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8/3/2019 A Note on Comdisco_s Lease Accounting
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A Note on Comdiscos Lease Accounting
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Accounting for Equipment Acquisition
Accounting for purchases
Accounting for operating leases Accounting for capital lease
Year Lease
Rentals
PV of Lease
Rentals
Beginning Balanceof Capital Lease
Obligations
InetrestExpenses @
10%
Payment of Capital LeaseObligations
Ending Balance of Capital LeaseObligations
1 100 90.91 379.08 37.91 62.09 316.99
2 100 82.64 316.99 31.70 68.30 248.69
3 100 75.13 248.69 24.87 75.13 173.55
4 100 68.30 173.55 17.36 82.64 90.91
5 100 62.09 90.91 9.09 90.91 0.00
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Accounting in Lessor BooksOperating Lease
Lease signedDr: Leased computer equipment $400Cr: Inventory of computer equipment: $400
Lease payment is received each year Dr: Cash $100Cr: Rental revenue $100
Depreciation expenseDr: Depreciation $50Cr: Accumulated Depreciation: $50
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Accounting in Lessor BooksCapital Lease
Signing leaseDr: Investment in financing lease: $410.15Cr: Inventory of computer equipment: $410.15
Receiving lease paymentDr: Cash $100Cr: Interest income: yCr: Net investment in financing lease: 100 - y
Year Lease
Rentals
PV of Lease
Rentals
Beginning Balanceof Capital Lease
Obligations
InetrestExpenses @
10%
Payment of Capital LeaseObligations
Ending Balance of Capital LeaseObligations
1 100 90.91 410.12 41.01 58.99 351.14
2 100 82.64 351.14 35.11 64.89 286.25
3 100 75.13 286.25 28.63 71.37 214.88
4 100 68.30 214.88 21.49 78.51 136.36
5 150 93.14 136.36 13.64 136.36 0.00
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Accounting for Discounted Lease PaymentsOperating Lease
Lease rentals assigned to bankDr: Cash $240.20Cr: Discounted lease rentals $240.20
Rental payment received each year and forwardingpayment to bank
Dr: Interest expenseDr: Discounted lease rentalCr: Rental revenue
Year Lease
Rentals
PV of Lease
Rentals
Beginning Balanceof Capital Lease
Obligations
InetrestExpenses @
12%
Payment of Capital LeaseObligations
Ending Balance of Capital LeaseObligations
1 100 89.29 240.18 28.82 71.18 169.01
2 100 79.72 169.01 20.28 79.72 89.293 100 71.18 89.29 10.71 89.29 0.00
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Accounting for Discounted Lease PaymentsCapital Lease
Lease payments assigned to bank in return for cashDr: cash $360.50Dr: Interest expense $18.60Cr: Net investment in direct financing (or sales-type lease): $379.10
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Lessee
Equipment Lease Payments
Equity investors put up to 20%
of equipment value in exchangefor lease payments after debtservice
Owner Trustee
Lenders advance 80%
equipment value inexchange for first clalease payments
Equipment OwnerLessor
Lender
Leveraged-Lease Strcuture
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Symptoms of Capital LeaseTransfer of ownership at the end of lease termPurchase option to the lessee at a price which is expected to be sufficiently lower than
fair value at the date the option becomes exercisable such that, at the inception of thelease, it is reasonably certain that the option will be exercised;Lease term is for the major part of the economic life of the asset even if title is nottransferred; At the inception of the lease the present value of the minimum lease payments amountto at least substantially all of the fair value of the leased asset; andLeased asset is of a specialised nature such that only the lessee can use it without majomodifications being made.
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Symptoms of Capital Lease
If the lessee can cancel the lease, the lessors losses associated with thecancellation are borne by the lessee;
Gains or losses from the fluctuation in the fair value of the residual fall to thelessee (for example in the form of a rent rebate equalling most of the salesproceeds at the end of the lease); andThe lessee can continue the lease for a secondary period at a rent which issubstantially lower than market rent.
