 Hello and welcome to this session in which we will discuss guaranteed or un-guaranteed residual value for leases specifically from the less source perspective. Remember the less source is the owner of the property, the less source is the one that's renting the property, leasing the property to the less see who's the renter. Now on the prior session we looked at this same topic however from the less sees perspective. Remember the less see is the renter is the person that's paying the money to use the property. So let's review what is guaranteed residual value. It means the party is guaranteeing a specific amount residual value for the asset at the end of the lease. So you lease the car five years later you'll return it. You are guaranteeing a value for this car for the car dealership for ten thousand. In other words the car is worth ten thousand dollar at the end of the lease and if you're guaranteeing that ten thousand well if that ten thousand is not there in value you have to come up with the money. This is if it's guaranteed if it's un-guaranteed you don't have to do anything about it. Now remember this is a review from the prior session for the less see include the residual value in the lease liability only if guaranteed. So from a less sees perspective remember the less see will have what the less see will have a liability. Why? Because the less see will have a loan basically a liability. They will include this residual value only notice only if guaranteed so it has to be guaranteed and plus the expected value is less than the guaranteed amount. So it would only include if it's guaranteed and that the expected value of the guarantee. Let's go back to the ten thousand if you are guaranteeing the value of the car for ten thousand and the value of the car is 12 you don't include this present value computation but if you're guaranteeing the car is eight and the value is expected to be seven you are three thousand dollar short you have to include the present value of this three thousand dollar in the computation. Now so include the residual value for the less so now include the residual value in the computation of the lease receivable remember the less sore will have a lease receivable so when we compute the lease receivable for the less sore we would always always always always always include the residual value whether it's guaranteed or unguaranteed well what does that mean it means it doesn't matter yes it matters we're going to have a small twist at the commencement of the lease and this is also what we need to learn so the first thing you need to know is this you would always include the residual value for the less sore whether the residual value is guaranteed or not when computing lease receivable however we're going to have a small twist when it comes to recording the sale and we will see the difference between whether it's guaranteed or unguaranteed residual value but let's talk about what is the residual value to the less sore let's think about this concept because it's we have to understand why we treat it a little differently with that small twist where we have that twist well think about it if the amount is guaranteed if the less see guaranteed the amount well it is as if the less sore sold the asset residual value so if it's guaranteed I'm either going to get the money if let's assume a car dealership Ford Motor Company lease the car and the the less see the person that that lease the car guaranteed the value of 10,000 well if the person return return the car and the car is all beat up they still have to pay 10,000 why because it's guaranteed at is for the less sore it's is if they sold the residual value it's assured recovery why because they're gonna either get the asset worth 10,000 back and they can sell it if they want to or they can get cash instead cash in lieu so technically they sold the residual value so the recovery is assured therefore here's what's gonna happen we're gonna increase again the residual value in the receivable of course we do that I told you about this but the residual value would also be included in the sale amount and this is important so if it's guaranteed it's gonna be included in the sale amount always be included in the receivable what if the residual value is unguaranteed let's think about this if it's unguaranteed the dealer the dealer Ford Motor Company cannot it cannot be assured that the residual value will be back to them they they're not they're not assured of the recovery because the the person that purchased the car the less see doesn't guarantee anything therefore there is no sale of the residual value what does that mean it means we're gonna reduce the sales and cost of goods sold by the present value of the residual value and this is where the twist takes place in other words the receivable the lease receivable is the same whether it's guaranteed or not the lease receivable the lease receivable will be the same what's gonna be different is the sale amount the sale amount and cost of goods sold now you're saying come on give me an example no worries we're gonna work example working both cases a comprehensive example to show you how this work from the less source perspective now if you are watching that's great you're looking for some help this is how you end up here watching my recording you are you are either an accounting student or a CPA candidate in both situation I advise you to go a step further go to farhatlectures.com subscribe I have lectures multiple choice through false exercises resources that's gonna help you with your accounting courses as well as your CPA review course I can help you understand the material differently which in turn will help you do better in your classes will help you do better on your CPA exam invest in yourself if you have not connected with me on LinkedIn please do so take a look at my LinkedIn recommendation like this recording if you're watching you're liking it please like it share it connect with me on Instagram Facebook Twitter and Reddit so let's review what we just said lease receivable equal to the present value of the payment received plus the present value of the residual value regardless whether that residual value is guaranteed or not guaranteed unguaranteed so this is always the case this is what the lease receivable is so the best way is to start an example illustrating illustrating both we're gonna work the same example that we work when we looked at the finance lease from the less sea and the less source perspective assume Boeing this Boeing capital corp a subsidiary of Boeing and Delta airline signs a lease agreement dated January 1st that called for Boeing to lease a mobile airplane ladder which is a ladder to delta beginning