LEASES (PAS 17) http://facebook.com/roniverse
ISSUES IN ACCOUNTING FOR LEASES : 1. Objective and scope of PAS 17 2. Definition and classification of leases 3. Accounting for an operating lease 4. Accounting for a finance lease for lessee 5. Accounting for a direct financing lease for lessor 6. Accounting for a sales-type lease for lessor 7. Accounting for sale and leaseback 8. Disclosures
The implicit interest rate in the lease is the discount rate that c auses the aggregate present value of the minimum lease payments and the unguaranteed residual value to equal the fair value of the leased asset and the initial direct costs of the lessor. (PVofMLP + PVofRV = FV + IDC) The lessee's incremental borrowing rate is the rate of interest that the lessee would have to pay on a similar lease, or the rate tha t the lessee would incur by borrowing funds to purchase the asset over a similar term and similar security.
OBJECTIVE & SCOPE OF PAS 17
Other situations that could also lead to classification as a finance lease are:
The objective of PAS 17 is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosures to apply in relation to finance and operating leases.
(5.) The lease assets are of a specialized nature such that only the lessee can use them without major modifications being made.
PAS 17 applies to all leases except for: for: 1. Lease agreements for minerals, oil, oil, natural gas, and similar regenerative regenerative resources; and 2. Licensing agreements for films, videos, plays, manuscripts, patents, copyrights, and similar items. Moreover, PAS 17 does not apply as the basis of measurement for the following leased assets: 1. Property held by lessees that is accounted for as investment property for which the lessee uses the fair value model set out i n PAS 40; 2. Investment property provided by lessors under operating leases (see PAS 40) 3. Biological assets held by lessees under finance leases (see PAS 41) 4. Biological assets provided by lessors under operating leases (see PAS 41)
(6.) If the lessee is entitled to cancel the lease, the lessor's losses associated with the cancellation are borne by the lessee. lessee. In this case, the lease is deemed noncancellable. Furthermore, cancellable lease was deemed noncancellable when: (a) the lease can be cancelled only upon the occurrence of some remote contingency. (b) the lease can be cancelled only with the permission of the lessor. (c) the lessee, upon cancelation, enters into a new lease for the same or equivalent asset with the same lessor. (d) the lease can be cancelled only upon payment of an additional amount or penalty of such magnitude that the lessee shall be discouraged from cancelling the lease. (7.) Gains or losses from fluctuations in the fair value of the residual fall residual fall to the lessee (for example, by means of a rebate of lease payments). (8.) The lessee has the ability to continue to lease for a secondary period at a rent that is substantially is substantially lower than market rent .
DEFINITION & CLASSIFICATION OF LEASE
A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series series of payment the right to use an asset asset for an agreed agreed period of time. The classification of leases adopted in this standard is based on the extent to which risks and rewards incident to ownership of a leased asset lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions. Rewards may be represented by the expectati on of profitable operation over the asset's economic life a nd of gain from appreciation in value or realisation of a residual value. A lease is classi fied as a finance lease if it transfers substantially all the risks and rewards incident to ownership even title may not pass to the lessee. All other leases are classified as operating leases. Whether a lease is a finance lease or a n operating lease depends on the substance of the transaction rather than its form. (substance over form) Classification is made at the inception of the lease. The inception of the lease is the earlier of the date of the lease agreement and the date of commitment by by the parties to the principal provisions of of the lease. At this date, the amounts to be recognized at the commencement of the lease term are determined, in case of a finance lease. The date from which the lessee is entitled to exercise its right to use the leased asset is asset is the commencement of the lease term. It is the initial recognition of the assets, liabilities, income or expenses resulting from the lease . Situations that would normally lead to a lease being classified as a finance lease include the following:
When a lease includes both land and building, an entity should determine the separate classification of the lease of the land and the buildi ng based on the classification criteria taking into account the fact that land normally has an indefinite economic life. Under the modification, land lease with lease term of several decades or longer may be classified as finance lease even if the title will not pass to the lessee at the end of the lease term. It is because in such arrangement, substantially all the ri sks and rewards are transferred to the lessee and the present value of t he leased asset i s considered negligible. However, separate measurement of the land and buildings elements is not required if the lessee's interest in both land and buildings is classified as an investment property in accordance with PAS 40 and the fair value model is adopted.
