872 SECTION 3 Financial Instruments and Liabilities leased asset for its full useful life. In this illustration, the equipment is expected to be useful for seven years, so depreciation is $68,440 ($479,079 ÷ 7 years). When a BPO Is Exercisable Before the End of the Lease Term In Illustration 15–11 we assumed that the BPO was exercisable on December 31, 2021—the end of the lease term. Sometimes, though, the lease contract specifies that a BPO becomes exercisable before the designated lease term ends. Since a BPO is expected to be exercised, the lease term ends for accounting purposes when the option becomes exercisable. For example, let’s say the BPO in the illustration could be exercised a year earlier—at the end of the fifth year. The effect this would have on accounting for the lease is to change the lease term from six years to five. All calculations would be modified accordingly. Stated differently, minimum lease payments include only the periodic cash payments specified in the agreement that occur prior to the date a BPO becomes exercisable. (We assume the option is exercised at that time and the lease ends.) The length of the lease term is limited to the time up to when a bargain purchase option becomes exercisable. December 31, 2021 Sans Serif Publishers, Inc. (Lessee) Depreciation expense ($479,079 * ÷ 7 years) ............................ 68,440 Accumulated depreciation ................................................. 68,440 Interest expense (10% 3 $54,542) ........................................... 5,458 Lease payable (difference) ....................................................... 54,542 Cash (BPO price) ................................................................. 60,000 CompuDec Corporation (Lessor) Cash (BPO price) ...................................................................... 60,000 Lease receivable (account balance) ..................................... 54,542 Interest revenue ( 10% 3 outstanding balance ) .................... 5,458 *The residual value is zero after the full seven-year useful life. Illustration 15–11B Journal Entries—with BPO The cash payment expected when the BPO is exercised represents part interest and part principal just like the other cash payments. Ethical Dilemma “I know we had discussed that they’re supposed to be worth $24,000 when our purchase option becomes exercisable,” Ferris insisted. “That’s why we agreed to the lease terms. But, Jenkins, you know how fast computers become dated. We can make a good case that they’ll be worth only $10,000 in three years.” The computers to which Ferris referred were acquired by lease. The lease meets none of the criteria for classification as a capital lease except that it would contain a bargain purchase option if the computers could be purchased for $10,000 after three years. “We could avoid running up our debt that way,” Jenkins agreed. How could debt be avoided? Do you perceive an ethical problem? Residual Value The residual value of leased property is an estimate of what its commercial value will be at the end of the lease term. In our previous examples of capital leases for which no BPOs were present, we assumed that the residual value was negligible. Now let’s consider the economic effect of a leased asset that does have a material residual value and how that will affect the way both the lessee and the lessor account for the lease agreement.
Spiceland_Inter_Accounting8e_Ch15
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