Chapter 10 - Direct Financing Lease-LESSOR

GENERAL RULE:
IF THERE IS A TRANSFER = IGNORE RESIDUAL VALUE
IF THERE IS NO TRANSFER = CONSIDER RESIDUAL VALUE
(REGARDLESS IF GUARANTEED OR UNGUARANTEED)
DIFFERENCE BETWEEN PROBLEMS WITH GUARANTEED AND
UNGUARANTEED:
- no difference in the computation in Gross Investment and Net
Investment in the Lease
- under guaranteed, residual value is considered in computing Gross
Profit and the determination of Sales and Cost of Sales
- under unguaranteed, residual value is ignored in computing Gross
Profit and the determination of Sales and Cost of Sales
- GROSS PROFIT MUST BE THE SAME UNDER the GUARANTEED
AND UNGUARANTEED RESIDUAL VALUE SCENARIO
-------------------------------------------------------------------------------------------------------------------------------------------------LEASED ASSET WILL REVERT BACK TO LESSOR
Gross Investment = Gross Rentals + Residual Value (whether
guaranteed or unguaranteed) [THE AMOUNT DEBITED TO LEASE
RECEIVABLE]
= Residual Value is ignored if the lease provides for a
transfer of title
Gross Rentals = Annual Gross Rentals x Lease Term
Annual Gross Rentals = Net Investment in the lease / Present Value
of an annuity of 1 for a number of periods
= (Cost of Asset - PV of residual value)/PV of an
annuity of 1
Net Investment in the Lease = [Annual Rental x Present Value of
an annuity of 1 + PV of Residual Value (guaranteed or unguaranteed)]
= or [Cost of the asset + Initial Direct Cost]
Unearned Interest Income = Gross Rental - Net Investment
- THE BALANCE IS A REDUCTION TO
LEASE RECEIVABLE TO ARRIVE AT ITS CARRYING AMOUNT
Sales = LOWER of Fair Value of Asset or Net Investment in the Lease
Cost of Sales = Cost of Asset + Initial Direct Cost paid by Lessor
Gross Profit = Sales - Cost of Sales
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-----------------------------------------------LEASED ASSET WILL NOT REVERT BACK TO LESSOR [BARGAIN

PURCHASE OPTION OR TRANSFER OF TITLE]
Gross Investment = Gross Rentals + Bargain Purchase Option [THE
AMOUNT DEBITED TO LEASE RECEIVABLE]
Gross Rentals = Annual Gross Rentals x Lease Term
Annual Gross Rentals = Net Investment in the lease / Present Value
of an annuity of 1 for a number of periods
= (Cost of Asset - PV of Bargain Purchase
Option)/PV of an annuity of 1
Net Investment in the Lease = [Annual Rental x Present Value of
an annuity of 1 + PV of Bargain Purchase Option]
= or [Cost of the asset + Iniitial Direct Cost]
Unearned Interest Income = Gross Rental - Net Investment
- THE BALANCE IS A REDUCTION TO
LEASE RECEIVABLE TO ARRIVE AT ITS CARRYING AMOUNT
GUARANTEED
Sales = LOWER of Fair Value of Asset or Net Investment in the Lease
Cost of Sales = Cost of Asset + Initial Direct Cost paid by Lessor
Gross Profit = Sales - Cost of Sales
UNGUARANTEED
Sales = LOWER of Fair Value of Asset or Net Investment in the
Lease(excluding PV of residual value)
Cost of Sales = [Cost of Asset - PV of Residual Value ]+ Initial Direct
Cost paid by Lessor
Gross Profit = Sales - Cost of Sales
-------------------------------------------------------------------------------------------------------------------------------------------------Problems with RESIDUAL VALUE AND THE LEASED ASSET WILL
REVERT BACK TO LESSOR
Annual Rental is computed as:
Net Investment in the Lease - Present Value of RESIDUAL VALUE = Net
Investment to be recovered from RENTAL
Net Investment to be recovered from RENTAL/Present Value of an
annuity of 1 for a number of periods = Annual Rental
note: ignore RESIDUAL VALUE IF THE ASSET WILL NOT REVERT TO
THE LESSOR
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if Fair Value of assset is LOWER than RESIDUAL VALUE

under guaranteed:
Cash
xx (receive the difference
from lessee + guaranteed residual value)
Asset
xx (recorded at the lower of
fair value and carrying amount)
Lease Recievable
xx
under unguaranteed: Loss on finance lease xx (receive the
difference from lessee + guaranteed residual value)
Asset
xx (recorded at the
lower of fair value and carrying amount)
Lease Recievable
xx
-------------------------------------------------------------------------------------------------------------------------------------------------ACTUAL SALE OF LEASED ASSET
CASH RECEIVED - [LEASE RECEIVABLE - UNEARNED INTEREST INCOME
or CARRYING AMOUNT OF LEASE RECEIVABLE] = Gain or Loss on sale