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Accounting for leases

Analysis

Lessor Corp would first determine the total net investment in the lease by calculating the present value
of the lease receivable and the unguaranteed residual asset.

□ The present value of the lease receivable is $4,500,000. This is the present value of the remaining
fixed lease payments, less the lease incentives payable to Lessee Corp, plus the exercise price of the
purchase option discounted at approximately 9.04%, the rate implicit in the lease. The exercise
price of the purchase option is included in the lease receivable because it is reasonably certain that
Lessee Corp will exercise the option.

□ Since it is reasonably certain that Lessee Corp will exercise its purchase option, Lessor Corp does
not expect to derive any additional value from the underlying asset; therefore, the unguaranteed
residual asset value is zero.

□ Lessor Corp’s net investment in the lease is $4,500,000 (the sum of the lease receivable
($4,500,000) and the unguaranteed residual asset ($0)).

Lessor Corp would record the following journal entry on the lease commencement date.

Dr. Lease receivable $4,5oo,000
Dr. Cash $500,000

Cr. Property, plant and equipment (leased asset) $5,000,000

EXAMPLE 4-9
Sales-type lease recognition – lease with significant variable payments

Lessor Corp will install an x-ray machine in a hospital (customer/lessee) and maintain it for a period
of five years. Lessor Corp can substitute the x-ray machine only in the event of malfunction, which is
expected to be infrequent. The customer will make all operational decisions (e.g., decide in which
department the x-ray machine will be used, hours of its operation) employees will operate the
machine. The customer will be responsible for providing all of the consumables needed (e.g., x-ray
films, chemicals). The customer will bear the risk of loss in the event of damage or theft and will be
responsible for purchasing insurance to protect against physical loss of the machine.

As is customary in this industry, Lessor Corp does not intend to repossess the machine at the end of
the term. Consequently, the customer may decide to continue to use the machine or scrap it after the
five-year period.

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