USA Lease balance forgiven

[rroessel]

The start-up I was helping out with collapsed and is going out of business. The lessor for the computer equipment has agreed to forgive the remainder of the balance of the lease and give the owner the computer. How do I account for that? Even though we aren't doing business anymore, I still have to generate financials and account for everything since we don't have the money to dissolve the LLC at this time. So, I'm still tracking everything.

Background Information: 2 years @ $54/month ($50 payment + $4 sales tax), with a $50 purchase option at the end of the lease. Cash and sales tax tracked in separate accounts. On the advice of an accountant, we set up the payable account to begin at $1,250 (24 payment + the bargain purchase option), and decreased it $50/month for each payment. 10 months have been paid (so 14 months are left). Remaining balance: $746 (10 months x $50 = $500, plus a $4 error; lessor switch accounting software and we were double-taxed for 1 month; $504 in total paid out).

What do we need to show that the remaining balance of the debt has been forgiven?

Thanks!

 

[kirby]

You had a liability account to pay $746 over time. Now that liability has been forgiven so you can remove it offset by ... what ??.
Now - if when you recorded the liability for $1,250 you offset that with the asset account -such as
DR Fixed asset - computer $1,250
CR Lease liability $1,250
then you now say to yourself - well when I now DR lease liability for $746 do I offset that by recording income of $746 or do I reduce the cost of the computer by $746.??

Following principal of conservatism you would reduce the cost of the computer. so entry is
DR Lease liability $746
CR Fixed Asset computer $746

and sorry about the business....

 

[bklynboy]

I think it needs to go against income and not reduce the asset as he is receiving something of value that was not paid for. This will also coincide with the likely tax treatment that would require a tax on the foregivenees (he should check with a tax expert on this) - I think its covered under COD (Cancellation of Debt) rules by the IRS.

 

[kirby]

If the above company followed the basic tax advice it would indeed M1 the reduction of asset on the financial books and show a gain on the tax books. Hopefully, they would, instead, use an experienced preparer who knows, for example, the "price reduced after purchase" rules which results in the reduction of the tax basis of the asset and no "income". There are many other exceptions and exclusions to the recognition of income on debt cancellation that may be available to them. And some are special for insolvent companies which may also apply to them.

 

[bklynboy]

If the above company followed the basic tax advice it would indeed M1 the reduction of asset on the financial books and show a gain on the tax books. Hopefully, they would, instead, use an experienced preparer who knows, for example, the "price reduced after purchase" rules which results in the reduction of the tax basis of the asset and no "income". There are many other exceptions and exclusions to the recognition of income on debt cancellation that may be available to them. And some are special for insolvent companies which may also apply to them.

Agree - I recommended a tax expert as this is an area that he may or may not be subject to a tax. Insolvency is an exclusion area but all otehrs are relatyed to areas beyond the issues here.

Overall I believe income is the better treatment for book purposes as you do have a gain an should be reflected through the P&L. Reducing the asset to me is only appropriate after the useful life has been exhausted.