the tax bene´¬üts associated with leasing. In recent years, the ´¬ünancial services income
from the tax advantaged transactions accounted for a growing portion of the companyÔÇ™s
ACCOUNTING POLICIES FOR LEASING
Comdisco offered computer equipment to its customers through a variety of lease ar-
rangements. Using the terminology of Financial Accounting Standards BoardÔÇ™s State-
ment No. 13, ComdiscoÔÇ™s leases can be classi´¬üed into one of three types: sales-type
leases, direct ´¬ünancing leases, or operating leases.
Both sales-type and direct ´¬ünancing leases transferred substantially all the bene´¬üts and
risks inherent in the ownership of the leased property to the lessee. A sales-type lease
usually gave rise to a dealerÔÇ™s pro´¬üt or loss for Comdisco. Therefore, in a sales-type
lease, the fair value of the leased equipment (normal selling price) at the inception of the
lease differed from the cost or carrying amount. In contrast, in a direct ´¬ünancing lease,
the primary service that Comdisco offered was the ´¬ünancing of the equipmentÔÇ™s acqui-
sition by a lessee. In such a lease, the fair value of the equipment was equal to the cost
or carrying amount. Comdisco earned only a ´¬ünancing income (interest) and no dealerÔÇ™s
pro´¬üt. An operating lease was a simple rental of the equipment, and Comdisco retained
ownership of the equipment throughout the lease term.
Under FASBÔÇ™s guidelines, the accounting classi´¬ücation of a lease was based on
whether or not it satis´¬üed certain conditions:
1. The lease transfers ownership of the equipment to the lessee by the end of the lease
2. The lease contains an option allowing the lessee to purchase the property at a bar-
3. The lease term is equal to 75 percent or more of the estimated economic life of the
4. The present value of the rental is equal to 90 percent or more of the fair market
value of the leased property.
5. Collectibility of the payments from the lessee is reasonably predictable.
6. No important uncertainties surround the amount of cost yet to be incurred by the
804 Case: Comdisco, Inc. (A)
74 Part 4 Additional Cases
A lease meeting at least one of the ´¬ürst four conditions and both of the last two con-
ditions was classi´¬üed as a sales-type lease or direct ´¬ünancing lease. Such a lease was
treated as a sales-type lease if the fair value of the leased equipment was different from
its carrying amount; otherwise it was classi´¬üed as a direct ´¬ünancing lease. A lease that
did not meet the combination of conditions just described was classi´¬üed as an operating
Accounting Treatment: Comdisco as Lessor
The accounting treatment in ComdiscoÔÇ™s ´¬ünancial statements for the above three types
of leases was as follows:
OPERATING LEASE. Lease revenue consisted of monthly rentals; the cost of equip-
ment was recorded as leased equipment. The difference between the cost and the esti-
mated residual value at the end of the lease term was depreciated on a straight-line basis
over the lease term. SalesmenÔÇ™s commissions and other initial direct costs were capital-
ized as deferred charges and were amortized on a straight-line basis.
SALES-TYPE LEASE. At the inception of the lease, the present value of rentals was
treated as sales revenue. Equipment cost less the present value of the residual was re-
corded as cost of sales. The present value of rentals and of the residual was recorded on
the balance sheet as net investment in sales-type lease. As each lease payment was re-
ceived, the net investment was reduced and interest income was recognized.
DIRECT FINANCING LEASE. At the inception of the lease, the cost of the leased
equipment was recorded as net investment in the direct ´¬ünancing lease. As each lease
payment was received, the net investment was reduced by the corresponding amount.
The difference between the sum of the lease payments and the cost of the leased equip-
ment was unearned pro´¬üt from the direct ´¬ünancing lease, and it was recognized monthly
so as to produce a constant rate of return on the net investment.
Accounting Treatment: Comdisco as Lessee
In addition to the above leases where Comdisco was a lessor, it was also often a lessee:
the company acquired equipment from computer vendors and others through leasing ar-
rangements. If such a lease met at least one of the ´¬ürst four conditions listed earlier, it
was classi´¬üed by Comdisco as a capital lease; otherwise, it was classi´¬üed as an operating
lease. The accounting treatment of the leases where Comdisco was a lessee was as
OPERATING LEASE. Monthly rentals were treated as rental expense.
CAPITAL LEASE. At the inception of the lease, the present value of lease rentals was
recorded as a capital lease asset. An equal amount was also recognized as a liabilityÔÇ”
Case: Comdisco, Inc. (A)
Part 4 Additional Cases
an obligation under the capital lease. The capital lease asset was depreciated over the
lease term. When a lease payment was made, the obligation under capital lease was re-
duced and interest expense on the lease obligation was recognized.
NONRECOURSE DISCOUNTING OF LEASE PAYMENTS
In order to ´¬ünance its investment in leased assets, Comdisco often assigned the stream
of lease payments to a ´¬ünancial institution at a ´¬üxed interest rate on a nonrecourse basis.
In return, Comdisco received from the ´¬ünancial institution a loan equal to the present
value of the lease payment stream. The ´¬ünancial institution received the lease payments
from the lessee as repayments of the loan. In the event of default by a lessee, the ´¬ünancial
institution had a ´¬ürst lien on the underlying leased equipment, with no further recourse
against the company.
For operating leases, proceeds from discounting were recorded on the balance sheet
as discounted lease rentals liability. As lessees made payments to the ´¬ünancial institu-
tions, discounted lease rentals were reduced by the interest rate method. For sales-type
leases and direct ´¬ünancing leases, proceeds from discounting were not included in dis-
counted lease rentals. Instead, future rentals were eliminated from the net investment in
sales-type or direct ´¬ünancing leases, and any gain or loss on the ´¬ünancing was immedi-
ately recognized in the income statement.
