(d) Prepare a lease amortization table for the full term of the lease. Round all amounts to the nearest dollar — Ramey Corporation diversified public company with nationwide

Ramey Corporation is a diversified public company with nationwide interests in commercial real estate development, banking, copper mining, and metal fabrication. The company has offices and operating locations in major cities throughout Canada. With corporate headquarters located in a metropolitan area of a western province, company executives must travel extensively to stay connected with the various phases of operations. In order to make business travel more efficient to areas that are not adequately served by commercial airlines, corporate management is currently evaluating the feasibility of acquiring a business aircraft that can be used by Ramey executives. Proposals for either leasing or purchasing a suitable aircraft have been analyzed, and the leasing proposal was considered more desirable.

The proposed lease agreement involves a twin-engine turboprop Viking that has a fair value of $1.5 million. This plane would be leased for a period of 10 years, beginning January 1, 2017. The lease agreement is cancellable only upon accidental destruction of the plane. An annual lease payment of $170,794 is due on January 1 of each year, with the first payment to be made on January 1, 2017. Maintenance operations are strictly scheduled by the lessor, and Ramey will pay for these services directly to suppliers as they are performed. Estimated annual repair and maintenance costs are $36,900. Ramey will pay all insurance premiums, which amount to a combined total of $34,000 annually, and provide proof of coverage to the lessor. Upon expiration of the 10-year lease, Ramey can purchase the Viking for $300,000. The plane’s estimated useful life is 15 years, and its value in the used plane market is estimated to be $400,000 after 10 years. The residual value will never be less than $275,000 because of the mandated engine overhauls and the maintenance prescribed by the manufacturer. If the purchase option is not exercised, possession of the plane will revert to the lessor; there is no provision for renewing the lease agreement beyond its termination on January 1, 2027.

Ramey can borrow $1.5 million under a 10-year term loan agreement at an annual interest rate of 10%. The lessor’s implicit interest rate is not expressly stated in the lease agreement, but this rate appears to be approximately 6% based on 10 net rental payments of $170,794 per year and the initial fair value of $1.5 million for the plane. On January 1, 2017, the present value of all net rental payments and the purchase option of $300,000 is $1,270,064 using the 10% interest rate. The present value of all net rental payments and the $300,000 purchase option on January 1, 2017 is $1.5 million using the 6% interest rate implicit in the lease agreement. The financial vice-president of Ramey Corporation has established that this lease agreement is a financing lease as defined by the IAS 17 standards followed by Ramey.

Instructions

(a) Using tables, a financial calculator, or Excel functions, recalculate the present value of the future minimum lease payments and prove the amount arrived at by the vice-president of Ramey Corporation.

(b) IAS 17 indicates that the crucial accounting issue is whether the risks and benefits of ownership are transferred from one party to the other, regardless of whether ownership is transferred.

1. What is meant by “the risks and benefits of ownership” and what factors are general indicators of such a transfer?

2. Would there be a difference in the determination made by the vice-president had Ramey been following ASPE?

(d) Prepare a lease amortization table for the full term of the lease. Round all amounts to the nearest dollar.

(e) What is the appropriate amount for Ramey Corporation to recognize for the leased aircraft on its statement of financial position after the lease is signed?

(f) How will the lease be reported on the December 31, 2017 statement of financial position and related statement of income? (Ignore any income tax implications.)

SOLUTION

(a) Using tables:

$170,794 Annual payment

X 7.80169 PV of annuity due of 1 for n = 10, i = 6%

$1,332,482 PV of annuity payments

$300,000 PV of purchase option in 10 years

X .55839 PV of 1 for n = 10, i = 6%

$167,518 PV of purchase option

$1,332,482 PV of periodic payments

+ 167,518 PV of purchase option

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$1,500,000 Total PV

Excel formula =PV(rate,nper,pmt,fv,type)
Using a financial calculator:
PV	$ ?	Yields $1,500,000.66
I	6%
N	10
PMT	$( 170,794)
FV	$( 300,000)
Type	1
(b)	Benefits of ownership are the ability to use the asset to generate profits over its useful life, to benefit from any appreciation in the asset’s value, and to realize its residual value at the end of its economic life. The risks, on the other hand, are the exposure to uncertain costs and returns, and to risk of loss from use or idle capacity and from technological obsolescence.
	The IFRS criteria use qualitative factors to establish whether or not the risks and rewards of ownership are transferred to the lessee, and supports classification as a finance lease:

There is reasonable assurance that the lessee will obtain ownership of the leased property by the end of the lease term. If there is a bargain purchase option in the lease, it is assumed that the lessee will exercise it and obtain ownership of the asset.

The lease term is long enough that the lessee will receive substantially all of the economic benefits that are expected to be derived from using the leased property over its life.

The lease allows the lessor to recover substantially all of its investment in the leased property and to earn a return on the investment. Evidence of this is provided if the present value of the minimum lease payments is close to the fair value of the leased asset.

The leased assets are so specialized that, without major modification at significant cost to the lessor, they are of use only to the lessee.

No numerical thresholds are applied, as is the case with ASPE, and so the treatment of the lease by the lessee would be the same, although it would be referred to as a finance lease, rather than a capital lease.

