Accounting For Leases
Accounting For Leases
BKAF3063 A122
Chapter Outline
Nature and classification of leases. Accounting by lessee: operating lease finance lease operating lease direct financing lease
Accounting by lessor:
Learning outcomes:
Define what is lease & differentiate between
operating & finance lease Record the leases transactions in the book of lessor and lessee Define and record sales and leaseback transantions
BKAF3063 A122
Definition of Lease
MFRS 117 (Para 4):
An agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.
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Advantages of Lease
1) 100% financing at fixed rates without requiring any down payment, lease payments often remain fixed. 2) Protection against obsolescence reduce risk of obsolescence. 3) Flexibility less restrictive provision than other debt agreements. 4) Less costly financing. 5) Off-Balance-Sheet financing specifically on operating lease.
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Classification of Lease
Finance Lease
Operating Lease
if it does not transfer substantially all the risks and rewards incidental to ownership.
DMart
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Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions
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Ownership Transfer
Legal form: Title remains with the lessor for all types of lease. Accounting view: Substance over form A lease that transfers substantially all of the benefits and risks incidental to the ownership of property should be accounted for as acquisition of an asset and the incurrence of an obligation by the lessee. practically how the asset treated/used vs. legally who own the asset Conclusion: The ownership rights differs according to type of the lease.
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YES
YES
YES
PV of MLP equals at least substantially all of FV of the leased asset? 90% or more
NO
YES
Finance Lease
YES
Finance Lease
Operating Lease
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Classification of Lease (Cont.): Para 11: Indicators of situations which individually or in combination could also lead to a lease being classified as a finance lease are:
YES
YES
YES
Operating Lease
Finance Lease
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Terms
Lease Term - Non-cancellable period for which lessee has contracted to lease. - Commencement of lease term = when recognition takes place. Inception date - the earlier of the date of the lease agreement and the date of commitment by the parties to the principle provision of the lease. - Inception of the lease = when leases are classified. Bargain purchase option (BPO) - option to purchase the asset at a price lower than fair value at the date of the option become exercisable.
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Terms (cont)
Minimum Lease Payment (MLP)
Payments over the lease term that the lessee is or can be required to make excluding contingent rent, cost for services, and taxes, to be paid and reimbursed to the lessor; together with (+) Guaranteed residual value: a) lessee: any amounts guaranteed by the lessee or related party; or b) lessor: any residual value guaranteed by lessee or party related to lessee, or third party.
(+) BPO (bargain purchase option)
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Terms (cont.)
Guaranteed Residual Value - Lessee: part of the RV guaranteed by the lessee or by a party related to the lessee (being the max amounts payable at the end of lease term) - Lessor: part of RV guaranteed by the lessee or by a third party unrelated to the lessor who is capable to pay the guaranteed amounts. Initial direct cost - incremental cost that are directly attributable to negotiating and arranging a lease, except for such costs incurred by manufacturer or dealer lessors. - Example: legal fees, lease agreement commission etc.
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Terms (cont.)
Gross Investment
a) the MLP receivable by the lessor under a finance lease, and b) any unguaranteed residual value accruing to the lessor.
Net Investment - the gross investment in the lease discounted at the interest rate implicit in the lease.
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Classification of Leasecont.
Para 15A 18:
When a lease includes both land and buildings elements, an entity
assesses the classification of each element as a finance or an operating lease separately in accordance with paragraphs 713. Land usually operating due to indefinite useful life. if title passed finance lease.
MLP allocated in the proportion to the relative FV of both elements. if cannot reliably allocated: entire lease is considered finance lease, unless it is clear that both are operating.
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Classification of Lease
Illustration 1: Pajakan Co. (Lessor) and Trojan Co. (Lessee) entered into leasing agreement on 1 January 2012. The term of lease is 15 years. The lease agreement is non-cancellable and has minimum lease payments with a present value of RM450,000. The lease involves the use of machinery that has a 17 years estimated useful life and is valued at RM460,000. The lease stated that Trojan has an option to purchase the asset for RM20,000 at the end of leased period.
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Classification of Lease
Solution to illustration 1:
Criteria
Transfer of title BPO Length of lease term PV of MLP Specialised BKAF3063 A122 assets
Satisfied? Y/N
N Y Y Y N
Explanation
Not transferred. BPO = RM20,000 useful life = 17 years; Lease term = 15 years. FV = RM460,000; PV of MLP = RM450,000. Not specified.
