 Hello and welcome to the session. This is Professor Farhad in which we would look at an accounting for leases and specifically from a less source perspective. In the prior session we looked at the less cease perspective. So it's very important to understand the difference from an accounting perspective for leases if you are dealing from a less source versus a less cease. So in this session we'll focus on the less source and let's go ahead and get started. Adam entered into a non-cancelable lease with Maggie. So Maggie is the less sore. The commencement date of the lease was June 1st, X1. The annual lease payment for that medical equipment starting at the commencement of the lease $20,471.94. So simply put the payments are made as we sign the lease. So immediately. So this is where we are dealing with an annuity due. The bargain purchase option is $4,000. Well simply put now we understand that this is a finance lease because the first question is this an operating or a finance lease. We are told there is a bargain purchase option. This makes it a finance lease. Remember to be a finance lease we have to meet one of five criteria. One of them is a bargain purchase option we already met. The lease term is five years. The economic life of the lease is 10. So under the lease life we don't qualify but we qualify under the bargain purchase. The less source costs $60,000. This is important because we're going to be doing accounting for the less sore. Important in a sense you need to be aware of it. The fair value of the asset is $91,000. If Maggie wants to sell it the less sore implicit rate is 8%. The less C incremental rate. We don't have to worry about the less C is 8% as well. And Maggie uses reversing entries. So we're going to go ahead first try to put the lease. Try to initially put the receivable on the books. So from a less source perspective they sold this asset. This is a finance lease. So when they sell it they have a receivable. So how do we compute the receivable because we're going to have a receivable. Before we proceed any further I have a public announcement about my company farhatlectures.com. Farhat Accounting Lectures is a supplemental educational tool that's going to help you with your CPA exam preparation as well as your accounting courses. My CPA material is aligned with your CPA review course such as Becker, Roger, Wiley, Gleam, Miles. My accounting courses are aligned with your accounting courses broken down by chapter and topics. My resources consist of lectures, multiple choice questions, true-false questions as well as exercises. Go ahead start your free trial today. No obligation, no credit card required. Well very similar to when we compute the liability. The liability for the less C because the less C will have a liability. The less sore will have to compute the present value of the rental payment of the payment which is the present value of the payments plus the present value of any guaranteed or unguaranteed residual value. So from the less source perspective you have to find the present value of either guaranteed or unguaranteed and this is the present value which is we don't have any guaranteed or unguaranteed residual value in this example but I do cover it in a separate session. And the present value of a bargain purchase option which we do have a present value of of a bargain purchase option of $4,000. Now let's go ahead and compute this. So we're looking at n equal to 5, i equal to 8%. Now you go to the present value table and you compute the present value of the payment. Remember this is the present value of an annuity due, not ordinary annuity. And we'll take the payment times the factor, we'll give us $88,280. Then we'll take the bargain purchase option, which is $4,000, times the present value of a single amount of a dollar. And the factor is 0.68058 will give us $2,720. You might see some rounding here. But anyway, the total receivable will be $491,000. So this is the receivable that goes on the books of the lessor. Now what we're going to do, we're going to switch to an Excel sheet and look at the journal entries from initiating the receivable until making the payments. So on this Excel sheet, we're going to starting by looking at June 1st, 20X1. We have a lease receivable of $91,000. And I showed you how we compute this. Now we're going to be receiving payment, annual lease payment. Well, the first annual lease payment is made immediately. So the first annual lease payment is $20,472,000. Since it's made immediately, it does not, it does not, it does not involve interest. Therefore, it's going to reduce, it's going to recover, it's going to reduce the receivable by this much $20,472. Therefore, the balance as of 612X1 is $70,582. Now let's go ahead and journalize the initial lease and journalize this payment. So from a lessor's perspective, what the lessor's going to do, they're going to debit a receivable of $91,000. They're going to credit sales of $91,000. They technically sold it. And remember, we were giving the cost of sales for $60,000. And we have to credit the inventory for $60,000. So this is