life
No profit, no cost or collection uncertainties

DIRECT FINANCING

LESSOR

1/2/12

Net Investment in Lease. 63,444

Cash 36,556

Equipment $100,000

12/31/12
Net Investment in Lease $ 6,344

Interest Revenue $ 6,344

1/2/13

Cash $36,556

Net Investment in Lease $36,556

LESSEE

1/2/12

Leased Asset $100,000

Leased Liability. $100,000

Lease Liability. $ 36,556

Cash $ 36,556

12/31/12

Depreciation Expense $ 33,333

Acc'd Depreciation $ 33,333

Interest Expense $ 6,344

Lease Liability. $ 6,344

1/2/13

Lease Liability. $ 36,556

Cash $36,556

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