I am getting ready to teach the leasing module in my MAcc class. I was going over the decisions to date on the FASB web, and I found the following:
“Lease payments should include amounts expected to be payable under residual value guarantees… The Boards discussed the subsequent measurement of residual value guarantees by lessees … and tentatively decided that:
The amounts expected to be payable under residual value guarantees included in the measurement of the lessee’s right-of-use asset should be amortized consistently with how other lease payments that are included in the measurement of a right-of-use asset are amortized. That is, amortization should be on a systematic basis from the date of commencement of the lease to the end of the lease term…”
So let’s suppose the guaranteed residual = expected residual = $10,000. At the end of the lease, the lease liability will be $10,000. The expected cash payment to the lessor is zero, and it will be zero if the asset is worth at least $10,000. But the asset’s carrying value is zero. This means a gain when the asset is returned.
Under current accounting for capital leases with guaranteed residual value, the residual value is used as salvage value when calculating depreciation for the leased asset. If I am reading this tentative decision correctly, all future leases will have to use zero as the salvage value. That will generally produce overstated depreciation expenses over the lease term followed by a gain at the end of the lease. Why would the Boards do this? Do they mistrust the accuracy of residual values? Or am I misreading the words?