Leasing Arrangement in Accounting - Essay Example

Thus the rate is on a par with what Sylvan would have paid, had he borrowed (from another source like a bank) an amount equivalent to the asset value.

The amount deducted each year towards depreciation on the machine is the income source from which the cost of the lease is recovered. Therefore, the term of the lease is equal to the period in which the value of the machine becomes zero.

The minimum lease payment made on each due date is inclusive of principal as well as interest. Interest is calculated, concerning the diminishing balance of debt, at the same fixed rate as that at which the minimum lease payment was discounted. Expenditure incurred under such costs as insurance, maintenance, and taxes is shown under the appropriate head in accrual or deferral accounts.

In the balance sheet, the asset figures as a fixed asset with a title like ‘Leased Equipment under Capital Lease’. An equivalent liability, by way of the amount paid towards the lease, is projected with a title like ‘Lease Liability’. The amount paid on the principal in the following year falls under the current part of the liability and the rest under the non-current part.

The present value of liability should eventually equal the aggregate of minimum lease payments projected by the lessee in the balance sheets during the following five (or less as the case may be) financial years from the time the lease agreement is enforced.

For Breton, the lessor, the lease arrangement is of direct financing nature. In the transaction, there is no mention of any such thing as dealer’s profit or manufacturer’s profit. Discounted present value of the minimum lease payment is more than 90 percent of the asset value at the time of commencement of the lease. No problems are predicted in connection with the collectability of minimum lease payments. Nor are there any dead costs deemed to have to be borne by the lessor.

It is mandatory for Breton, the lessor, to document a ‘Lease Receivable’. The present value of minimum lease payments as well as the present value of residual value should be reflected in it. The machine, having been credited to the appropriate asset head, should no longer be shown in the ‘Lease Receivable’.

Breton, the lessor, has to follow the effective interest method of amortization, in which the implicit rate of interest (obtained by discounting aggregate of payments and uncertain residual value to the asset value at the time the lease is enforced) will be put at 9 percent. Lease Receivable shows the payment received as a reduction and interest (calculated on diminishing balance at the implicit rate) as income.

Breton, the lessor, is required to put in black and white the details of minimum lease payments for the following five (or less as the case may be) financial years from the time of enforcement of the lease. He is also required to furnish the details of uncertain residual values accumulating in his favor if any and of unearned income by way of interest, apart from the details of the minimum lease payments for the rest of the lease period.