Chapter 13 - Solution Manual

Case 13 2 a pippen has a capital lease although there

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Case 13-2 a. Pippen has a capital lease. Although there is no transfer of ownership, no bargain purchase option, and the lease term is not 75% of the economic life of the asset, the present value of the minimum lease payments is 90% of fair value. Pippen would calculate the present value utilizing a rate of 10%. Under the assumption that the lease payments occur at the beginning of each period, the present value of the minimum lease payments would be $93,649 (10,000 x 9.3649). 90% of fair value would be only $83,363 (92,625 x 90%). b. If Grant treats the lease as a capital lease, it would be reported as a sales-type lease. Since the description of the lease does not mention that the residual value is guaranteed, the presumption should be that it is not. Grant's gross investment is $202,750 (10,000 x 20 + 2,750). This amount would be recorded as lease payments receivable and reduced by the initial $10,000 payment to 192,750. The initial net investment is the fair value of the asset, $92,625. The difference between the gross investment and the net investment is unearned income, $110,125. The net investment adjusted for loan payments and interest is reported in the balance sheet at year end. Interest is calculated on the net investment using the effective interest rate of the lessor. For a sales type lease, the effective rate and the implicit rate for the lessor are always the same. Hence, interest revenue of $9,915 (82,625 x 12%) would be recorded. The accompanying debit would be to unearned income. If the residual value is guaranteed, Sales of $92,625 and cost of goods sold of $75,000 would be recognized. If the residual value is not guaranteed, both sales and cost of goods sold would be reduced by the present value of the expected salvage value of $2,750, discounted at 12%. This has no effect on gross profit, the amount reported for the net investment, or the calculation of interest. c. If the lease is a sales type lease, Grant would not report any depreciation expense for 2011. Income before tax would increase by the amount of gross profit, $17,625 ($92,625-$75,000) and by the amount of interest revenue. If there are initial direct costs, they would be shown as a selling expense.
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279 The balance sheet would report the gross investment minus payments received and the remaining unearned income. Because sales are operating activities, the cash inflow of $10,000 would be an operating inflow that would be reported under the direct method of reporting operating cash flows. If the indirect method were used to report cash flows from operating activities, the increase in the net investment (from zero to its year end balance) would be subtracted from net income. d. Grant should report the lease as a sales-type lease because the 90% test is met. Fair value $92,625 less $2,750 x 0.1037 ( 285) $92,340 = 90% x 92,625 In addition, to qualify as a sales type lease, the certainty criteria also must be meet. There must be no important uncertainties surrounding the collectibility of the receivable or any anticipated future cash outflows of the lessor.
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