to initially put the lease, I'm sorry, put the receivable on the books because the lessor, Maggie sold this asset to Adam. Now, bear in mind, if we had any guaranteed residual value, let's assume, let's assume that's the case, and it was for $3,000, the present value of $3,000. We do, we would reduce the sales by 3, and we would reduce the cost of sales by 3, just FYI, just in case you're wondering. But again, I did cover this in a separate recording, but I wanted to give you a different scenario. But here we don't have any unguaranteed residual value. Then if you remember, we made a payment immediately. Now let's book the journal entry for this payment. For this payment, it's basically pretty straightforward. Since we made it immediately, we're going to, since we received it immediately, the lessy paid it immediately, we're going to debit cash, and we're going to reduce the receivable. And this is what happened here, debit cash, credit the receivable, and receivable went down to $70,528. So this is the balance. Now, what's going to happen? By the end of the year, 1231, which is seven months later, seven months later from June 1st till 1231, we're going to have to do what? We're going to have to accrue any interest on that deal. So let me, let me show you how do we compute the interest for one year. So the interest from June 1st, 20X1 to June 1st, 20X2 is $5,642. How do we compute the interest? Well, it's the balance of the receivable as of the beginning of the period times 8%. Now on June 1st, 20X2, we're going to be paying $20,472. $5,642 is considered interest revenue, and the remaining will reduce the receivable. But we are not at June 1st, 20X2. First, we have to worry about 1231, 20X2. At this point, we have to accrue any interest receivable. Well, how do we accrue interest receivable? We're going to take the $5,642, which is the full year interest and multiply it by 712. Why 712? Because it's starting in June, June, July, August, September, October, November and December. And that's going to give us at 1231 accrued interest of $3,291.30. So June 31st, I'm sorry, December 31st, 20X1, we accrue the interest. This is to accrue the interest and record the revenue for that accrued interest. Now I told you that MAGI uses reversal accounting. Therefore, a day later, after we publish the financial statement, show the receivable, show the revenue, on the financial statement, what we do is we reverse it. We're going to credit the receivable and debit the revenue to remove it. To remove it. So it's going to make our life easier on June 1st. Therefore, this entry appeared on the financial statement. Then for the next year, we removed it. So this week and keep it, but we're going to remove it for simplicity. Let's keep on going since we are working with this. On June 1st, 20X2, MAGI would receive the second payment from Adam. The payment is for $20,472. MAGI would credit interest revenue $5,642, which is, we already computed this amount here, and I showed you how to do it. And MAGI would credit a lease receivable for $15,830. So the lease receivable will go down by that much. Then we can, let's, let's finish the table here. Then how do we finish the table? Well, a year later, we'll make another payment. The interest will be based on the previous balance and the remaining will go toward the receivable. The balance will go down. Then we would receive another payment. Again, part of it will be interest receivable, interest revenue, and the remaining will be the balance. Then we'll make, we'll receive another payment. Again, we compute the interest revenue. Then the remainder is a count receivable. Then we have the bargain purchase payment of $4,000 and it should be around zero. Okay. So this is how we compute the table. So make sure you are familiar with the table, how to compute the table. And if you can do the journal entry four, if you can do the journal entry for this, you can do the journal entry for the remainder. Now, how about MAGI? How about depreciation? How much MAGI will depreciate? And the answer is nada. No depreciation for MAGI because technically MAGI sold the asset to Adam. So there's no depreciation. This is a finance lease. How about, how about if MAGI had doubts or doubt or doubts about Adam making the payment? So let's assume she sold it, but she's not sure whether Adam is going to make the payment or not. Well, if there's any doubts, then we have no sale here because we have doubts. Under those circumstances, what we have to do when we receive the cash, we're going to be considered unearned revenue until we earn it. There's no sale here. Therefore, we will debit unearned revenue and once we earn the revenue, well, it's easy. We debit unearned revenue and we credit revenue. Basically, because we have a doubt, no payment, no sale took place under those circumstances. What should you do now? Go to Farhat Lectures and work additional MCQs through false. Look at additional resources. Take your CPA exam seriously. This topic is covered. Don't shortchange yourself. Good luck. Study hard. And of course, stay safe. The CPA exam is worth it.