Coming Changes to Lease Accounting F09

# Right to use asset account for the same net effect on

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“right to use asset” account for the same net effect on  the balance sheet Depreciation decreases slightly from \$27,949 to  \$27,352 for the last four years of the lease

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The capitalized value Notice that in both the increased and decreased  lease term situations, the originally anticipated  “value” of the leased asset changes abruptly by a  substantial amount Is this logical?   Whether or not this makes sense, the liability balance  MUST change!
Worst Case Scenario For those wanting to cook the books: Instead of the example lease, write the contract for  seven one-year renewal options at CU 35,000 per year Each year, decide that the remaining lease term is just  one more year Use the highest possible incremental borrowing rate to  keep the liability at the lowest possible number  In the example on next slide, I left it at 8% but if one could argue for 9% or 10%, the liability would be even smaller!

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Worst Case Version Liability would always be CU 32,407  (PV of 35,000 in one year at 8%) Period Payment Interest Principal Adj for Renewal Balance Rate used 0 32,407 1 35,000 2,593 32,407 (32,407) 32,407 8% 2 35,000 2,593 32,407 (32,407) 32,407 8% 3 35,000 2,593 32,407 (32,407) 32,407 8% 4 35,000 2,593 32,407 (32,407) 32,407 8% 5 35,000 2,593 32,407 (32,407) 32,407 8% 6 35,000 2,593 32,407 (32,407) 32,407 8% 7 35,000 2,593 32,407 0 8% 245,000 62,777 62,777
Worst Case Version Depreciation expense would always be CU 32,407  (PV of 35,000 in one year at 8%) and combined  impact of interest and depreciation would equal cash  flow Period Depr Expense Acc'd Depr Adj asset Right-to- use Asset Book value of Asset Impact on P&L (depr + int) 0 32,407 32,407 1 32,407 32,407 32,407 64,815 32,407 35,000 2 32,407 64,815 32,407 97,222 32,407 35,000 3 32,407 97,222 32,407 129,630 32,407 35,000 4 32,407 129,630 32,407 162,037 32,407 35,000 5 32,407 162,037 32,407 194,444 32,407 35,000 6 32,407 194,444 32,407 226,852 32,407 35,000 7 32,407 226,852 - 226,852 - 35,000 226,852 245,000

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Too complicated? Think about a typical rent situation for retail space.   Rent is a fixed amount PLUS a percentage of sales. Since it is impossible to predict the future with  accuracy, it is likely that the liability account would  have to be revised EVERY reporting date! This is quite complicated because it theoretically  affects depreciation expense The other issue is whether to run the difference in  liability (gain or loss) through the income statement or  use some other technique
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• Spring '13
• brock
• lease term, Worst-Case Scenario series

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