Bear minimum payment free essay sample

Big Bear Power (Big Bear) is a widely held public utility company that has posted strong financial results for several years. Big Bear has positive cash flow, and it is in compliance with all its debt covenants. Big Bear leases a combustion turbine from Goliath Co. (Goliath) for a 10-year noncancelable term. The lease agreement is signed on December 15, 2010, and Big Bear’s right to use the turbine begins on January 1, 2011. Various provisions and other facts from the lease are listed below. Provision 1 Big Bear pays Stipe, Berry, Mills and Buck LLP, its external legal counsel, $500,000 in connection with negotiating the lease agreement. Big Bear is also required to pay $1 million of legal fees incurred by Goliath. 840-10-25-5 For a lessee, minimum lease payments comprise the payments that the lessee is obligated to make or can be required to make in connection with the leased property, excluding the following: Any guarantee by the lessee of the lessors debt and the lessees obligation to pay (apart from the rental payments) executory costs such as insurance, maintenance, and taxes in connection with the leased property. 840-10-25-7 For a lessor, minimum lease payments comprise the payments described in paragraphs 840-10-25-5 through 25-6 for a lessee plus any guarantee of the residual value or of rental payments beyond the lease term by a third party unrelated to either the lessee or the lessor, provided the third party is financially capable of discharging the obligations that may arise from the guarantee. So Big bear should not include this legal fee in the minimum payment Provision 2 The stated default provisions in the lease stipulate that Big Bear must purchase the combustion turbine from Goliath (at a price equal to the remaining lease payments) within 30 days if a â€Å"change in control† event occurs. Additionally, Big Bear would be required to pay a penalty of $500,000. A â€Å"change in control† event is defined under the lease as either (1) a situation in which a person or entity becomes the beneficial owner, directly or indirectly, of 50 percent or more of the outstanding voting shares of Big Bear or (2) a situation in which Big Bear merges with another entity. As of the inception of the lease, Big Bear does not expect a â€Å"change in control† event to occur during the term of the lease. Provision 3 The lease agreement stipulates that Big Bear’s lease payments shall be $1 million per year, payable ratably over 12 months at the beginning of each month. For each calendar year of the term of the lease after 2011, Big Bear will pay minimum rent in an amount equal to $1 million increased (but not decreased) by the same percentage as the increase in the consumer price index (CPI) from January 1 of the prior year until January 1 of each respective year. As of the inception of the lease, the most recent annual increase in CPI was 4 percent. 840-10-25-4 This guidance addresses what constitutes minimum lease payments under the minimum-lease payments criterion in paragraph 840-10-25-1(d) from the perspective of the lessee and the lessor. Lease payments that depend on a factor directly related to the future use of the leased property, such as machine hours of use or sales volume during the lease term, are contingent rentals and, accordingly, are excluded from minimum lease payments in their entirety. (Example 6 [see paragraph 840-10-55-38] illustrates this guidance. ) However, lease payments that depend on an existing index or rate, such as the consumer price index or the prime interest rate, shall be included in minimum lease payments based on the index or rate existing at lease inception; any increases or decreases in lease payments that result from subsequent changes in the index or rate are contingent rentals and thus affect the determination of income as accruable. 840-10-25-5 For a lessee, minimum lease payments comprise the payments that the lessee is obligated to make or can be required to make in connection with the leased property, excluding both of the following: a. Contingent rentals b. Any guarantee by the lessee of the lessors debt and the lessees obligation to pay (apart from the rental payments) executory costs such as insurance, maintenance, and taxes in connection with the leased property. 840-10-25-6 If the lease contains a bargain purchase option, only the minimum rental payments over the lease term and the payment called for by the bargain purchase option shall be included in the minimum lease payments. Otherwise, minimum lease payments include all of the following: a. The minimum rental payments called for by the lease over the lease term. b. Any guarantee by the lessee (including by a third party related to the lessee) of the residual value at the expiration of the lease term, whether or not payment of the guarantee constitutes a purchase of the leased property. If the lessor has the right to require the lessee to purchase the property at termination of the lease for a certain or determinable amount, that amount shall be considered a lessee guarantee of the residual value. If the lessee agrees to make up any deficiency below a stated amount in the lessors realization of the residual value, the residual value guarantee to be included in the minimum lease payments shall be the stated amount, rather than an estimate of the deficiency to be made up. c. Any payment that the lessee must make or can be required to make upon failure to renew or extend the lease at the expiration of the lease term, whether or not the payment would constitute a purchase of the leased property. Note that the definition of lease term includes all periods, if any, for which failure to renew the lease imposes a penalty on the lessee in an amount such that renewal appears, at lease inception, to be reasonably assured. If the lease term has been extended because of that provision, the related penalty shall not be included in minimum lease payments. d. Payments made before the beginning of the lease term. Such payments shall be considered as part of minimum lease payments and included in the 90 percent test, as specified in paragraph 840-10-25-1(d), at their future value at the beginning of the lease term—that is, to give effect to the time value of money, the future value at the beginning of the lease term of the lease payments would be calculated just as payments during the lease term are discounted back to the beginning of the lease term for purposes of applying the 90 percent test in that paragraph. The lessee shall use the same interest rate to accrete payments to be made before the beginning of the lease term that it uses to discount lease payments to be made during the lease term. e. Fees that are paid by the lessee to the owners of the special-purpose entity for structuring the lease transaction. Such fees shall be included as part of minimum lease payments (but shall not be included in the fair value of the leased property) for purposes of applying the 90 percent test in paragraph 840-10-25-1(d). 840-10-25-7 For a lessor, minimum lease payments comprise the payments described in paragraphs 840-10-25-5 through 25-6 for a lessee plus any guarantee of the residual value or of rental payments beyond the lease term by a third party unrelated to either the lessee or the lessor, provided the third party is financially capable of discharging the obligations that may arise from the guarantee. 840-10-55-38 This Example illustrates paragraph 840-10-25-4, which states that lease payments that depend on a factor directly related to the future use of the leased property, such as machine hours or use of sales volume during the lease term, are contingent rentals and, accordingly, are excluded from minimum lease payments in their entirety. Assume that a lease agreement for retail store space stipulates a monthly base rental of $200 and a monthly supplemental rental of one-fourth of one percent of monthly sales volume during the lease term. Even if the lease agreement is a renewal for store space that had averaged monthly sales of $25,000 for the past 2 years, minimum lease payments would include only the $200 monthly base rental; the supplemental rental is a contingent rental that is excluded from minimum lease payments. The future sales for the lease term do not exist at lease inception, and future rentals would be limited to $200 per month if the store were subsequently closed and no sales were made thereafter. 840-10-55-39 This Example illustrates paragraph 840-10-25-4, which states that lease payments that depend on an existing index or rate, such as the prime interest rate, shall be included in minimum lease payments based on the index or rate existing at lease inception. Assume that an equipment lease stipulates a monthly base rental of $2,000 and a monthly supplemental rental of $15 for each percentage point in the prime interest rate in effect at the beginning of each month. If the prime interest rate at lease inception is 10 percent, minimum lease payments would be based on a monthly rental of $2,150 [$2,000 + ($15 X 10) = $2,150]. If the lease term is 48 months and no executory costs are included in the rentals, minimum lease payments would be $103,200—that is, $2,150 X 48. If the lease is classified as a capital lease and the prime interest rate subsequently increases to 11 percent, the $15 increase in the monthly rentals would be a contingent rental included in the determination of income as it accrues. If the prime interest rate subsequently decreases to 9 percent, the $15 reduction in the monthly rentals would affect income as accruable. In the circumstance of either the increase or decrease, minimum lease payments would continue to be $103,200.