Lessor’s Calculation of Lease payments

Amount to be recovered (fair value) $659,805 Less: Present value of the third-party-guaranteed residual value* ($150,000 x .75131^*) (112,697)

Amount to be recovered through periodic lease payments $547,108

_____________________

Lease payments at the beginning 

of each of three years: ($547,108 ÷ 2.73554^**) $200,000

^* present value of $1: n=3, i=10%

^** present value of an annuity due of $1: n=3, i=10%

Note: Since the residual value is guaranteed to the lessor, it is included in the lessor’s minimum lease payments and therefore affects the 90% of fair value test.

Requirement 2

Since [1] title to the conveyer does not transfer to the lessee, [2] there is no BPO, and [3] the lease term (3 years) is less than 75% of the estimated useful life (6 years), the critical classification criterion is [4] whether the present value of minimum lease payments exceeds 90% of the fair value of the conveyer ($659,805). The present value is influenced by the fact that the residual value is (a) relatively large and (b) guaranteed, but by a third-party, not the lessee. The residual value, if guaranteed (by the lessee or by a third party guarantor), is included in the minimum lease payments by the lessor when applying the 90% of fair value criterion and thus increases the likelihood that it is met. However, when the residual value is guaranteed by a third-party guarantor and not by the lessee, it is not included in the lessee’s minimum lease payments. So, if a residual value is sufficiently large and guaranteed by a third-party guarantor, it may cause the 90% of fair value criterion to be met by the lessor, but not by the lessee.

Problem 15-11 (continued)

For the lessor, the criterion is met: The present value of minimum lease payments ($659,805) is more than 90% of the fair value ($659,805 x 90% = $593,825). Also, since the fair value exceeds the lessor’s carrying value, the conveyer is being “sold” at a profit, making this a sales-type lease:

Fair value $659,805

minus

Carrying value (450,000)

equals

Dealer’s profit $209,805

Lessee’s Calculation of the Present Value of Minimum Lease Payments

Present value of periodic lease payments^* ($200,000 x 2.73554^**) $547,108

^** present value of an annuity due of $1: n=3, i=10%

^*Since the residual value is not guaranteedby the lessee, it is excluded from the lessee’s minimum lease payments and therefore does not affect the 90% of fair value test.

For the lessee, the criterion is not met: The present value of minimum lease payments ($547,108) is less than 90% of the fair value ($659,805 x 90% = $593,825). So, this is an operating lease to the lessee.

Problem 15-11 (continued)

Requirement 3

December 31, 2011

Poole (Lessee) Prepaid rent(2011 payment; 2012 expense) 200,000 Cash(lease payment) 200,000 Allied (Lessor) Lease receivable (present value of minimum lease payments) 659,805 Cost of goods sold (lessor’s cost) 450,000 Sales revenue (present value of minimum lease payments) 659,805 Inventory of equipment (lessor’s cost) 450,000 Cash(lease payment) 200,000 Lease receivable 200,000

Requirement 4

Since the lessee records the lease as an operating lease, interest expense is not recorded and an amortization schedule is not applicable.

Lessor (third-party-guaranteed residual value included):