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Welcome back.
In this example, we're going to take the same example that we've been working on,
but we're going to modify it just a little bit so that it's an operating lease,
and show you how that would be accounted for.
So we're going to change one small fact, and
that is there's no residual value guarantee.
So if there's no residual value guarentee,
we're going to fall below the 90% threshold.
And the lesser will account for this as an operation lease.
So an interesting fact about eliminating that residual value guarantee,
it will actually change the implicit rate of return within the lease,
in other words the discount rate that the lessor's going to use to measure this.
Now we're going to look where the implicit rate where the net investment is equal
to the carrying value plus the initial costs.
It's also the some of the present value of the lease payments plus the the present
value of the unguaranteed residual minus any deferred profit.
So the rate that makes that all true in our example is 5.8%.
So here's that classification, you see that by using that new rate and
taking out the residual value guarantee.
We're now down to the present value of the lease payment,
being only 75, 76% roughly of the fair value of the leased asset,
so we're definitely going to be an operating lease in this category.
So what's the diffference with an operating lease?
Well, there's no derecognition.
I'm going to leave the asset on the books.
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And it continues to be depreciated.
I'm not going to recognize a net investment the least, I'm not going to
have that lease receivable, I'm just going to have the leased asset on the books,
I'm going to recognize the rent prospectively on a straight-line basis.
So it's like the rent is an executor contract.
This is continuing the previous accounting that we had in the old accounting
standard.
We're going to recognize the revenue straight-line and how we do that,
well it would be the sum of the lease payments less deferred initial cost
divided by the term, which in this case equals $9,167.
As you can imagine from our early examples back in the previous module,
if you have uneven length payments.
The calculations can be a little bit more difficult, you need to sum them up and
divided them by the lease term.
Whatever it is, you need to calculate the straight line rent.
So here's the journal entries.
When the lease is signed, I'm going to take my initial lease class,
which I probably would have already paid for.
And I'm going to now capitalize them and create an asset that would be amortizable
over the lease term as part of the straight line rent payment.
And then the rent payments will be recognized annually, I would look,
record the receipt of cash.
I would have the rent revenue and
I will have the amortization of those initial cross.
Depreciation is of course it's calculated over the useful life of an asset not
the economic life those are different.
So the lessor intent could give you a difference in how you would depreciate
the asset, so is the lessor has an asset that they intend to lease again.
So for example if the useful life could be 9 years with the residual of 0
at the end of those 9 years, it would be scrapped.
I would take the value of the asset,
the procuring value of the asset which is 54,000.
Subtract the residual value divided by 9.
I have a depreciation of $6,000.
But what if, they do not intend to lease the asset again
at the end of the lease term.
But instead, they would dispose of it at that time.
Well, then the useful life would only be the six years of the lease term.
And if there's an estimated residual of 20,000, I would take the carrying
value of the asset, minus that estimated residual value, and divide that by six,
and I would be depreciating the asset by $5,667 over the lease term.
So it does matter how the lessor determines the useful life,
whether their business model is to lease the assets again at the end of
the lease term, or to dispose of them at the end of the lease term while
there's still useful capacity left in the asset.
And of course, that lease the assets going to be tested for
impairment as a long-lived asset.
It won't be tested as a financial instrument.
We call it for a sales type please.
That receivable is going to be tested using the new lessor current
estimated credit loss model where this asset is going to continue to
be considered a- long-term fixed asset, a long-lived asset.
And it will be tested under that impairment model, so
two different things entirely.
So that concludes our discussion of lessor accounting.
We'll move on next and talk a little bit about as soon as we back.
John HeppClinical Assistant Professor of Accountancy