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Capital vs. Operating
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Financial vs. Operating
Finance Lease Operating Lease
Total lease rental > asset priceLease period = life of asset No fixed future commitment
Irrevocable by both parties Cancelable by lessee on notice
Purpose: financing an asset Purpose: using an assetAlso called capital lease
Lessee bears: maintenance,insurance, taxes
Lessor bears: maintenance,insurance, taxes
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Financial vs. Operating
Finance Lease Operating Lease
Min lease rental = rate ~ equalto lessee marginal cost of debt
Risk on asset falls on lessee
Payout will include; asset cost,cost of financing, lessor
overhead, rate of returnSimilar to mortgage loans
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Types of Financial Leases
Direct leasesLessor purchased equipment or asset and rented it out to lessee
Sale-and-leasebackLeveraged leases
Lessor borrowed money to fund part of purchase of assets, pledging t
lease contract as security for the loan
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Leveraged LeaseParties involved..,
Lessor contributes equity (20% to 40%)LesseeFinancier finance by way of term loans
Used for assets requiring huge capital outlay, AirplaneSatellitesShips
RailsOff-shore drinkingNuclear machinesPower generation plantsLarge chemical plantsGas pipe lines
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Sale and Lease Back
Operating Lease TypeIf a sale and leaseback transaction results in an operating lease,and it is clear that the transaction is established at fair value, any
profit or loss should be recognised immediately.If the sale price is below fair value, any profit or loss should berecognised immediately except that, if the loss is compensated bfuture lease payments at below market price, it should be deferreand amortised in proportion to the lease payments over the periofor which the asset is expected to be used.If the sale price is above fair value, the excess over fair valueshould be deferred and amortised over the period for which theasset is expected to be used.
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Sale and Lease Back
Finance Lease Type
Do not recognize any excess or deficiency of sales
proceeds over the carrying amount immediately as asincome or loss in the financial statements of a seller-lessee.Instead, it should be deferred and amortised over the
lease term in proportion to the depreciation of the leasedasset.
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Accounting for Capital Lease At the inception of a finance lease, the lessee should recognise thlease as an asset and a liability. Such recognition should be at an
amount equal to the fair value of the leased asset at the inceptionof the lease.However, if the fair value of the leased asset exceeds the presentvalue of the minimum lease payments from the standpoint of thelessee, the amount recorded as an asset and a liability should bethe present value of the minimum lease payments from thestandpoint of the lessee.In calculating the present value of the minimum lease paymentsthe discount rate is the interest rate implicit in the lease, if this ispracticable to determine; if not, the lessees incremental borrowingrate should be used.
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Estimating Discount Rate
Lessee computes the present value of the minimum leas
payments using itsincremental borrowing rate , withone exceptionIf the lessee knows theimplicit interest rate computedby the lessor and it is less than the lessees incremental
borrowing rate, then lesseemust use the lessors rate.
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Recovery Test
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Capital Lease Accounting Asset and Liability Recorded at the lower of:
Present value of the minimum lease payments (excluding executory costs) o
the fair-market value of the leased assetDepreciation Period
If lease transfers ownership, depreciate asset over the economic life of theassetIf lease does not transfer ownership, depreciate over the term of the lease
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Why Leasing?Benefits to lessee..,
Leasing 100% financing
Offers cash flow benefitsOff balance sheet financing Avoidance of loan covenantsTax planningCreation of working capitalHedge against risk of inflation and obsolescenceFast and flexible financingTo over come monopoly actUsed in non-priority sector and service sector
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Why Leasing?
Benefits to lessor.., Additional financial productReduces riskIncreases profitability Accelerates salesHigher leverage [Max. of 10:1]
No gestation periodLow cost of operations
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Lease vs. Buying
Lease financingIncreases companys debt capacity
Used when public market is saturated Also includes interest componentInvestors will not recognize a financial lease liability as a form of debt?
Liabilities: PV of financial lease payments Assets: PV of financial lease payments
Possibility of increasing book income by avoiding depreciation and interest?Lease payments includes depreciation and interest
Possibility of evading capital-expendituresTo avoid capital-approval procedures
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Difference between Lessor and Lessee Creating
More Value for Lease
Tax rate differences between lessor and lesseeRealizing depreciation deduction by lessor and lessee Asset acquisition and maintenance cost specializationor scale of economiesRealizing salvage values superiority of property
knowledgeLeverage abilities between lessor and lessee differencein interest deductibility