Question

The residual value is the estimated fair value of the leased property at the end of the lease term.

(a) Of what significance is (1) an unguaranteed and (2) a guaranteed residual value in the lessee’s accounting for a capitalized-lease transaction?

Short answer

Unguaranteed residual values are not included in the lessee’s minimum lease payments. The capitalized value is affected initially by the presence of a guaranteed residual value.

Step-by-step solution

Meaning of Residual Value

The salvage value of an asset is known as its residual value. It signifies the sum of value that an asset's proprietor might anticipate inducing when the item is disposed of. The elemental challenge with the remaining value though is deciding how to calculate the sum that will be earned from an asset at an afterwards period.

Explaining the significance

1. The lessee's accounting for a lease with no guaranteed residual value is similar to the lessee's accounting for a lease with no residual value, in terms of computing the minimum lease payment and the capitalized value of the leased asset and lease liabilities. The non-guaranteed residual value, in other words, is not included in the lessee's minimum lease payment.
2. A guaranteed residual value affects the calculation of the lessee's minimum lease payment as well as the capitalized amount of the leased asset and lease liabilities. The introduction of the guaranteed residual value affects the initial capitalized value because the present value of the lease loan is now made up of two components – the periodic lease payment and the guaranteed residual value.

The amortization of the lease obligation will result in a lease liability balance equal to the guaranteed residual value at the end of the lease term. Depending on the relationship between the actual residual value and the amount promised, the lessee may record a profit or loss at the end of the lease.