Accounting for Leases under ASU 840 – Lessor and Lessee Perspectives

Introduction

Leases are common financial arrangements where one party, the lessor, provides an asset to another party, the lessee, in exchange for periodic payments. Accounting for leases is subject to various accounting standards, and in this scenario, we will explore how Lessor and Lessee Companies account for a lease under ASU 840, considering different aspects such as lease payments, lease obligations, interest revenue, and interest expenses.

Lease Payment Calculation for Lessor

The Lessor, in this case, has a machine with a cost and fair value of $100,000, which is leased for a 10-year period. The Lessor aims to earn a 10% return on its net investment. To calculate the lease payment, we can use the present value of the annuity formula. The net investment is the cost of the machine minus the residual value.

Net Investment = Cost of Machine – Residual Value Net Investment = $100,000 – $10,000 = $90,000

Using the present value of an annuity formula:

������������=�������������×����1−(1+����)−�LeasePayment=1−(1+Rate)−nNetInvestment×Rate​

Where:

Net Investment = $90,000

Rate = 10% or 0.10

n = Number of Years = 10

Lease Payment = 90,000×0.101−(1+0.10)−101−(1+0.10)−1090,000×0.10​ Lease Payment ≈ $17,396.80

Therefore, the lease payment for Lessor would be approximately $17,396.80 per year.

Lease Obligations for Lessee

When the lease is signed, Lessee Company would report lease obligations on its balance sheet. The lease obligation is the present value of future lease payments. In this case, it is a 10-year lease with annual payments of $17,396.80.

Using the present value formula:

���������������=������������×1−(1+����)−�����LeaseObligation=LeasePayment×Rate1−(1+Rate)−n​

Where:

Lease Payment = $17,396.80

Rate = 10% or 0.10

n = Number of Years = 10

Lease Obligation = 17,396.80×1−(1+0.10)−100.1017,396.80×0.101−(1+0.10)−10​ Lease Obligation ≈ $117,977.17

So, when the lease is signed, Lessee would report a lease obligation of approximately $117,977.17 on its balance sheet.

Interest Revenue for Lessor and Interest Expense for Lessee

In the first year, both Lessor and Lessee would recognize interest revenue and interest expense based on the 10% discount rate. The interest is calculated on the opening balance of the lease obligation for Lessee and the net investment for Lessor.

For Lessor: Interest Revenue = Opening Lease Receivable × Rate Interest Revenue = $90,000 (Net Investment) × 10% = $9,000

For Lessee: Interest Expense = Opening Lease Obligation × Rate Interest Expense = $117,977.17 × 10% = $11,797.72

Impact of Lessee Guaranteeing Residual Value

If the Lessee guarantees the residual value of $10,000, it changes the accounting treatment. In this case, Lessee would include the guaranteed residual value as part of the lease payment calculation. The Lessee would also recognize the guarantee as a liability.

The Lessee would increase its lease payments to cover the guaranteed residual value, and the lease obligation on the balance sheet would also be higher due to the guaranteed amount.

Conclusion

In this scenario, we’ve examined how Lessor and Lessee Companies account for a lease under ASU 840, considering factors such as lease payments, lease obligations, interest revenue, and interest expenses. The treatment varies depending on whether the Lessee guarantees the residual value, as this affects the calculation of lease payments and obligations. Accurate accounting is crucial for both parties to transparently reflect their financial positions and meet regulatory requirements.