MGMT 35100 1st Edition Lecture 6Last Lecture OutlineI. Asset Swap II. Equity Swap III. Modification of debt financing IV. Conversion of Debt Current Lecture Outline I. Accounting For Leases a. What Are Leases? II. Basic Ideas of Lease Accounting III. Basic Concepts and Notations IV. Types of LeasesV. Lessor’s Accounting Current Lecture I. Lease: a contract under which one party (Lessee) pays rents and acquire to use an asset that is owned by another party (Lessor)a. Why?i. Tax advantages (depreciation, GRV, and interest/rent expense) GRV- guaranteed residual value of the asset ii. Off-balance sheet debt financing for certain leases (not debt on B/S) – don’t have to show the liability on the b/sII. Basic ideasa. RV: residual value- value at the end of asset at end of the lease i. Lease Liability: at signing, is = PV of all rent payments + PV of RV – if you are required to take over asset at end of the term III. Basic concepts a. NCL: non-cancellable leases b. C- capital leasec. OL- operating lease d. STL: sales-type leasee. DFL: direct financing leasef. MLP: minimum lease payment **= MRP+GRV (or BPO price) + any payment requiredat end of the lease g. MRP: lessee’s minimum basic rental payments These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.h. URV: unguaranteed residual value- not obligated under contract i. PV of Lessee’s PV= (MRP-ExCost if included in MRP)(PVOA) + (GRV or BPO price)(PVS) – only include residual value if it is guaranteed 1. Must use the lower of implicit vs. borrowed interest ratesii. PV of Lessor’s PV: = (MRP- EXCost if included in MRP)(PVOA)+ (RV or BPO price + receipt at lease end)(PVS)  this is equal to the fair value of the asset; residual value is always there1. Uses the implicit interest rate i. ExCosts: Executory costs: cost of owning the asset; like repair, maintenance, property tax, insurance – different than rent* j. Gross Investmentk. Net Investment= PVor= fair value of assetl. Unearned Interest Revenue: lessors unearned interest revenue (GrosInv- NetInv)--- receivables IV. Types of Leases a. Capital: lessee recognizes depreciation i. Use economic life if lease qualifies under transfer of ownership or BPOii. Use lease term if lease qualifies under lease term being greater than or equalto 75% of the assets economic life or if the PV of the MLP is greater than or equal to 90% of the assets FV to the Lessor b. Operating: lease is treated like rental payments using periodic rent payments V. Lessor’s Accounting a. STLi. Meets 1 or more CL criteria ii. There is a profit or loss iii. Collection of MLP is reasonably assured iv. There is no Lessor’s cost yet to be considered v. ^ all of these conditions must be metb. Net Receivable = Gross lease receivable – unearned interest revenue HP 15-11/1 12/31 12/31|-----------1----------|-----------2-----------|----------3------------|-----------4------------|---------5----------|1. Roadway (Lessee):The lease is . . . a CL because (lease 5 yrs) > (life 5 yrs)(.75) NoPVee> (.90)(FV 804,727)-- TruePVee= ((200k)(PVOA, 5, 8%)+ (URV -0-)(PVS,5,8%)= 798,542FV= PVor= ((200k)(PVOA, 5, 8%)+ (RV 75k)(PVS,5,8%)= 804, 727PVee = $798,542PV0r = $804,727Alcam (Lessor): The lease is . . . Sales-Type Lease b/c-(1)-(2) profit= sales realized -cost of sales = (804,727 – PV URV) 600k – PV of URV=204, 727 – so profit -(3) No collection problem -(4) No leftover