(c) The conditions of the lease lead us to conclude that the risks and benefits of ownership have passed from the lessor to the lessee. Evidence of this includes the bargain purchase option of $300,000 compared to the residual value, which is estimated at $400,000 and will never fall below $275,000. This fact taken with the fact that the lease term is 10 of the 15 years of the useful life of the airplane, it would be foolish for Ramey not to exercise the option to purchase the plane. Airplanes and their engines, when properly maintained, retain their value.

Since Ramey is already paying for the repairs and maintenance, it will benefit from this investment in the increased resale value of the airplane once the bargain purchase option is exercised. Ramey will consequently benefit from any appreciation in value of this asset, beyond the term of the lease.

(d) The appropriate amount for the leased aircraft on Ramey Corporation’s statement of financial position after the lease is signed is $1,500,000, the fair value of the plane and the present value of the net rental payments and bargain purchase option discounted at 6%.

(e)

Ramey Corporation

Lease Amortization Schedule

(Lessee)

Date	Date			Annual Lease Payments	Annual Lease Payments	Annual Lease Payments	Annual Lease Payments			Interest (6%) on Unpaid Obligation	Interest (6%) on Unpaid Obligation	Interest (6%) on Unpaid Obligation	Interest (6%) on Unpaid Obligation		Reduction of Lease Obligation	Reduction of Lease Obligation	Reduction of Lease Obligation			Balance of Lease Obligation	Balance of Lease Obligation
																				$1,500,000	$1,500,000
Jan. 1,	Jan. 1,	Jan. 1,	2017	2017	2017	2017	$170,794	$170,794	$170,794					$170,794	$170,794	$170,794	$170,794	1,329,206	1,329,206	1,329,206	1,329,206	1,329,206	1,329,206
Jan. 1,	Jan. 1,	Jan. 1,	2018	2018	2018	2018	170,794	170,794	170,794			$79,752	$79,752	91,042	91,042	91,042	91,042	1,238,164	1,238,164	1,238,164	1,238,164	1,238,164	1,238,164
Jan. 1,	Jan. 1,	Jan. 1,	2019	2019	2019	2019	170,794	170,794	170,794			74,290	74,290	96,504	96,504	96,504	96,504	1,141,660	1,141,660	1,141,660	1,141,660	1,141,660	1,141,660
Jan. 1,	Jan. 1,	Jan. 1,	2020	2020	2020	2020	170,794	170,794	170,794			68,500	68,500	102,294	102,294	102,294	102,294	1,039,366	1,039,366	1,039,366	1,039,366	1,039,366	1,039,366
Jan. 1,	Jan. 1,	Jan. 1,	2021	2021	2021	2021	170,794	170,794	170,794			62,362	62,362	108,432	108,432	108,432	108,432	930,934	930,934	930,934	930,934	930,934	930,934
Jan. 1,	Jan. 1,	Jan. 1,	2022	2022	2022	2022	170,794	170,794	170,794			55,856	55,856	114,938	114,938	114,938	114,938	815,996	815,996	815,996	815,996	815,996	815,996
Jan. 1,	Jan. 1,	Jan. 1,	2023	2023	2023	2023	170,794	170,794	170,794			48,960	48,960	121,834	121,834	121,834	121,834	694,162	694,162	694,162	694,162	694,162	694,162
Jan. 1,	Jan. 1,	Jan. 1,	2024	2024	2024	2024	170,794	170,794	170,794			41,650	41,650	129,144	129,144	129,144	129,144	565,018	565,018	565,018	565,018	565,018	565,018
Jan. 1,	Jan. 1,	Jan. 1,	2025	2025	2025	2025	170,794	170,794	170,794			33,901	33,901	136,893	136,893	136,893	136,893	428,125	428,125	428,125	428,125	428,125	428,125
Jan. 1,	Jan. 1,	Jan. 1,	2026	2026	2026	2026	170,794	170,794	170,794			25,688	25,688	145,106	145,106	145,106	145,106	283,019	283,019	283,019	283,019	283,019	283,019
Jan. 1,	Jan. 1,	Jan. 1,	2027	2027	2027	2027	300,000	300,000	300,000			16,981	16,981	283,019	283,019	283,019	283,019	0	0	0	0	0	0
						$1,837,146	$1,837,146			$ 507,940	$ 507,940	$ 507,940	$ 507,940	$1,329,206	$1,329,206	$1,329,206	$1,329,206
(f)		The leased aircraft will be reflected on Ramey Corporation’s statement of financial position as follows:
	Property, Plant and Equipment
		Equipment under lease	$1,500,000
			Less accumulated depreciation*	81,667
				$1,418,333
	Current liabilities
		Obligations under lease
			Interest payable	$ 79,752
			Principal – crurent portion	91,042
	Non-current liabilities
		Obligations under lease	$1,238,164

The following items relating to the leased aircraft will be reflected on Ramey Corporation’s statement of income:

Depreciation expense (Note A) $81,667

Interest expense (from table) 79,752

Repairs and maintenance expense 36,900

Insurance expense 34,000

* [($1,500,000 - $275,000) ÷ 15] = $81,667

Note A: The company leases a Viking turboprop aircraft under a finance lease. The lease runs until January 1, 2024. The annual lease payment is paid in advance on January 1 and amounts to $170,794. The aircraft is being depreciated on the straight-line basis over the economic life of the asset, estimated as 15 years. The depreciation on the aircraft included in the current year’s depreciation expense and the accumulated depreciation on the aircraft amount to $81,667.