Acct 414
SOLUTION
Prof. 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
0
1
2
Date
1/01/02
1/01/02
1/01/03
1/01/04
Lease Payment
36,556
36,556
36,556
Interest
0
6,344
3,323
Principal
36,556
30,212
33,233
Balance
100,000
63,444
33,232
0
1
Acct. 414 – Spring 2006
n
Lease 2
FMV =
MLP Lessee
0
1
2
3
4
5
6
B
90,000 90% FMV
3 Lease Term
3 Economic Life
100.00% LT as % Eco. Life
Comments
36,556
36,556
36,556
Lessor Cash
Flows
Comments
0
1
2
3
4
5
6
C
MLP Lessor
0
1
2
3
4
5
6
E
100,000
Lessee's discount
10.00% rate
Lessee's
PVMLP:
100,000 Annuity Due
Lease 2
Type of Lease:
FOR LESSEE:
Why?
Capital
LT >75% Eco Life
A
D
HOMEWORK ASSIGNMENT
(63,444)
36,556
36,556
10.00% Guess
10.000% Implicit Rate
Comments
36,556
36,556
36,556
DIRECT FINANCING
LESSOR
1/2/12
Net Investment in Lease.
Cash
Equipment
63,444
36,556
$100,000
12/31/12
Net Investment in Lease
Interest Revenue
$ 6,344
1/2/13
Cash
Net Investment in Lease
$36,556
LESSEE
1/2/12
Leased Asset
Leased Liability.
Lease Liability.
Cash
12/31/12
Depreciation Expense
Acc'd Depreciation
Interest Expense
Lease Liability.
1/2/13
Lease Liability.
Cash
$ 6,344
$36,556
$100,000
$100,000
$ 36,556
$ 36,556
$ 33,333
$ 33,333
$ 6,344
$ 6,344
$ 36,556
$36,556
Lessor's PVMLP =
100,000 Annuity Due
Lease 2
Type of Lease:
FOR LESSOR:
Why?
Dir Fin
LT >75% Eco Life
No profit, no cost or
collection
uncertainties
2