ACCOUNTING FOR AN OPERATING LEASE LESSEE
LESSOR
AT COMMENCEMENT OF THE LEASE. Initial direct costs - often incurred by the lessor, such as commissi ons, legal fees, and other direct attributable costs in negotiating and arranging a lease, shall be presented as an addition to the carrying amount of the leased asset in the statement of financial position and recognized as an expense over the lease term on the basis as the lease income. •
Deferred IDC Cash #
(1.)There is transfer of ownership by the end of of the lease term. (2.) The lessee has the bargain purchase option at a price which is expected to be sufficiently be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it i s reasonably certain that the option will be exercised . (3.) The lease term is for the major part of the economic life of the asset, even if title is not transferred. PAS, unfortunately, didn't specified what percentage represents a "major part". But, under USA GAAP , the lease term must be at least 75% of economic life of the leased asset. Economic life is either: (a) the period over which an asset is expected to be economically usable by one or more users; or (b) the number of production or similar units expected t o be obtained from the asset by one or more users. Useful life is the estimated remaining period, from t he beginning of the lease term, without limitation by the lease term, over which the economic benefits embodied in the asset are expected to be consumed by the enterprise. enterprise.
(4.) The present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset at t he inception of the lease. Again, PAS 17 didn't set a percentage to define what "substantially all" is. Under USA GAAP, present value of minimum lease payments must be at least 90% of fair value of the leased property. In general, minimum lease payments are payments which the lessee is required to make in connection with the lease and consist of: a. the total of periodic rental payments ; and b. any bargain purchase option price; or c. any guaranteed residual value In computing for the minimum lease payments, the discount factor to be used is the implicit interest rate if it is practic ally determinable; otherwise, the lessee's incremental borrowing rate must be used.
•
XX
Lease bonus - paid by the lessee to the lessor in addition to the periodic rentals are treated as prepaid rent by the lessee and unearned revenue by the lessor and to be amortized over the lease term.
Prepaid Rent Cash # •
XX
XX XX
Cash XX Unearned Rent Income XX #
Refundable security deposits - shall be accounted for as an asset by the lessee and a liability by the lessor.
Rent deposit Cash #
XX XX
Cash XX Liability for rent deposit XX #
AT PAYMENT/RECEIPT OF OF THE RENT. PAS 17 provides that the lease payment should be recognized as an expense ( for for lessee) lessee) or revenue ( for for lessor ) in the income statement over the lease term on a straight-line basis, unless another systematic basis is more representative of the time patt ern of the user's benefit. Rent expense Cash # •
•
XX XX
Cash Rent income #
XX XX
Unequal rental payments - are not uniform periodic payment of rentals. Such unequal rental payments much be summed and be amortized uniformly on the straight line basis as rent expense or income over the lease term. The lessee/lessor must, therefore, record an asset or liability arising from the difference between the amount paid/received and the amount recognized as lease expense or revenue. Rent incentives - such as rent-free periods or contributions by the lessor to the lessee's relocation costs, costs, under SIC 15, should be recognized by the enterprise as a reduction of the rent income or expense over the lease term, irrespective of the i ncentive's nature or form, or the ti ming of payments.
Leases (PAS 17) Page 1
Total Periodic Rentals
XX
Less: Rent incentives
(XX)
Total Total Rent Rent incom income/ e/ex expe pens nsee over over the leas leasee ter term m
XX
Divided by: Lease term (in months/years)
XX
Monthly/annual rent expense/income
XX
If there is reasonable certainty that the lessee will obtain ownership of the leased asset at the end of the lease term , depreciation must be recorded by the lessee based on the useful life of the asset . Otherwise, the leased asset must be depreciated over the lease term or useful life, life, whichever is shorter. The depreciation policy for depreciable leased assets shall be consistent with that for depreciable assets that are owned, and the depreciation recognised shall be calculated in accordance with IAS 16 Property, Plant and Equipment and IAS 38 Intangible Assets.