TAX ADVANTAGED TRANSACTIONS
In addition to leasing equipment to computer users, Comdisco undertook leasing trans-
actions with investors who were interested in tax shelters. While the speci´¬üc terms and
conditions of these tax advantaged transactions varied, a typical transaction was as fol-
1. After the inception of the initial user lease and independent of it, Comdisco sold
all the leased equipment to a third-party investor. This sale usually occurred three
to nine months after the commencement of the initial user lease. The sales price
equaled the then current fair market value of the equipment. The payment from
the investor to Comdisco consisted of: (a) cash and a negotiable interest-bearing
promissory note due within two years for 10ÔÇ“22 percent of the sales price (the
ÔÇťequity paymentÔÇŁ) and (b) an installment note for the balance payable over an 84-
2. Simultaneously with the sale, Comdisco leased the equipment back from the in-
vestors for 84 months. The lease payments under the leaseback obligation were
equal to the installment payments receivable by Comdisco from the investor (1.b).
3. As part of the leaseback arrangement, during the 61st through 84th months of the
leaseback period, the investor shared in the re-lease proceeds that the company re-
ceived from subleasing the equipment to a user. Upon the expiration of the lease-
back period, the investor had the exclusive right to the equipment.
806 Case: Comdisco, Inc. (A)
76 Part 4 Additional Cases
The net result of the above transaction was that Comdisco gave up the depreciation
tax bene´¬üt, a portion of the rental revenues for months 61ÔÇ“84, and 100 percent of the
equipment value after the 84th month. In return, the company received the nonrefund-
able equity payment (1.a).
If the equipment sold to the investor was originally under an operating lease, the eq-
uity payment was recorded by Comdisco as ´¬ünancial services revenue in the period in
which the tax advantaged transaction occurred. From the fourth quarter of 1983, the
company began to allocate as cost of ´¬ünancial services a portion of the net book value
of the equipment at lease termination. For sales-type and direct ´¬ünancing leases, the eq-
uity payment was ´¬ürst applied to reduce a portion of the residual value of the equipment
shown in the balance sheet (as investment in sales-type and direct ´¬ünancing leases). This
is because the companyÔÇ™s ability to recover the residual value was decreased due to the
rental sharing under the tax advantaged transaction. The excess of the equity payment
over the residual value reduction was recorded as ´¬ünancial services revenue in the period
in which the tax advantaged transaction occurred.
During the ten years ending in 1982, ComdiscoÔÇ™s sales and pro´¬üts grew rapidly. During
´¬üscal 1982 the company reported $29.4 million pro´¬üts on revenues of $471.6 million,
representing an 88 percent increase in pro´¬üts and 56 percent increase in sales during the
year. (See Exhibit 3 for an abridged version of the 1982 annual report.) The company
continued its strong growth performance in ´¬üscal 1983. The companyÔÇ™s pro´¬üts and rev-
enues in the ´¬ürst nine months of the ´¬üscal year were $36.1 million and $401.4 million,
respectively. (See Exhibit 2 for the companyÔÇ™s interim report for this period.)
In ComdiscoÔÇ™s second quarterly report for 1983, Kenneth Pontikes commented on the
These new activities, along with the continued growth of the companyÔÇ™s lease and
customer base, enhance the companyÔÇ™s long term growth prospects. The compa-
nyÔÇ™s history of outstanding performance and the recent issuance of $250,000,000
of convertible subordinated debentures, which further strengthened the companyÔÇ™s
capital base, provide it with the ´¬‚exibility required for continued growth in todayÔÇ™s
The companyÔÇ™s shares, listed on The New York Stock Exchange, re´¬‚ected this opti-
mistic outlook: their price appreciated from about $9 in January 1982 to $37 by the end
of September 1983. Exhibit 1 shows the movement of ComdiscoÔÇ™s stock price and Stan-
dard and PoorÔÇ™s 500 index from January 1982 to September 1983. ComdiscoÔÇ™s stock
price increased by more than 300 percent during this period compared to a roughly 40
percent increase in Standard and PoorÔÇ™s 500 index. However, as the Fortune magazine
comments indicate, many analysts considered ComdiscoÔÇ™s stock to be still undervalued
and expected it to continue to outperform the market.
Case: Comdisco, Inc. (A)
Part 4 Additional Cases
1. Evaluate ComdiscoÔÇ™s business activities and the companyÔÇ™s strategy.
2. Using the information in ComdiscoÔÇ™s financial statements and footnotes, fill in the
following to the extent possible (use plug figures if necessary):
Balance as of Increases Decreases Balance as of
Account 9/30/81 during ´¬üscal ÔÇ˜82 during ´¬üscal ÔÇ˜82 9/30/82
__________ + = __________
capital leases __________ ÔÇ“ __________
__________ + = __________
rentals __________ ÔÇ“ __________
Net investment in
__________ + = __________
leases __________ ÔÇ“ __________
Identify the business transactions that would have given rise to the changes identi´¬üed
in the above accounts.
3. Analyze the relative contribution of rentals, sales of computer equipment, and finan-
cial services to ComdiscoÔÇ™s reported profits during fiscal years 1981 and 1982 and
the first nine months of fiscal year 1983. What are the reasons for the differences in
the profit margins of these three activities? Which activity is contributing most to
4. Evaluate the quality of ComdiscoÔÇ™s disclosure in its annual report regarding the com-
panyÔÇ™s lease accounting policies. Do you think the disclosure is adequate to evaluate
the companyÔÇ™s performance?
808 Case: Comdisco, Inc. (A)
78 Part 4 Additional Cases