In short, residual value is the approximated fair worth of the leased asset at the end of the lease, and also can be either guaranteed or unguaranteed by the lessee. Guarantee residual values are usually included in the minimum lease payments.

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Both guaranteed and unguaranteed residual worths affect accountancy by the lessee and also lessor. Because that the lessor the decision of the lease payments through a residual value is additionally different.


This write-up discusses residual worth of leased asset and also how it affects the accountancy by both lessee and lessor. It come with case examples, computation and also the compelled journal entries. But before that, i would perform a rapid overview ~ above some facets of a resources lease i beg your pardon is essential to enable you to understand computation main topic. Read on…

Important aspects of a capital Lease

The computation and entries required in a funding lease depend on a good understanding the the adhering to four elements:

1. Minimum Lease Payments – They space the payments embraced or required to be payment by the lessee to the lessor. They include the following:

Minimum Rental Payments which room the minimum forced payments by the lessee under the lease terms.Guaranteed Residual Value which is an approximated residual value of the leased building as guaranteed by the lessee or a 3rd party, unrelated come the lessor. That is the amount the the lessor has actually the right to need the lessee to acquisition the asset that the lessor is guaranteed to realize.Penalty on fail to Renew or Extend the lease that is sometimes required of the lessee.Bargain purchase Option which is an choice at the inception of the lease, to purchase the lease property at the end of the lease term at a resolved price sufficiently below the supposed fair value to make the acquisition reasonably assured.

2. Executory Costs – Which space the ownership-type costs, such together insurance, maintenance and tax expenses, to it is in excluded, if born by the lessee, native the computation of current value the the minimum lease payments.

3. The Discount Rate – i m sorry is offered in the computation that the current value the the minimum lease payments and included after:

The Lessee’s Incremental take out loan rate characterized as: ‘‘the price that, in ~ inception of the lease, the lessee would have actually incurred to borrow the funds essential to buy the leased heritage on a secured loan v repayment terms similar to the payment schedule referred to as for in the lease’’; orThe Lessor’s attention Rate implicitly in the lease if recognized by the lessee and also it is less than the lessee’s incremental take out loan rate. The is the discount price that translates the present value the the minimum lease payments and also any unguaranteed residual value getting the lease to the fair worth of the leased property to the lessor.

 

Lease instance With Residual Value

For example, let’s suppose that the lie Dharma agency expected the Chinese restaurant tools to have actually a residual worth of $2,500. It would certainly compute the lease payments together follows:

Fair industry Value of tools of the lie Dharma firm = $50,000

Less existing Value the Residual worth ($2500 x 0.62092 = $1,552.30

Amount to be recovered through the lie Dharma company through the lease payment is $50,000 – $1,552.30 = $48,447.70

Five regular Lease payment ($48447.70/4.16986) = $11,618.54

 

Lease example With guaranteed Residual Value

The guaranteed residual worth is had in the minimum lease payment which require that the lessee capitalize the current value of the amount guaranteed. Come illustrate, let’s go back to the lied Dharma firm as the lessor and also Putra firm as the lessee example and assume that Putra firm agrees to guarantee the whole amount of the residual worth of $2,500. The capitalized amount for Putra company is as follows:

1. Present value of five annual rental payment discounted at 10% ($11,618.543 x 4.16986) = $48,447.70

Plus

2. Existing value that a single sum that $2,500 (the guarantee residual value) discounted at 10% ($2,500 x 0.62092) = $1,552.30

3. Current value that minimum lease payments = $50,000.00

Here is Putra company’s lease amortization schedule, making use of ‘Annuity due Basis’ v ‘Guaranteed Residual Value’:

*
Notes:

*rounded

(a) compelled lease payments

(b) Executory costs paid by the lessee and included in rental payments

(d) (a) – (b) – (c)

(e) coming before balance – (d)

The over lease amortization schedule is the basis because that the adhering to journal entries:

1. Capitalization of lease ~ above January 1, 2011.

. Leased devices under funding Leases = $50,000

. Obligation under capital Leases = $50,000

2. An initial rental payment ~ above January 1, 2011

. Residential property Tax price = $3,000.00

. Responsibilities under funding Leases = $11,618.543

. Cash = $14,618.543

3. Acknowledgment of accrued interest on December 31, 2011

. Interest price = $3,838.145

. Interest Payable (or Accrued Interest responsibility under funding Leases) = $3,838.145