(if payment is lowe r than annual rent): Rent expense XX Cash XX Cash XX Rent receivable XX Rent payable XX Rent Income # #
CITERIA XX
(or if payment is great er than annual rent): Rent expense XX Cash XX Prepaid rent XX Rent income XX Cash XX Unearned rent income XX # # AT PAYMENT OF OTHER COSTS. Leasehold improvements - installed by the lessee shall be capitalized by the lessee as an asset and depreciated over over the life of the improvement or the lease term, term, whichever is shorter. Any residual value is ignored by the lessee in computing the depreciation since the lessor becomes the legal owner of the leasehold improvement in the end of the lease term. •
Leasehold improvement XX Cash XX # •
Other executory costs - incurred by any party such as real property taxes, insurance and maintenance shall be recognized immediately as period cost in the books of who is liable for such costs in the agreement.
(if paid by the lessee): Expense account XX Cash XX # (if paid by the lessor): Expense account Cash #
XX XX
AT COMMENCEMENT OF THE THE LEASE . In this date, the lessee must init ially record the leased asset and lease liability equal to the lower of the fair the fair value of the leased asset and asset and the present the present value of the minimum lease payments. payments.
XX
Any initial direct costs paid by the lessee must be recognized recognized by the lessee as part of the leased asset .
Payments
Interest Expense
Amort Amortizat ization ion Carry Carrying ing Value Value of Liability
At commencement
XX
At payment
XX
Interest expense Lease liability Cash
(CV x interest rate)
(payment interest)
(CV amortization)
XX XX XX #
AT PAYMENT OF OTHER COSTS . Contingent rents paid by the lessee that is not fixed in amount but based on factors other than passage of time such as percentage of sales, usage, price index, and market rate of interest, are expensed immediately as incurred. Contingent rent expense Cash #
XX XX
Any executory costs paid by the lessee must be expensed immediately as incurred. Expense account Cash
3-8
Useful Li fe fe or or Lease Te Term, wh whic he hever i s shorter
Depreciation expense XX Acc. Depreciation XX # The accrued interest is a portion a portion of the interest expense from the commencement of the lease or from the last payment to the dat e of the next payment. Interest expense XX Interest payable XX # AT ACTUAL PURCHASE OF LEASE LEASE ASSET. When a lessee actually purchased the leased asset under a finance lease, the cost of the asset purchased is equal to the carrying amount of the leased asset plus any cash payment and payment and minus the balance of the lease liability. liability. Car Carrying ing value alue of le lease ased ass asset et
XX
Add: Any cash payment
XX
Less: ess: Lease ase liab liabil ilit ity y bal balance ance
(XX) XX)
Cost of the asset purchased
XX
Asset XX Lease Liability XX Acc. Depreciation XX Asset under finance lease Cash #
XX XX
Lease liability Cash
XX XX #
Car Carrying ing value alue of le lease ased ass asset et
XX
Less: ess: Lease ase liab liabil ilit ity y bal balance ance
(XX) XX)
Loss on finance lease
XX
XX
AT PAYMENT OF RENTAL. RENTAL. In this date, the lessee must apportion its payment of rental - first to the finance the finance cost and the remaining as payment for the principal lease liability. liability. An amortization table maybe necessary. Date
Useful Life
However, if the bargain purchase option is not exercised, the excess of the lease liability over the carrying amount of the machinery must be recognized as loss on finance lease .
XX
Asset under finance lease XX Cash #
1- 2
AT EXERCISE OF THE BARGAIN PURCHASE PURCHASE OPTION. Since the present value of the minimum lease payment is already inclusive of the bargain purchase option price, the lessee will only close the lease liability account.
ACCOUNTING FOR A FINANCE LEASE FOR LESSEES
Asset under finance lease Lease liability #
BASIS OF DEPRECIATION
XX XX #
AT END OF THE REPORTING PERIOD . At this date, the lessee must record the depreciation of the leased asset and any accrued interest, in case the payment of rentals doesn't coincide coincide with the end of the reporting period. period.
