[jmgray]

If a lessee and lessor use different interest rates to account for a capital lease, has GAAP been violated?

[haider78605]

How it is possible because the principal amount, time and installments are same so how the interest rate may be different

[morgaine300]

I don't really know leases since it's a topic I haven't done since school umpteen years ago, but mathematically, the principal amount would not be the same if done based on a present value at two different interest rates.

[dileepasampath]

Yes.Haider78605 is correct.. The question is wrong..

[morgaine300]

Haider78605 never answered the question. The question asked if GAAP had been violated. (I suspect, however, that OP is gone at this point anyway.)

[haider78605]

A situation which is impossible to happen, then there is no question of GAAP violation. And if in Morgaine thinks that the GAAP has been violated, please give the reference.

[morgaine300]

I never said whether GAAP had been violated or not. Where exactly do you see that? I did in fact say that I haven't done leases since school so I don't remember the specifics of that.

I also stated that at least mathematically, that the principle would be different if done based on present value using two different rates.

I am repeating what I said in my first post. Did you bother to read it? Please read what I actually say before commenting. If you've now read it, then feel free to comment on what I did actually say.

But so far you have only commented on things I never said.

[haider78605]

Principal and installment amounts are always same for the lessor and lessee, as whatever is paid is received, therefore there is no question of different present values at different rates, as you have told yourself that you have not gone through leasing since schooling, therefore you are trying to protect yourself by covering that mathematically it is possible, even mathematically it is not possible.

[dileepasampath]

Come on.. Lessor and Lessee are always using the same interest rates. The rate determines by the lessor and it get incorporated to Lessee's book there after. So the rates are same. So there in no question of GAAP violating. (So don't fight over this issue)
Do you want me to post a numarical example on this?

[morgaine300]

I'm not trying to "cover" myself. I stated explicitly right from the start that I don't remember lease rules, so what the heck is it that I'm covering myself for? I don't feel there's any need to protect myself about the fact that I don't (15 years later) remember everything from school. Perhaps it is your own feelings about forgetting stuff that are being projected on me?

The payments, term length and interest rate are what would affect present value. So it IS indeed possible to have the payments the same amount, but still have the present value (principle) turn out being different. It absolutely is mathematically possible for this to happen.

I can take a series of payments over the same term, use two different interest rates and come up with two different principal amounts. The reason I stated I didn't know the lease rules was simply because I don't know if you're allowed to do it, but mathematically it can be done.

If this is not allowed in a lease, then simply state that it "can't" happen because it's not allowed. Which would make the answer to OP's question, yes, it violates GAAP. But don't tell me it can't mathematically be done. Therefore, OP's question is valid. It might break some rule and not be proper, but it can be done.

The only reason I posted to begin with is because you never answered OP's question by saying yes or no. You dismissed the question as being invalid. I think it's valid and should be answered.

(Though by stating it "can't" be done, there is somewhat of an implication that it's not "allowed.")

[rehmanvohra]

For the benefit of all concerned, I am quoting from para 20 of IAS 17 Leases:

Finance leases: Initial recognition by the lessees

20 At the commencement of the lease term, lessees shall recognise finance leases as assets and liabilities in their statements of financial position at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease. The discount rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee's incremental borrowing rate shall be used. Any initial direct costs of the lessee are added to the amount recognised as an asset.

I think the question must be looked at with care. Assume that the lessor does not provide the interest charged. The lessee must calculate on his own, There are methods of calculating interest rates.

In case the interest rate can not be determined accurately, the lessee may use his own incremental borrowing rate. This is permissible under IAS. Hence there is no violation at all if different rates are used.

[haider78605]

I think so you have not understood the questions there are different variables in leasing, total amount to be paid, the time, the interest rate and the installment, when a lease contract is executed the lessee has to pay the same amount of installment to lessor over a specified time and what total amount to be paid is also the fixed, if all three variables have the same value, how the fourth one has the different value.

[rehmanvohra]

I am quoting the original question posted by jmgray

If a lessee and lessor use different interest rates to account for a capital lease, has GAAP been violated?

Now in simple layman's terms I understand the problem as seeking guidance or opinion on the violation of GAAP rules when the lessor and lessees use different rates of interest.

There are other variables involved such as bargain purchase option and guaranteed and unguaranteed residual value.

To my mind the question of variables is not relevant. The relevant part is the usage of different interest rates by the lessor and lessee. That is the reason for quoting from IAS 17 which categorically stipulates the use of interest or discount rates.

If you were to read the paragraph 20 once again, it will be clear that the IAS permits lessee to use incremental borrowing rate when the rate implicit in the lease is not practicable to determine.

I am sure you will agree that it is the lessor who determines the periodic installments based on his working of the variables as you suggested. If the lessor does not inform the lessee of the rate used and it is not practicable to determine the rate by the lessee, what interest rate should the lessee use?

Perhaps you may be able to guide us all.

[haider78605]

It means that by using different interest rate, the lessee is taking any other value of assets in his books as compared to lessor. Both of them can not use the same present value for the same total amount or same installment if rates are different. According to IAS it is not of the concern that what is recorded by lessee and lessor as present value, thus both are taking different fair value of the assets.

[morgaine300]

come on..Lessor and Lessee are always using the same interest rates. The rate determines by the lessor and it get incorporated to Lessee's book there after. So the rates are same. So there in no question of GAAP violating. (So dont fight over this issue)
Do you want me to post a numarical example on this?

Do you want me to?

My argument has NEVER been over whether GAAP allows it, or whether it actually ever gets done. I really wish people would actually read what I'm saying if they want to argue with me.

The OP's original question is whether doing so would violate GAAP. The issue I'm having is that haider immediately dismissed the question as even being a valid question and did not even bother answering the question, based on a belief that it's mathematically impossible. (And if you think it's mathematically impossible, I suggest you go review time value of money.)

My argument is over dismissing the question because it's supposedly mathematically impossible. It is not! The things that determine a present value are the rate, the payments, the length of lease, how often the payments are made (and therefore compounding period). Yes, if the rate is different, the present value certainly is going to be different, proving it mathematically CAN be done. And while both parties indeed must be using the same payment, they could be using two different present values and it wouldn't affect the equal payments. It would affect the amount recorded as liability and the amortization of the loan. But the payments could remain the same.

OP's question is essentially asking is the above allowed by GAAP? Haider dismissed this question and did not answer it.

The last few posts essentially prove that it can be done, and now the question seems to be whether it's allowed. That would be the part I can't answer -- and now rehmanvohra and heider can continue arguing over that one. Even though I don't remember details, I do remember that two different rates can exist -- just not the rules of what is to be done about it. From reading the posts, it appears to me rehmanvohra has a valid point.