Another good question has been raised by one of my readers, this time involving purchased leveraged leases. The question is – “If you purchase a leveraged lease, for example, in year 25 of a 30 year lease, can you still use leveraged lease accounting?” The short answer is yes, but being a good accountant (and teacher at heart), I will give you the long answer.
On a broad level, FASB 13 tells us that, once the lease is classified at inception, its classification is not revisited unless there is a new transaction. A new transaction would be the result of a renewal or extension, for instance, or if both parties to the deal agree to a revision in the terms of the agreement. Neither of these events occur when a lease is purchased. Purchased leases are addressed more specifically in paragraphs 12-16 of FIN 21, Accounting for Leases in a Business Combination. Although the purchase of a leveraged lease may not be the result of a business combination, we use the provisions of FIN 21 as guidance. Essentially, FIN 21 tells us that the purchaser retains the leveraged lease classification as of the date of the purchase. The purchase price becomes the net investment in the lease, which must be broken down into its components of net rents receivable, unguaranteed residual, and unearned income. The unearned income will be a function of the remaining cash flows.
The remaining after-tax cash flows need to be calculated by considering the remaining rents and residual, the tax position of the new lessor, the effect of the MACRS depreciation, debt repayment, and the tax rate. Although goodwill as allocated under FASB 141 is mentioned as a component of the purchase price in FIN 21, it should not be considered in a straight purchase of the leveraged lease. Once the cash flows are determined, the MISF rate must be calculated, which is used to allocate the cash flows to income over the remaining life of the lease in accordance with the leveraged lease provisions of FASB 13.
It is not always easy to follow a verbal explanation without some form of illustration, but if you are familiar with how the leveraged lease works you should get an idea. For those of you who want a numeric illustration, there is one in Appendix A of FIN 21, although it has some funky components and uses some ancient tax law. Still, all in all, it should give you an idea of what needs to be done. Other than that, there is not much out there in the way of good examples so let me know if you need further clarification.
When you purchase a leveraged lease must you book the original residual value amount?
Posted by: Anonymous | March 27, 2006 12:25 PM | Permalink to Comment