Question

What is included in the Minimum Lease Payments (MLP)? What is the relationship among the present value of MLP, the interest rate implicit in the lease, the residual value of leased asset, and the fair value of leased asset?

Answer 1

Q.1 What is included in the Minimum Lease Payments (MLP)? What is the relationship among the present value of MLP, the interest rate implicit in the lease, the residual value of leased asset, and the fair value of leased asset?

Answer : Minimum Lease Payments : The minimum lease payment is the lowest amount that a lessee can expect to make over the lifetime of the lease. Accountants calculate minimum lease payments in order to assign a present value to a lease in order to record the lease properly in the company's books.

Following are included in the minimum lease payment :-

The minimum payment is known as the minimum lease payment. Minimum lease payments are rental payments over the lease term including the amount of any bargain purchase option, premium, and any guaranteed residual value, and excluding any rental relating to costs to be met by the lessor and any contingent rentals.

present value of MLP:-

The Present Value of the minimum lease payments (MLP) is 90% or more of the fair value of the assets. So if you take the example in criterion two, the Fair market value of an asset is $ 460,000, and the Present Value of Minimum Lease Payments is $450,000, which is more than 90%, so lease agreement satisfied the MLP present value criteria.

interest rate implicit in the lease : -

The interest rate implicit in the lease is defined in IFRS 16 as 'the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.

Residual value of leased asset :

The residual value of an asset is based on what a company expects to receive in exchange for selling or parting out the asset at the end of its lease term or useful life. Different industries and fields use and calculate residual value differently.

The formula to figure residual value follows:

Residual Value = (The percent of the cost you are able to recover from the sale of an item x The original cost of the item.)

For example, if you purchased a $1,000 item and you were able to recover 10 percent of its cost when you sold it, the residual value is $100.

Fair value of leased asset :- The present value of the sum of all lease payments and any lessee-guaranteed residual value matches or exceeds the fair value of the underlying asset. The asset is so specialized that it has no alternative use for the lessor following the lease term.

Step 1: Determine the present value factor to use, 4 years (n-1) and 12% gives us 3.0373 + 1.0000 = 4.0373 present value for annuity due at 12% for 5 years.

Step 2: Calculate the present value of cash flows associated with the lease. $ 10,000 x 4.0373 = $ 40,373 Value of Leased Asset.