Vehicle TRAC lease example

Many companies lease cars and trucks. This allows them to use late-model vehicles without worrying about disposing of the vehicle a few years down the road. Often auto leases for businesses come with a TRAC (Terminal Rental Adjustment Clause), which specifies that the auto will be sold at the end of the lease. If the auto sells for a lower price than anticipated, the lessee makes up the difference, while, if it sells for more, the excess is paid back to the lessee. This means that the lessor essentially has no risk and is simply providing financing and management of the vehicle.

If a lessee prefers operating leases, some lessors will adjust the TRAC so that 10.1% of the value of the vehicle is at risk (not covered by the guarantee), which keeps the lease’s present value below 90% of the fair value. This is called a “Split TRAC” lease. Under ASC 842, there are fewer incentives to execute Split TRAC leases than there were under ASC 840, as the lease is still on the balance sheet.

TRAC lease example

Let’s take an example of a Ford Focus sedan leased for three years using a split TRAC lease. We’ll look at it from the lessee’s side of the transaction. The purchase price (fair value) after rebates would be $16,100. The lease calls for payments of $189/month for 36 months. The TRAC clause stipulates a final estimated value of $10,955, of which $9,075 is guaranteed and $1,880 is unguaranteed. Your incremental borrowing rate (the interest rate you would pay to finance a purchase of the car) is 4%. Let’s assume the Focus has a 7-year economic life.

TRAC lease example

Under ASC 842

The lease is considered operating, and is capitalized at the present value of the rent plus the expected guaranteed residual payment. If it is expected, at the inception of the lease, that the car will sell for at least the $10,955 estimated value, then only the rent is used for capitalization. If the initial direct costs are unknown, we use the incremental borrowing rate of 4% as the discount rate, and the ROU asset and liability are $6,422.91. In either case, the liability and net asset will be the same throughout the life of the lease, amortized using the interest method.

Debit Credit
Initial booking
Right-of-use asset
5,500.00
Operating current liability
500.00
Long-term liability
5,000.00
Monthly rent payment
Operating current liability
5,500.00
Operating lease cost
500.00
Operating accumulated depreciation
6,000.00
Cash operating rent payments
189.00
Liability reclassification, long-term to current
Long-term liability
175.08
Current liability
175.08

For this lease, the journal entries for month two’s rent payment would be:

Debit Credit
Current liability
168.78
Operating lease cost
189.00
Operating accumulated depreciation
168.78
Cash operating payment
189.00
Operating long-term liability
175.65
Operating current liability
175.65
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Easy testing.

Load this example into EZLease from our bulk import template.

Under ASC 842, you have to disclose a maturity analysis of your future lease payments separately from other liabilities.

The following is a schedule by years of minimum future payments on noncancelable leases as of Dec. 31, 2019:

Account
Year ending December 31, 2010
2020
2,268
2021
2,268
Total lease payments required
4,536
Less amount representing interest
169.15
Present value of net minimum lease payments
4,366.85

Under IFRS 16

Given that the lease is not a low-value lease and doesn’t qualify as a short-term lease (recognition exemptions), it must be recognized as a lease. The calculated initial ROU asset and liability are the same as for ASC 842. However, during the life of the lease, the asset is depreciated on a straight-line basis, while the liability is amortized using the effective interest method, which will cause the remaining liability always to be larger than the net ROU asset.

To enter this lease in EZLease, follow these steps* :

System settings are 12/31 Year End with an ASC 842 Implementation Date of 1/1/2019 or earlier.

Vehicle TRAC lease example

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