Jump to content
ATX Community
Sign in to follow this  
BulldogTom

2014 mistake - how to correct - kinda accounting

Recommended Posts

Client bought a bunch of equipment, some of it small tools, some of it light equipment, some heavy equipment.  Financed it through a leasing company in 2014.  Did not read the lease and did not realize there was a residual buy out or an automatic renewal of the lease payments.  The prior accountant expensed the tools and capitalized the equipment at the purchase price.  The lease was recorded as a loan with the total rent payments less purchase price equaling interest.  When I picked up the client, it looked like a loan that was being properly amortized and the equipment was being properly depreciated.   I never asked for the loan docs from the client because they had an amortization schedule on what they called the loan.  Everything was fine until the "loan" was paid off this year.  Here comes the bill from the leasing company for the residual buyout or continuation of the rent payments.  The client paid the 70K residual payment rather than getting stuck for continuing rental lease payments.

What would you do if you inherited this?  (I know, the client should have read what he signed, and we have had that conversation).

Tom
Newark, CA

Share this post


Link to post
Share on other sites

Given the circumstances as you describe them, I don't see "doing nothing" as a realistic option.

Clearly this was an operating lease. You are fortunate with the timing since all years can be amended.

Option # 1  - Amend all years

Option # 2  - File a 3115 - Change in Accounting Method

In both scenarios you would reverse the previous entries and expense the operating lease payments, then allocate the 70 K residual payment to the assets and capitalize or expense accordingly. The choice between option # 1 or option # 2 would depend on the effect of each years taxes and on whether the 3115 calculations would result in additional tax due or not. If the 3115 resulted in additional taxes then you would get a 4 year spread on the payment.

It will be very interesting to see how this turns out. Keep us up to date !

  • Like 1

Share this post


Link to post
Share on other sites

I'm not so sure this was an operating lease. There are criteria, but usually if the client intends to own the equipment at the end of the lease term, we capitalize it.

If the loan balance was zero at the end of the lease term, and the $70k residual balance came as a surprise then I'm guessing the original purchase price of the assets may have been understated and/or the imputed interest may have been miscalculated.

The first thing I would do is take a look at the lease documents.  

Share this post


Link to post
Share on other sites

Comparison chart

Capital Lease versus Operating Lease comparison chart
Edit this comparison chart Capital Lease Operating Lease
Lease criteria - Ownership 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.
Lease criteria - Bargain Purchase Option 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.
Lease criteria - Term 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
Lease criteria - Present Value 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
Risks and Benefits Transferred to lessee. Lessee pays maintenance, insurance and taxes Right to use only. Risk and benefits remain with lessor. Lessee pays maintenance costs
Accounting 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
Tax 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 expens
  • Like 2

Share this post


Link to post
Share on other sites

Design and usage of the 3115 should be to change accounting methods and not simply to correct errors.  I believe the 3115 to be one of the most needlessly proliferated of all forms.

If you are doing it "wrong" and now are doing it "right" doesn't mean you've changed methods or approach.  It could simply mean that you made a mistake.

From the original post, the rules and procedures were in place from the very beginning about capital leases, imputed interest, present value, etc.  None of these change simply because it was done wrong.  Not that it applies to this situation, but most of the needless 3115s I have seen have been for depreciation, when the only "change" was the wrong year, the wrong application of DDB, misuse of "bonus" depreciation, and mishandling of s.179.  These are simply errors and not changing any of the rules or procedures of depreciation.

Share this post


Link to post
Share on other sites

Edsel, you are overstating your position.

The IRS is very clear that the recurring use of an error constitutes a incorrect method.

When the 3115 rules were liberalized they were intended to deal with these kinds of problems

as opposed to filing amendments.

  • Like 2

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
Sign in to follow this  

  • Recently Browsing   0 members

    No registered users viewing this page.

×