CHAPTER 15 Leases 879 When the Lessee’s Incremental Borrowing Rate Is Less Than the Lessor’s Implicit Rate Instances are few in which the lessee actually would use its incremental borrowing rate. Here’s why. We noted earlier that, like any other asset, a leased asset should not be recorded at more than its fair value. Look what happens to the present value payments if Sans Serif uses a discount rate less than the 10% rate implicit in Illustration 15–6 (let’s say 9% ): $100,000 3 4.88965* 5 $488,965 p aRy emn etan lt s L e cs osset e ’s *Present value of an annuity due of $1: n 5 6, i 5 9%. But remember, the fair value of the equipment was $479,079. The $100,000 amount for the rental payments was derived by the lessor, contemplating a fair value of $479,079 and a desired rate of return (implicit rate) of 10%. So, using a discount rate lower than the lessor’s implicit rate usually would result in the present value of minimum lease payments being more than the fair value, and we record the lease at the fair value. This conclusion does not hold when the leased asset has an unguaranteed residual value. You will recall that the lessor’s determinations always include any residual value that accrues to the lessor; but when the lessee doesn’t guarantee the residual value, it is not included in the lessee’s present value calculations. Combining two previous examples, let’s modify our demonstration of an unguaranteed residual value to assume the lessee’s incremental borrowing rate was 9%. Because the residual value was expected to contribute to the lessor’s recovery of the $479,079 fair value, the rental payments were only $92,931. But, the lessee would ignore the unguaranteed residual value and calculate its cost of the leased asset to be $454,400. $92,931 3 4.88965* 5 $454,400 p aRy emn etan lt s L e cs oses et ’s *Present value of an annuity due of $1: n 5 6, i 5 9%. In this case, the present value of minimum lease payments would be less than the fair value even though a lower discount rate is used. But again, if there is no residual value, or if the lessee guarantees the residual value, or if the unguaranteed residual value is relatively small, a discount rate lower than the lessor’s implicit rate will result in the present value of minimum lease payments being more than the fair value. When the Lessor’s Implicit Rate Is Unknown What if the lessee is unaware of the lessor’s implicit rate? This is a logical question in light of the rule that says the lessee should use its own incremental borrowing rate when the lessor’s implicit rate is unknown to the lessee. But in practice the lessor’s implicit rate usually is known. Even if the lessor chooses not to explicitly disclose the rate, the lessee usually can deduce the rate using information he knows about the value of the leased asset and the lease payments. After all, in making the decision to lease rather than buy, the lessee typically becomes quite knowledgeable about the asset. Even so, it is possible that a lessee might be unable to derive the lessor’s implicit rate. This might happen, for example, if the leased asset has a relatively high residual value. Remember, a residual value (guaranteed or not) is an ingredient in the lessor’s calculation of the rental payments. Sometimes it may be hard for the lessee to identify the residual value estimated by the lessor if the lessor chooses not to make it known. 27 As the lease term and risk of obsolescence increase, the residual value typically is less of a factor. 27 Disclosure requirements provide that the lessor company must disclose the components of its investments in nonoperating leases, which would include any estimated residual values. But the disclosures are aggregate amounts, not amounts of individual leased assets.
Spiceland_Inter_Accounting8e_Ch15
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