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Lease payments - should be recognised as an expense in the income statement on a straight-line basis over the lease term. Lease payments should exclude costs for services such as insurance and maintenance.
No records on the assets or liability related to the value of the assets (off balance sheet).
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Date
1/1/11
31/12/11 1/1/12 31/12/12 1/1/13 31/12/13 1/1/14 31/12/14 1/1/15 31/12/15
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Particulars
Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent
Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent
Debit
18,000
14,000
Credit
18,000 14,000
16,000
16,000
14,000 14,000 14,000 14,000 14,000 14,000 12,000 12,000 14,000 14,000 10,000 10,000 14,000 14,000
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Title is not transferred, therefore lessor should present assets in their balance sheet according to the nature of the assets.
Payments received from lessee are recorded as Rent Revenue on a straight-line basis over the lease term. Costs including depreciation incurred in earning the lease income are recognised as an expense.
Initial direct costs incurred by lessor shall be added to the carrying amount of the leased asset and recognised as an expense over the lease term. 25
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Operating Lease :
Accounting by Lessor
Date 1/1/11 31/12/11 Particulars Dr. Cash Cr. Unearned rent revenue Dr. Unearned rent revenue 14,000 Debit 18,000 Credit 18,000
14,000
22,500 16,000 16,000 14,000
22,500
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Should be recognized as assets and liabilities (as if the assets being purchased) at amounts equal to the fair value of leased asset or if lower, at the PV of MLP [Para 20].
Cost of assets recorded in lessees book: Fair value at inception date.
The lower of:
OR
Reason: the leased asset should not be recorded for more than its fair value.
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xxx *
xxx *
Lease term
OR
Economic useful life
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PV of MLP
Journal entry on 1 Jan 2012 Dr. Leased asset Cr. Lease Liability (to recognise the asset leased)
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75,816 75,816
31 Dec 14
31 Dec 15 31 Dec 16
20,000
20,000 20,000
4,974
3,471 1,818 (D) X 10%
15,026
16,529 18,182 (A) - (B)
34,712
18,183 0 Preceeding - (C)
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Debit Credit 12,418 7,582 20,000 15,163 15,163 13,660 6,340 20,000 15,163 15,163
16,529 3,471
20,000 15,163
15,163
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01/01/05 Dr. Lease receivable Cr. Fixed assets Unearned interest revenue 31/12/05 Dr. Cash Cr. Lease receivable
Dr. Unearned interest revenue Cr. Interest revenue 31/12/06 Dr. Cash Cr. Lease receivable Dr. Unearned interest revenue Cr. Interest revenue
100,000
20,000
20,000 6,340 6,340
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On 1/1/2011, ABC Bhd entered into lease agreement with terms: a) non-cancellable lease term of four years, b) Lease rental of RM10,000 per year to be paid on 31 Dec, commencing 31/12/2011. c) ABC Bhd has an option to buy the equipment at the end of lease term for RM1,000. On 1/1/2011, it was estimated tha the fair value of the equipment would be RM5,000 after 4 years usage. The FV of the equipment on 1/1/2011 was RM42,000 and have estimated useful life of 5 years. The implicit rate was 5%.
PV of MLP
1/1/11 : Dr. Leased Equipment Cr. Lease Payable Depreciation exp = 36,282 / 5 = RM7,256.40 31/12/14 - exercise of BPO: Dr. Lease Payable Cr. Cash
1,000
1,000
36,282 5,718
commencing 31/12/2011.
c) ABC Bhd guaranteed to lessor that the leased asset would
have a residual value of RM5,000 at the end of lease term. The FV of the equipment on 1/1/2011 was RM42,000 and have estimated useful life of 5 years. The implicit rate was 5%. The estimated residual value at the end of lease term was RM7,000.
Depreciation exp = (39,572- 5,000) / 4 = RM8,643 31/12/14, if FV of leased asset is RM3,000, Dr. Lease Payable 5,000 Accumulated depreciation Cr. Leased Equipment Dr. Loss on finance lease 2,000 Cr. Cash
41,218 5,782
sells the asset to another and simultaneously leases it back from the new owner.
?
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In the book of seller/lessee: - To recognize gain from sales of asset: immediate or defer.
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Should not be recognized immediately, instead, should be deferred and amortized over the lease term.
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<
FV
>
recognize immediately
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Disclosure Requirements
For Lessee: Para 31: Finance lease. Para 35: Operating lease.
For Lessor: Para 47: Finance lease. Para 56: Operating lease.
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