January 1st x1 here's the details of the lease the term of the lease is five years non-cancelable requiring equal payments of 20 000 and we're going to compute the payment anyway annuity due basis which is the first payment means be paid on January 1st x1 the fair value of the ladder is 95 000 with an estimated economic life of five years the expected residual value after five years is 2960 for the purpose of this example we're going to assume it's a guaranteed residual value the the there is no renewable option the ladder would revert back to Boeing at the termination of the lease Delta's incremental borrowing rate is five percent Boeing sets an annual rate to earn four percent and that is known so we know how much Boeing is earning therefore we're going to be using the four percent collectability of payment is assured so that's good that means we're going to get the money simply put this is a finance lease we already talked about this the question is how do we compute and the cost of the ladder for Boeing is 80 000 that's giving that's also a giving figure the first thing we're going to do we're going to compute the payment although it's giving it's just a good review how do you compute the payment you take the fair value of the least asset least equipment minus the present value of the residual value which is 2960 times 0.82193 the factors and that's going to give us the present value of two thousand four hundred and five dollars amount to be recovered is this much ninety two thousand five ninety five will take ninety two thousand five ninety five divided by the present value of an of an annuity do and n equal to five i equal to four the same thing here n equal to five i equal to four percent and we'll come up with the payment of twenty thousand now the lease receivable equal to the ninety five thousand which is the present value of the payments which is right here the present value of the payment plus the present value of the residual value together will give us ninety five thousand therefore we debit lease receivable ninety five thousand we credit sales revenue ninety five thousand now why did we do so so what we did in the sales so this ninety five thousand dollar here it included the present value of the payments plus the present value of the guaranteed residual value why did we do that because we assumed in this example the amount of residual value is guaranteed this is what we're working so once we work the end guaranteed you will see the difference then we debit cost of goods sold eighty and credit inventory eighty thousand this is the entry now what's going to happen next is we're going to build an amortization schedule and this is what we did in the prior session this is the amortization schedule the lease receivable is ninety five thousand and we go through the payments i'm not going to go over this schedule because i did go i did go over this schedule in the prior session but real quick i'm going to go over one entry real quick the first payment twenty thousand would reduce the receivable to seventy five because we received it on the same date the second payment what's going to happen it's going to be split between interest revenue and reduction of the receivable the receivable becomes fifty eight and those are the journal entries so on and so forth so again if you're looking at this page and saying what why why why doesn't he go over it because i didn't go over it before the point i'm trying to make here is the residual value is included in the table and this is for the guaranteed for the guaranteed residual value and let me tell you for the end guaranteed residual value it's also going to be included okay but let's see what what's going to be the difference okay now so this is for guaranteed now let's switch the example and the only thing i'm going to switch in the example i'm going to assume that this residual value twenty nine twenty six is unguaranteed now how would the less sore deal with this unguaranteed residual value this is this is what we're trying to do to see the difference between the two well here's what's going to happen the payment is the same we compute the payment the same the least receivable is the same this is exactly what we did the least receivable is the same what's going to what's going to be difference is this the least receivable will be 95 000 sales will be 92 sign five ninety five so why is sales ninety two thousand five ninety five well because what we do is we cannot record the whole sales because the 95 000 represent the present value of the payment received plus the present value of the residual value here here, we cannot assume we're going to get that present the guaranteed residual value. Therefore we deduct 24.05, therefore our sales will be 92,595. Then we debit cost of goods sold by 77.595. Where did this number came from? The cost of goods sold is giving us 80,000, we reduce it by the present value of the residual value and inventory credited is 80,000. If you add the debits and the credits, they should equal to each others. So what is the difference between this entry and the prior entry? Well, let's think about this. Here's the prior entry. I just showed you the prior entry, let me highlight it, box it in a different color. This is the entry when the residual value was guaranteed. Sales was 90, cost of goods sold was 80. So if we take, I'm sorry, sales was 95. So if we take 95 minus 80, we'll get to the profit of 15,000. Now, let me put this in a different color, when the residual value is unguaranteed, what did I tell you? I told you that we're gonna reduce the sale by the present value, which becomes 92,595 and cost of goods sold is 77.595. If we take those two numbers and we'll find the difference, the profit also 15,000. So notice in both situation, in both situation, in both situation, it is the same. It is the same. The profit is 15,000. The only difference, what's the only difference? The only difference is they are, they are the sales and the cost of goods sold are two different figures. That's the only difference. Now, when it comes to the amortization schedule, it's the same amortization schedule starting with 95 and we have the residual value. However, when it comes, when we go to the income statement presentation, sales revenue is 92,595, cost of goods sold is 77,595, which will give you still a profit of 15, however, under the guaranteed, you book 95,000 of sales, the gross amount and 80 of cost of goods sold, which also gave you an amount of 15. So that's the difference between the two. The point to remember, guaranteed residual value is included in the amortization schedule for both. What should you do now? 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