Practice Problem

LEASE Example #13

On October 1, 2012, Knightco (lessee) and Jack Dear Corp. sign a lease with the following terms:

1.Term: 4 years, with possible renewal (see #11) / 2.Payments of $68,565
3.Implicit interest rate (NOT known to lessee) 10% / 4.Lessor retains title to the asset at end of lease
5.Fair value of asset $260,000 / 6.Cost of asset $200,000
7.Incremental borrowing rate: 12% / 8.First payment due 10/1/12
9.Estimated useful life of asset: 6 years / 10.No collection or cost uncertainties for lessor
11.Lease can be renewed for one more year at
$17,000. The actual value is probably $25,000. / 12.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.
13.There are no guarantees of residual value

LESSOR AMORTIZATION TABLE

Date / Payment / Interest / "Principal" / Balance
0
1
2
3
4
5

LESSEE AMORTIZATION TABLE

Date / Payment / Interest / "Principal" / Balance
0
1
2
3
4
5

Lease #13

Lessee – Knightco Inc. / Debit / Credit
Lessor – Jack Dear Corp. / Debit / Credit

Practice ProblemSOLUTION

Lease Example #13
bargain renewal option, unguaranteed RV

For this problem, classifying the lease depends on determining the lease term.

Also note that the lessor has a unguaranteed residual value - the amount depends on whether the lease is renewed.

Classify lease

Term = 5 years out of 6 = 83.3% of Economic Life. Therefore, capital lease.

No uncertainties (item 10) and FMV > cost so it is a sales-type lease for the lessor

Find PVMLP for lessee:

n=4, i=12%, pmt=68,565, fv=17,000 (the payment at the beginning of the 5th year), annuity due
PVMLP = 244,050 (needed to do JEs for lessee)

Remember that when there is an unGRV, the PVMLP will NOT equal the FMV of the asset – but we don’t actually have to compute PVMLP for the lessor since we already know it is a sales type lease.

Lease / Lessee
13 / Capital / LT / 12% / Bargain renewal option
Lessor
Sales-Type / LT / 10% / Bargain renewal option, Unguaranteed residual value
n / Lease 13
FMV = / 260,000
234,000 / 90% FMV
5 / Lease Term
6 / Economic Life
83.33% / LT as % Eco. Life
MLP Lessee / Comments
0 / 68,565
1 / 68,565
2 / 68,565
3 / 68,565
4 / 17,000 / BRO
5
6
12.00% / Lessee's discount rate
A / Lessee's PVMLP:
244,050 / Annuity Due
Lease 13
B / FOR LESSEE: / Why?
Capital / LT > 75% Eco Life
Lessor Cash Flows / Comments
0 / (191,435)
1 / 68,565
2 / 68,565
3 / 68,565
4 / 17,000 / BRO
5 / 15,000 / UnGRV
6
10.00% / Guess
C / 10.000% / Implicit Rate
MLP Lessor / Comments
0 / 68,565
1 / 68,565
2 / 68,565
3 / 68,565
4 / 17,000 / BRO
5
6
D / Lessor's PVMLP =
250,686 / Annuity Due
Lease 13
E / FOR LESSOR: / Why?
Sales type / LT > 75% Eco Life
Profit, no cost or collection uncertainties

Example 13#

Lessor #13 – Note that BRO is at beginning of 5th year and the equipment is returned at the end of the 5th year.

Date / Lease Payment / Interest / Principal / Balance
10/01/12 / 10% / 260,000
0 / 10/01/12 / 68,565 / 0 / 68,565 / 191,435
1 / 10/01/13 / 68,565 / 19,141 / 49,423 / 142,012
2 / 10/01/14 / 68,565 / 14,200 / 54,365 / 87,647
3 / 10/01/15 / 68,565 / 8,764 / 59,801 / 27,846
4 / 10/01/16 / 17,000 / 2,784 / 14,216 / 13,630
5 / 10/01/17 / 15,000 / 1,370 / 13,630 / 0

10/1/12
Net Investment in Lease $191,435

Cash 68,565

Sales $250,686

COGS 190,686
Inventory 200,000

Since there is an unguaranteed residual value, the lessor did not “sell” the entire asset. Therefore, sales and COGS are reduced by the present value of the residual value or $9,314.

12/31/12

Interest receivable (3/12) $ 4,785

Interest Revenue $ 4,785

1/1/13
Cash 68,565
Interest receivable 4,785
Interest revenue 14,357
Net investment in lease 49,423

…
12/31/16
Net Investment in Lease 1,364
Interest Revenue 1,364

1/1/17 – at end of lease:
Used Asset $ 15,000
Net Investment in Lease $15,000

Lessee – Lease #13

Date / Lease Payment / Interest / Principal / Balance
10/01/12 / 12% / 244,050
0 / 10/01/12 / 68,565 / 0 / 68,565 / 175,486
1 / 10/01/13 / 68,565 / 21,058 / 47,506 / 127,979
2 / 10/01/14 / 68,565 / 15,358 / 53,207 / 74,772
3 / 10/01/15 / 68,565 / 8,973 / 59,592 / 15,180
4 / 10/01/16 / 17,000 / 1,820 / 15,180 / 0

10/1/12

Leased Asset $244,050

Lease Liability. $244,050

Lease Liability. $ 68,565

Cash $68,565

12/31/12
Depreciation Expense (3/12) 12,203

Acc'd. Depreciation 12,203
[244,050  5 * 3/12]

Interest Expense $ 5,265

Interest Payable. $ 5,265

10/1/13
Lease liability 47,506
Interest payable 5,265
Interest expense 15,794
Cash 68,565

12/31/13
Depreciation Expense 48,810

Acc'd. Depreciation 48,810

Interest Expense $ 3,840

Interest Payable. $ 3,840