A Note on Comdisco_s Lease Accounting

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


Obligations

InetrestExpenses @

10%



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


Obligations

InetrestExpenses @

12%



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

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A Note on Comdisco_s Lease Accounting

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