Question

Explain how the guarantee of a residual value may (or may not) affect a lessee’s initial recording and subsequent accounting related to a lease.

Answer 1

In context of financial lease, lessee records the initial recognition of the asset on lower of fair value or PV of MLP.

MLP or minimum lease payment is the sum of lease rentals payable and residual value guaranteed by the lessee to the lessor.

Therefore if lessee guarantees the residual value at a lower amount such that the PV of MLP becomes lower than fair value of the asset, then initial recognition shall be made at a lower amount than fair value and accordingly the aseset is reflected at a lower value in the balance sheet and lower depreciation is available.

In the final year of lease, after all lease payments are over, the lessor is reflected at fan amount equal to the guaranteed residual value of asset in the books of lessee.

Accordingly a higher GRV shall have opposite effects. However if PV of MLP becomes higher than fair value of the asset then no further effect is seen.