Lease liability XX Loss on finance lease XX Acc. Depreciation XX Asset under finance lease #
XX
AT THE END OF THE LEASE TERM TERM . At end of the lease term, the lessee will simply close all accounts related to the lease. Lease liability XX Acc. Depreciation XX Asset under finance lease #
XX
However, if the lessee has guaranteed the residual value of the leased asset, any cash payment made to compensate the deficiency of the fair value shall be accounted for as loss in finance lease. Needless to say, if the fair value (actual residual value) of the leased asset is greater t han the amount guaranteed by the lessee, no loss or gain shall be recognized since there is no cash settlement occurred. Lease liability XX Acc. Depreciation XX Loss on finance lease XX Asset under finance lease Cash #
XX XX
ACCOUNTING FOR A DIRECT-FINANCING A DIRECT-FINANCING LEASE LEASE FOR FOR LESSORS
In the lessor's perspective, a finance lease is either a direct financing lease or a sales-type lease. lease. A lessor under direct financing lease is actually engaged in financing business wherein he earns only interest income from the transaction. In direct financing lease, the fair value of the leased asset is equal to its cost; therefore, no dealer's profit is t o be recognized. (FV = Cost) Under sales-type lease, the dealer or manufacturer, in fact, is selling its products who cannot procure the product product by in the form of lease particularly for buyers who single outlay of cash, especially when it costs a lot t o buy such asset. Thus, the dealer-lessor doesn't dealer-lessor doesn't only recognize interest income, but also a dealer's profit on profit on sale. In sales-type lease, the fair value of the leased asset does not necessarily equal to the cost of purchasing the asset. (FV ≠ Cost)
Leases (PAS 17) Page 2
AT COMMENCEMENT OF THE THE LEASE . At commencement of the lease term, conceptually, the lessor should record a finance lease receivable in the balance sheet, at an amount equal to the net investment in the lease. However, practically , the lease receivable is recorded equal to the gross investment of the lease.
AT ACTUAL SALE OF LEASED ASSET. When a lessee actually purchased the leased asset, the lessor must acc ount for the difference between the sales price and the carrying value of of the lease receivable. Sales price
Conceptually, Lease Receivable = Net investment or LR = Cost + IDC Practically,
Less Less:: carry carrying ing valu valuee of lea lease se rec receiv eivab able le (or (or LR LR - UII UII) Gain (loss) on sale of leased asset
Lease Receivable = Gross investment or LR = GR + RV (or LR = GR GR + BPO)
Cash XX Unearned interest income XX Lease receivable Gain on finance lease #
absolute Gross investment - the gross rentals for the entire lease term plus the absolute amount of residual value, whether guaranteed or not; or the absolute value of bargain purchase option. Net investment - the cost of the asset plus any init ial direct cost incurred by the lessor . Unearned interest income - the total financial revenue of the lessor which is the difference between the gross investment and net investment.
Gross investment (GR + RV or BPO)
XX
Less: Net investment (Cost + IDC)
(XX)
Unearned Interest Income
Net investment to be recovered from from rentals
XX
Divided by: PV annuity factor of MLP
XX
Annual rental
XX
Cash XX Asset account (@FV) XX Lease receivable #
XX
Divided by: PV annuity factor of MLP
XX
Annual rental
XX
Asset account (@FV) XX Lease receivable Gain on finance lease #
Payments
Interest income
Amor Amortiz tizati ation on
At commencement
Pres Presen entt Value Value of Receivable XX
At payment
XX
Cash
(PV x interest rate)
(payments interest)
(PV amortization)
XX Lease receivable #
Unearned interest income XX Interest income #
AT THE COMMENCEMENT OF THE LEASE . Like under the directfinancing type of lease, the lessor must record a finance lease receivable in its statement of financial position in equal to the gross investment investmen t of the lease. Because the lease is acc ounted for as a sales-type lease, the net investment is only the aggregate present value of the minimum lease payments and the unguaranteed residual value. However, aside from the finance revenue to be recognized by the dealerlessor over the lease term in connection with the lease, he should include selling profit or loss in the same period as they would for an outright sale. If artificially low rates of interest are cha rged, selling profit should be restricted to that which would apply if a commercial rate of interest were charged.
XX
Net investment - the aggregate present value of the minimum lease payments and the unguaranteed residual value.
XX
Unearned interest income - the total financial revenue of the lessor which is the difference between the gross investment and net investment. Sales - equal to the net investment or the fair value of the asset, whichever is lower . Cost of sales - equal to the coat of the asset sold plus initial direct cost.
AT PAYMENT OF OTHER COSTS . Any executory costs paid by the lessor must be expensed immediately as incurred. Expense account Cash
XX XX
rentals for the entire lease lease term plus the Gross investment - the gross rentals absolute amount of residual value, whether guaranteed or not; or the absolute value of bargain purchase option. (same in direct-financing)
XX Rent Income #
XX
XX
Contingent rents paid by the lessee that is not fixed in amount but based on factors other than passage of time such as percentage of sales, usage, price index, and market rate of interest, are recorded by the lessor as lease revenue.
