PROJECT 2 – LEASE RESEARCH

ACCT 414 –Spring2010

Analyze each of the following situations to determine the appropriate lease classification for both the lessee and the lessor. You must use the Excel answer sheet provided – it has present value formulas already written. The first problem has already been solved to illustrate how to enter data. However, you will turn in a printout. Be sure to follow instructions (see end of this document).

Similar to Spring 1995 302 project – a variation was used Spring 2001 & Spring 2006

1.Laramie Leasing Co. (lessor) and Cottonwood Corp. (lessee) signed a lease on January 1, 2010.

(a)The leased property cost Laramie Leasing $700,000 which is also its market value at the inception of the lease. The property is new.

(b)The term of the lease is six (6) years.

(c)The lease does not provide for renewal options.

(d)The leased asset has an estimated useful life of 9 years.

(e)The leased property reverts to Laramie Leasing at the end of the lease.

(f)The lease payments are $130,000 per year beginning January 1, 2010.

(g)Laramie is reasonably certain of the collectability of the rental payments and has no additional costs to be incurred since Cottonwood Corporation has agreed to pay all executory costs including property taxes, insurance, and maintenance.

(h)Cottonwood Corp.'s incremental borrowing rate is 10%. Colville has no way of knowing or estimating Laramie Leasing Co.'s implicit interest rate.

(i)No investment tax credit was available on this type of leased property.

(j)Residual values of the leased asset: $60,000 at the end of 6 years, $50,000 at the end of 7 years, $30,000 at the end of 8 years, and $15,000 at the end of 9 years. The residual value is unguaranteed.

2.Same as #1 except for (c) since Cottonwood has an option to renew the lease for one more year for an additional lease payment of $30,000.

3.Same as #1 except for (c) sinceCottonwood has an option to renew the lease for three additional one-year terms at a cost of $15,000 per year. See item (j) for residual values.

4.Same as #1 except for (a) sinceLaramie Leasing manufactured the leased equipment at a cost of $595,000.In addition, (j) an unrelated third party is providing a guarantee of the residual value to Laramie Leasing for $1,000 (initial direct cost). See item (j) for residual values. In addition, assume that the equipment was specially designed for Cottonwood and would probably be of little use to other potential lessees.

5.Same as #4 except the following differences: (d) The leased property is undeveloped land with an unlimited useful life. (a) This piece of real estate was purchased by Laramie Leasing several years earlier for possible future expansion at a cost of $350,000 and (j) is expected to be worth $900,000 at the end of the 6-year lease. Cottonwood Corporation plans to use the land as a parking lot and will incur substantial upfront costs to pave the property.(h) Cottonwood’s incremental borrowing rate is 9%.(c) Also assume that the lease is renewable for two additional 6-year lease terms for the same annual lease payment.

6.Same as #4 except for (g) since Laramie Leasing Co. is required by the lease terms to provide maintenance on the leased equipment. Cottonwood estimates that it would cost about $5,000 per year to buy an equivalent maintenance contract from Laramie Leasing or a third-party supplier. Laramie Leasing Co.’s estimated cost to provide maintenance is $4,000 per year.

7.Same as #1 except for (a) since the leased equipment is not new and (d) the remaining useful life is 6 years instead of 9. When Laramie Leasing acquired the asset, the useful life was 40 years. The $700,000 in item (a) is the book value at the beginning of the lease which approximates the fair value of the used equipment. At the end of this six-year lease, the asset will be worth next to nothing and will be scrapped.

8.Same as #1 except that there is a $120,000 penalty for nonrenewal of the lease for another year at the same $130,000 lease payment.

9.Same as #1 except Laramie Leasing is a start-up company and needed to borrow the money to purchase the equipment. Cottonwood Corporation co-signed the note, thus guaranteeing Laramie Leasing Co.’s debt for eight years. See item (j) for residual values.

The RESEARCH part of the assignment pertains to FASB using the Accounting Standard Codification System. For the IFRS solutions, rely on the notes I’ve given you about IFRS to determine the likely classification – I don’t’ expect you to research the IASB standards although $20 would give you “search” access with a student membership in IAAER (if you are interested). Also, I heard that IASB just started putting basic standards on their website.

Please provide CITATIONS in good form for your answers – if it goes beyond the basics on the flow charts. You may use WORD instead of the excel sheet provided for the citations but they should be attached. You may find it helpful to “cut and paste” selected quotations. Note that the first problem has already been solved on the Excel sheet and the formulas for PVMLP and implicit interest rate are already written and included. Focus on getting the minimum lease payments (cash flows) in the correct time periods and the “mechanics” of computation happen automatically.

Each of the 8 questions (2 through 9) is worth 11 points: 2 points each for the US GAAP PVMLPs & implicit interest rates and 5 points are allocated to the classifications under US GAAP and IFRS. The final 12 points are awarded based on evidence that you did conduct research and provided citations as appropriate.

The "Why" explanation area needs only one of the 4 rules (FASB) or 5 indicators (IFRS): TT, BPO, LT > 75% Eco Life, PVMLP > 90% FMV, specialized nature. Indicate the first one on the list that is satisfied. The lessor might have additional reasons -- indicate the one violated, i.e., addl costs or collectability. Abbreviations are fine as long as they are obvious (like the ones in this paragraph). It might be helpful to do all of the lessee problems first under US GAAP first. Then go back through the assignment to do the lessor side. Finally, think about whether a decision using IFRS would be different.

You may work in groups of two or three people on this assignment. Turn in one answer sheet with all names clearly marked. Plan to sit together in class on Feb. 23 as we discuss the solution. YOU MUST USE THE EXCEL ANSWERSHEET PROVIDED.

DUE DATE:Thursday, Feb. 23, 2010. Please turn in the original and keep a photocopy to mark as we go over the project during class as a review for Exam 1. No projects will be accepted after class begins.

You must use answer sheet provided

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