Question

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

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

Short answer

The annual lease payment amount will be the same whether the value is guaranteed or non-guaranteed.

Step-by-step solution

Meaning of Fair value

The real worth of an item - a product, stock, or security – that's concurred upon by both the dealer and the buyer is referred to as fair value. The fair value applies to an item that's sold or exchanged within the market where it belongs or under standard circumstances – not to one that's being liquidated.

Explaining the significance

If the residual value is not guaranteed or guaranteed, the amount to be charged by the lessee is the same. As a result, whether the residual value is guaranteed or non-guaranteed, the amount of the annual lease payment established by the lessee is the same.