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Chapter15: Leases

Sales-Type Leases

A sales-type lease in addition to interest revenue earned over the lease term, the lessor receives a manufacturer's or dealer's profit on the sale of the asset. differs from a direct financing lease in only one respect. In addition to interest revenue earned over the lease term, the lessor receives a manufacturer's or dealer's profit on the “sale” of the asset.19 This additional profit exists when the fair value of the asset (usually the present value of the minimum lease payments, or “selling price”) exceeds the cost or carrying value of the asset sold. Accounting for a sales-type lease is the same as for a direct financing lease except for recognizing the profit at the inception of the lease.20

 

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FINANCIAL
Reporting Case

Q2,  p. 807

p. 823

   To illustrate, let's modify our previous illustration. Assume all facts are the same except Sans Serif Publishers leased the copier directly from CompuDec Corporation, rather than through the financing intermediary. Also assume CompuDec's cost of the copier was $300,000. If you recall that the lease payments (their present value) provide a selling price of $479,079, you see that CompuDec earns a gross profit on the sale of $479,079 − 300,000 = $179,079. This sales-type lease is demonstrated in Illustration 15-3.

ILLUSTRATION 15-3

Sales-Type Lease

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Remember, no interest has accrued when the first payment is made at the inception of the lease.

On January 1, 2011, Sans Serif Publishers, Inc., leased a copier from CompuDec Corporation at a price of $479,079. The lease agreement specifies annual payments of $100,000 beginning January 1, 2011, the inception of the lease, and at each December 31 thereafter through 2015. The six-year lease term ending December 31, 2016, is equal to the estimated useful life of the copier.

   CompuDec manufactured the copier at a cost of $300,000.

   CompuDec's interest rate for financing the transaction is 10%.

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*Of course, the entries to record the lease and the first payment could be combined into a single entry:

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You should recognize the similarity between recording both the revenue and cost components of this sale by lease and recording the same components of other sales transactions. As in the sale of any product, gross profit is the difference between sales revenue and cost of goods sold. Dell Inc. “sells” some of its products using sales-type leases and disclosed the following in a recent annual report:

 

Recording a sales-type lease is similar to recording a sale of merchandise on account:

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Real World Financials

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   All entries other than the entry at the inception of the lease, which includes the gross profit on the sale, are the same for a sales-type lease and a direct financing lease.

   Accounting by the lessee is not affected by how the lessor classifies the lease. All lessee entries are precisely the same as in the previous illustration of a direct financing lease.

   Graphic 15-7 shows the relationships among various lease components, using dollar amounts from the previous illustration.

p. 824

GRAPHIC 15-7

Lease Payment Relationships

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The difference between the total payments and their present value (selling price of the asset) represents interest.

If the price is higher than the cost to the lessor, the lessor realizes a profit on the sale.

*The lessor's gross investment in the lease also would include any unguaranteed residual value in addition to the minimum lease payments. Any residual value guaranteed by the lessee is included in the minimum lease payments (both companies). We address these issues later in the chapter.

If profit is zero, this would be a direct financing lease.

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WHERE WE'RE HEADED
 

The IASB and FASB are collaborating on a joint project for a revision of lease accounting standards. The Boards have agreed on a “right of use” model by which the lessee recognizes an asset representing the right to use the leased asset for the lease term and also recognizes a corresponding liability for the present value of the lease payments, regardless of the term of the lease. Many people expect the new standard to result in most, if not all, leases being recorded as an intangible asset for the right of use and a liability for the present value of the lease payments. Thus, the notion of operating leases might disappear.

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   For an example, let's revisit Sans Serif's operating lease in Illustration 15-1 on p. 815. None of the four criteria was met that would have caused it to be a capital lease, including Criterion 4:

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   Accordingly, under existing standards, we recorded no asset and no liability for this operating lease. Under the new standard, on the other hand, Sans Serif would be deemed to have received the “right of use” of the asset and would record an intangible asset for the right of use and a liability for the present value of the lease payments:

The FASB and IASB are working together on a standard that would dramatically impact the way we account for leases, perhaps eliminating the concept of operating leases.

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   The goal of the two Boards is to issue a final Standard by June of 2011. The focus of the project is lessee accounting. Lessor accounting will be considered at a later date. The impact of any changes will be significant; U.S. companies alone have over $1.25 trillion in operating lease obligations.21

IFRS ILLUSTRATION




19A lessor need not be a manufacturer or a dealer for the arrangement to qualify as a sales-type lease. The existence of a profit (or loss) on the sale is the distinguishing factor.

20It is possible that the asset's carrying value will exceed its fair value, in which case a dealer's loss should be recorded.

21John Hepp, “Proposed Standard Would Eliminate Operating Lease Accounting,” Grant Thornton Marquee, Winter 2009.

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