4. Acknowledgment of the yearly depreciation the leased equipment on December 31, 2011.

. Depreciation Expense-Capital Leases = $9,500.00

. Gathered Deprecation–Capital Leases <($50,000 – $2,500)/5 years> = $9,500.00

5. In ~ the end of the year 2011, the duty Under resources Leases in the balance paper is divided into that current and noncurrent sections as follows:

A. Current Liabilities

Interest Payable = $3,838.145

Obligations under resources Leases = $7,780.398

B. Noncurrent Liabilities

Obligations under Lease = $30,601.059

6. Record the second rental payment in development January 1, 2012

. Home Tax price = $3,000.00

. Duties under funding Leases = $7,780.398

. Accrued interest on duties under resources Leases = $3,838.398

. Cash = $14,618.543

7. The very same patterns that entries are followed through the year zero

Lease instance With Unguaranteed Residual Value

The lessee does not acknowledge the unguaranteed residual value in the computation that the minimum lease payments and the capitalization that the leased legacy under obligation. To illustrate, let’s go back to the lie Dharma firm as the lessor and also Putra company as the lessee example and assume the Putra company does not agree to insurance the whole amount that the residual worth of $2,500.

The capitalized amount for Putra firm is together follows:

1. Existing value that five annual rental payments discounted at 10% ($11,681.543 x 4.16986) = $48,447.70

Plus

2. Unguaranteed residual value of $2,500 not capitalized = $0

Present worth of minimum lease payment = $48,447.70

Here is Putra that company lease amortization schedule, making use of ‘Annuity early Basis’ v ‘Unguaranteed Residual Value’:

*

The over amortization schedule is the basis because that the adhering to journal entries:

1. Capitalization of lease ~ above January 1, 2011

. Leased devices under funding Leases = $48,447.70

. Obligation under resources Leases = $48,447.70

2. An initial rental payment top top January 1, 2011

. Building Tax expense = $3,000.00

. Obligations under capital Leases = $11,618.543

. Cash = $14,618.543

3. Acknowledgment of accrued attention on December 31, 2011

. Interest cost = $3,682.915

. Attention Payable = $3,682.915

4. Acknowledgment of yearly depreciation expense on December 31, 2011

. Depreciation Expense–Capital Leases = $9,689.54

. Gathered Depreciation–Capital Leases = $9,689.54

($48,447.70/5 years)

5. In ~ the end of the year 2011 the responsibility under resources Leases in the balance sheet is split into its current and noncurrent portions as follows:

A. Current Liabilities

Interest Payable = $3,682.915

Obligations under resources Leases = $7,935.628

B. Noncurrent Liabilities

Obligation under resources Leases = $28,893.529

6. Record the 2nd rental payment on January 1, 2012

. Building Tax cost = $3,000.00

. Duties under funding Leases = $3,682.915

. Accrued interest on obligations under capital Leases = $7,935.628

. Cash = $14,618.543

7. The very same patterns the entries are complied with through the year zero.

Recording Lease with Residual worth On Lessor’s Book

For the lessor the presumption is the the residual value will it is in realized even if it is it is guarantee or unguaranteed. Return to the previous example of the lie Dharma agency as the lessor and Putra company as the lessee and the residual worth of $2,500 (whether guaranteed or unguaranteed), the following information is relevant to the lessor:

1. Pistol Investment: ($11,618.543 x 5) + $2,500 = $60,592.7152.

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2. Unearned interest revenue: $60,592.715 – $50,000 = $10,592.7153.

3. Net invest = $60,592.715 – $10,592.715 = $50,000.00

And, right here is lied Dharma’s lease amortization schedule, using ‘Annuity early Basis’, v ‘Guaranteed Residual Value’:

*

Notes:

*rounded

(a) forced lease payments

(b) Executory costs paid through the lessee and included in rental payments

(d) (a) – (b) – (c)

(e) preceding balance – (d)

The lease amortization schedule because that the lessor above is the communication of the complying with journal entries: