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 |
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 |
| 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 | ||
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
