870 SECTION 3 Financial Instruments and Liabilities Bargain Purchase Options and Residual Value Bargain Purchase Options We mentioned earlier that a bargain purchase option (BPO) is a provision of some lease contracts that gives the lessee the option of purchasing the leased property at a bargain price. We have discussed BPOs in the context of how they affect the classification of leases, but none of our earlier illustrations included a situation in which a BPO was present. You should have noted that a bargain price is defined in such a way that an additional cash payment is expected when a BPO is included in the agreement. Remember, a bargain price is one that is sufficiently below the property’s expected fair value that the exercise of the option appears reasonably assured. Because exercise of the option appears at the inception of the lease to be reasonably assured, payment of the option price is expected to occur when the option becomes exercisable. The expectation that the option price will be paid effectively adds an additional cash flow to the lease for both the lessee and the lessor. That additional payment is included as a component of minimum lease payments for both the lessor and the lessee. It therefore (a) is included in the computation of the amount to be capitalized (as an asset and a liability) by the lessee and recorded as a receivable by the lessor, but (b) reduces the amount of the periodic rent payments the lessor will need to receive from the lessee to recover the desired “selling price.” This is indicated in Illustration 15–10 . PART B ● LO15–7 When a BPO is present, both the lessee and the lessor view the option price as an additional cash payment. The lessee adds the PV of the BPO price to determine its asset and liability. • The lessee adds the present value of the BPO price to the present value of periodic rental payments when computing the amount to be recorded as a leased asset and a lease liability. • The lessor, when computing periodic rental payments, subtracts the present value of the BPO price from the amount to be recovered (fair value) to determine the amount that must be recovered from the lessee through the periodic rental payments. Illustration 15–10 Effect of a Bargain Purchase Option For demonstration, let’s suppose the equipment leased in Illustration 15–7 could be purchased by Sans Serif for an option price of $60,000 at the conclusion of the lease. To make this a “bargain” purchase option, assume the residual value at the conclusion of the lease is expected to be $75,000. This situation is assumed in Illustration 15–11 . On January 1, 2016, Sans Serif Publishers, Inc., leased printing equipment from CompuDec Corporation at a price of $479,079. The lease agreement specifies annual payments beginning January 1, 2016, the inception of the lease, and at each December 31 thereafter through 2020. On December 31, 2021, at the end of the six-year lease term, the equipment is expected to be worth $75,000, and Sans Serif has the option to purchase it for $60,000 on that date. The estimated useful life of the equipment is seven years. The residual value after seven years is zero. 21 CompuDec manufactured the equipment at a cost of $300,000 and its interest rate for financing the transaction is 10%. Lessee’s calculation of PV of minimum lease payments: Present value of periodic rental payments ($92,931 3 4.79079 † ) $445,211 Plus: Present value of the BPO price ($60,000 3 .56447 * ) 33,868 Present value of minimum lease payments (Recorded as a leased asset and a lease liability) $479,079 (continued) 21Our discussion of the effect of a bargain purchase option would be precisely the same if our illustration were of a direct financing lease (for instance, if the lessor’s cost were $479,079) except that neither sales revenue nor cost of goods sold would be recorded in a direct financing lease. Illustration 15–11 Bargain Purchase Option
Spiceland_Inter_Accounting8e_Ch15
To see the actual publication please follow the link above