Question

1. Under a finance lease, how is the lessee’s cost (i.e., the initial Lease Payable account) computed:
   1. When there is no bargain purchase option or residual value?

2. When there is a bargain purchase option?

3. When there is no bargain purchase option but there is a guaranteed residual value?

4. When there is no bargain purchase option but there is an unguaranteed residual value?

5. Which discount rate does the lessee use in computing the lessee’s cost (Lease payable)—the lessor’s implicit rate or the lessee’s incremental borrowing rate? Why? Any exceptions?

I use Intermediate acct. 10 e by spiceland.

Answer 1

Finance lease - It is a lease, which transfers substantially all the risk and rewards incidental to ownership of an asset to the lessee by the lessor but not the legal ownership.

a) In the financial lease, a lessee has an option to buy the leased asset at the end of term at price, which is lower than its expected fair value but if there is no bargain purchase than after the end of the lease term the lessee will not have an option to buy the leased asset.

b) When there is a bargain purchase option lessee will have an option to buy the leased asset at the end of the lease term.

c) In respect of lessee - Guaranteed residual value is such part of the residual value which is guaranteed by or on behalf of the lessee.

In respect of lessor - Such part of the residual value, which guaranteed by or on behalf of or on behalf of the lessee or by an independent third party.

If there is no bargain purchase than there will be no guaranteed residual value because the lessee is not purchasing the machine at the end of the lease term.

d) Unguaranteed residual value - The difference between the residual value and guaranteed residual value.

Unguaranteed residual value =  Residual value - Guaranteed residual value

If there is an unguaranteed residual value but no bargain purchase in this case if there is no bargain purchase only then the concept of unguaranteed value will also not arise.

e) The lessee uses the lessor's implicit rate for computing the lease payables this is because when the lessor gives an asset on lease ( particularly on finance lease), the total amount, which he receives over a lease period by giving the asset on lease, includes the element of interest plus payment of principal amount of asset. The rate at which the interest amount is calculated can be simply called implicit rate of interest.