Hello and welcome everyone to our lesson today. In today's lesson, we will continue our discussion on accounting for lease contracts. But today we are going to introduce one level of complexity. That is, when the contract specifies a purchase option. When the lessor offers the lessee such a low price to purchase the leased asset in a way that it's reasonably certain that the lessee will exercise the purchase option, we refer to this case as bargain purchase option. In a bargain purchase option, then the set up will be a little bit different. Let us see how our model of accounting for leases would be affected by including this element. If it is reasonably certain that the lessee will exercise the purchase option, then the accounting for the lease is affected in the following four ways. Number 1 the, lease is classified as a finance sales type lease. That means it's from the lease's point of view to finance or from lessor's, it's a sales-type because it's one of the five criteria we talked about. It's one of the criteria that will make that lease, will qualify the lease contract to be a finance lease from the lessee's point of view or as sales-type from the lessor's point of view. Number 2, both the lessee and the lessor will consider the exercise price of the option to be an additional cash payment. Now, the lease payments is not only limited to the periodic lease rental or payment, but now there is an additional lease payment, additional cash, which is that cash price if the lessee exercise the option of purchasing the asset. Number 3, the lease term is assumed to end on the date that the option is expected to be exercised. Now, because there is an option, the lease term, and that will be very important factor if there is a purchase option, when we go to number 4, where is that the lessee should amortize the right-of-use asset over the economic life of the asset, not on the lease term. Why is that? This is because the lessee is expected to own the asset at the end of the lease term, that's why expecting what is going to happen, because we said that the option is certainly or reasonably certain to be exercised, the lessee will amortize the lease asset over its useful life. Since both parties, the lessee and the lessor, will include the purchase price as an additional lease payment, then obviously it will be included in the lease payable from the lessor's point of view, and it will be included in the lease receivable from the lessor's point of view. Then, and I emphasize that a lot, then we expect that we will have a similar amortization tables between amortizing the payable in the lessee's books and amortizing the receivable in the lessor's book. That is given or assuming that they are using the same discount, actually the rate of return for the lessor and the borrowing rate for the lessee. Once those two rates are the same, which we are going to assume, and the lease payable and the lease receivable are the same, then we expect the same amortization table for both of them. We will emphasize that point because there are some terms, some factors that will affect the amortization of the lease payable and the lease receivable in the lessee's books versus the lessor's books. If a lease contract includes a termination clause that allows the lessee to terminate the lease, we will actually treat that penalty because it will be terminated by charging the lessee a penalty. We will consider the termination penalty to be an additional cash payment. Exactly that what we did with the purchase option or the purchase price if that option was exercised by the lessee. If termination is predicted, we will consider the lease term to start at the beginning of the lease until it is expected to be terminated, meaning to the termination day. The accounting for the termination penalties is similar to the accounting for the purchase option as we discussed, it will be an additional payment that will be included in the present value of the lease paid. Our takeaway for today is that introducing a bargain purchase option in the lease contract, where it is reasonably certain that it will be exercised does not complicate the model too much. All what we noticed that we will include that in calculation of the present value, that will be an additional payment. We calculate the present value, add it to the present value of the periodic lease payments. Basically, it's an additional present value calculation. Simply stated, the main difference is that the present value of the purchase price, as I said, will add another calculation and will be included with the right of use assets and the lease liability from the lessees point of view. As you can see, in front of you, the lease receivable. In this case, you can see the equation for our view, the lease receivable equal the lease payable, equal the present value of the periodic lease payments. Those are the periodic payment, plus here is an additional component that was added, which is the present value of the purchase price because of the bargain purchase option that we have talked about. Finally, as I want to emphasize that a lot because that will pop up and it will organize your thoughts actually, because you can plan your work upfront when you expect that in upfront. Finally, since the lease receivable from the lessor's point of view and the lease payable from the lessee's point of view are the same, and they are going to be using the same discount rate, then obviously we'll have similar amortization schedules for both of them. Thank you very much.
