CASE ANALYSIS OUTLINE

1.

Brief History of the Case

2.

Definition Of Terms

3.

Statement of the Problem

4.

Objective of the Case

5.

Areas of Consideration

6.

Alternative Courses of Actions

7.

Recommendations

BRIEF HISTORY OF THE CASE

Persistent learning deals with educational tools and softwares that aid students in
learning. The target market was very large and untapped. Initially, there was no
competitor of the company and with sophisticated systems and softwares, the

company succeeded in capturing a large market share. At first, company used

Venture Capital to finance immense growth of the company. The company went
public on NSADAQ and completed its initial public offering in 2004. By spending
equity funds on a range of very successful projects at its disposal, company
expected enormous expansion in upcoming years. For these new projects, company
needed new computers. The company narrowed down the options of obtaining
equipment to two types of leases; one-dollar-purchase lease and fair value lease.
However, leasing equipment was not a normal practice in this industry;
management was concerned about financial reporting implications of different
options. The company does not want to create complications in its financial
statements at this stage.

DEFINITION OF TERMS
Lease - is an agreement conveying the right to use property, plant, and
equipment (PP&E) usually for a stated period of time.
Lessee - The party that gets the right to use the asset
Lessor - the party that owns the asset but leases it to others
Bargain Price Option - The lease contains an option to purchase the
leased property at a bargain price.
Estimated Economic Life - The lease term is equal to or greater than 75
percent of the estimated economic life of the leased property.
Fair Value - The present value of rental and other minimum lease
payments, excluding that portion of the payments representing executory
costs, equals or exceeds 90% of the fair market value of the leased property.
One Dollar- Purchase (Finance or Capital Lease) - essentially, a
purchase on credit. The lessee records the asset on its balance sheet, and
also records a liability (lease obligation) on its balance sheet. The lessor
removes the asset from its balance sheet, and records another asset (lease
receivable). The payments are divided into principal and interest. The lessee
is allowed to depreciate the asset.
Fair market Value (True Lease of Operating Lease) - essentially, a
rental agreement. The lessor retains the asset on its balance sheet (and is
allowed to depreciate it); the lessee does not record anything on its balance
sheet. The payments are rent.

STATEMENT OF THE PROBLEM

Newly public Persistent Learning is acquiring vital computer assets. They
need to determine how the lease or purchase decision will impact their
financial statements, and how the market will react given previously forecast
earnings and competitor's accounting. Hence, Persistent Learning
management shall make a decision whether to do a One-DollarPurchase lease or Fair Market Value Lease.

OBJECTIVES

To determine how the One-dollar-purchase and Fair Market Value will

impact their financial statements.

To make a decision on what lease methods are going to be used that

fits the demand in the market.

AREAS OF CONSIDERATION
Financial Reporting Environment

Leasing equipment was not a normal practice in this industry;

management was concerned about financial reporting
implications of different options. The company does not want to
create complications in its financial statements at this stage.

There is demand in the market.

School enrollment was expected to set new records every year from
2006 until 2014, the last year for which the National Center for
Education Statistics had projected enrollment.
2003 - 55 million students enrolled
2014 projected of 56.7 million students

ALTERNATIVE COURSES OF ACTIONS

Opt to One- Dollar-Purchase Lease Method - the lessee does not own
the asset.

Provide much-needed flexibility to Persistent Learning

that frequently update or replace their equipment.
Persistent Learning is protected from the risk of obsolescence.
For the accounting : the asset does not have to be included in
the balance sheet. The corresponding debt liability does not have
to be calculated or included either.
Lease payments were higher

Opt to Fair Market Value Method treats the lessee as the owner of the
assets

Lower monthly payments.

The lease is considered a loan. Interest payments are considered

operational expenses.

The lessee can claim depreciation on the asset every year.

The asset is included in the balance sheet: the outstanding loan

amount (net present value of all future lease payments) is
included as a liability, and the present market value of the asset
is included as an asset.
It allows the lessee to purchase at its FMV.

Comparison Chart

Lease criteria Ownership

Lease criteria Bargain

Purchase
Option

Lease criteria Term

Lease criteria Present Value

Risks and
Benefits

Accounting

Tax

ONE DOLLAR LEASE

FMV LEASE

Ownership of the asset might be

transferred to the lessee at the end of the
lease term.

Ownership is retained by the lessor during

and after the lease term.

The lease contains a bargain purchase

option to buy the equipment at less than
fair market value.

The lease cannot contain a bargain

purchase option.

The lease term equals or exceeds 75% of

the asset's estimated useful life

The lease term is less than 75 percent of

the estimated economic life of the
equipment

The present value of the lease payments

equals or exceeds 90% of the total original
cost of the equipment.

The present value of lease payments is

less than 90 percent of the equipment's
fair market value

Transferred to lessee. Lessee pays

maintenance, insurance and taxes

Right to use only. Risk and benefits remain

with lessor. Lessee pays maintenance
costs

Lease is considered as asset (leased asset)

and liability (lease payments). Payments
are shown in Balance sheet

No risk of ownership. Payments are

considered as operating expenses and
shown in Profit and Loss statement

Lessee is considered to be the owner of

the equipment and therefore claims
depreciation expense and interest expense

Lessee is considered to be renting the

equipment and therefore the lease
payment is considered to be a rental
expense

RECOMMENDATIONS

The newly public Persistent Learning should acquire new computer sets
in a form of lease and we recommended a Fair Market Value lease. Its
usually best used for purchases of equipment that is high-tech or fastchanging like software or computer equipment. At the end of the term,
the lessee most often returns the equipment to the lessor or in some
cases is granted the option to purchase the equipment at fair market
value..

Generally has lower monthly payments than a Capital Lease or a bank

loan and its most often used as a shorter-term lease than a Capital
Lease.
The FMV lease payments are 100% tax deductible as an operating
expense, since the equipment is not seen as a purchase.