Cash
XX
ACCOUNTING FOR A SALES A SALES -TYPE -TYPE LEASE FOR LEASE FOR LESSORS
Upon the receipt of the rental payment, the lessor will just credit i ts receipt of cash to lease receivable, but need also to recognize the earned portion of the unearned interest revenue using the scientific method of amortization. Date
XX
Needless to say, if the fair value (actual residual value) value) of the leased asset is greater than the amount guaranteed by the lessee, a gain on finance lease is to be recognized.
(If the lessee obtains ownership at the end of lease term): Net investment (or Cost + IDC) IDC)
(XX)
However, if the lessee has guaranteed the residual value of the leased asset, the lessor will will received cash payment from from the lessee to compensate the deficiency of the fai r value and therefore, no more loss shall be recognized.
(If the leased asset will revert back to the lessor):
(XX)
XX
Gain (loss) on finance lease
AT RECEIPT OF RENTAL PAYMENTS . Since the aggregate present value of the minimum lease payments and the unguaranteed residual value is equal the cost or FV of the leased asset and the initi al direct costs of the lessor (PVofGR + PVofRV = Cost + IDC), the periodic rental payment can be computed as:
Less: PV of the residual value
XX XX
Less: carrying value of lease receivable
XX XX
XX
XX
Fair value of leased asset
Asset account (@FV) XX Loss on finance lease XX Lease receivable #
Net investment (or Cost + IDC) IDC)
(XX) (XX)
AT THE END OF THE LEASE TERM . At end of the lease term, the lessor will simply close all accounts related to t he lease, but any difference between the carrying value of the lease receivable and the fair value of the asset shall asset shall be accounted for as gain or loss on finance lease .
XX
Lease Receivable (GI) XX Asset under finance lease (NI) Unearned interest income (UII) #
XX
Gross investment (GR + RV or BPO) Less Less:: Net Net inve investm stmen entt (PV (PVof ofGR GR + PVo PVofR fRV V or or PVo PVofB fBPO PO))
XX
Unearned Interest Income
XX
XX (XX) (XX) XX
# (If the lessee guaranteed the residual value of the leased asset: AT END OF THE REPORTING PERIOD . In case the balance sheet date doesn't coincide with the payment date, the lessor must accrue any interest receivable. Interest receivable Interest income #
Sales (Lower of NI and FV of the asset) Less: Cost of sale ( Cost + IDC) Gross profit on sale
XX
(XX) XX
XX (If the lessee does not guaranteed the residual value:)
AT EXERCISE OF THE BARGAIN PURCHASE OPTION. When the lessee exercised the bargain purchase option, the lessor must derecognize any lease receivable and unearned interest income t hereof.
Sales (Lower of of NI and FV of of the asset) - PVofURV Less: Cost of sale ( Cost - PV PVofURV + IDC) Gross profit on sale
Cash XX Unearned interest income XX Lease receivable #
XX
XX
Leases (PAS 17) Page 3
XX (XX) XX
Lease receivable (GI) XX Sales (NI) XX Unearned interest income XX # Cost of sales Inventory #
(c) If the sale price is above fair value , the excess over fair value should be deferred and amortized over the period of use. The difference between the fair value at the time of the t ransaction and the carrying amount should be recognized immediately in the profit or loss.
XX XX
NOTE: 1. That the gross investment under direct financing and sales-type is the same; 2. That the net investment of the lease under direct-financing lease becomes the cost of sale in sales-type lease ; 3. That gross profit on sale under guaranteed residual value and unguaranteed residual value is just the same; and 4. That in direct financing lease, the aggregate present value of the minimum lease payments and the unguaranteed residual value is equal the cost or FV of the leased asset and the initia l direct costs of the lessor, but in sales type lease, it doesn't necesaarily equal. In direct financing, PVofGR + PVofRV = Cost + IDC (Net investment ) = (Cost of sale) But in sales-type lease, Net investment
≠
DISCLOSURES:
FOR LESSEES:
Cost of sale
AT SUBSEQUENT TRANSACTIONS TRANSACTIONS . Same as direct financi ng lease except for the asset under finance lease must be accounted for as an inventory.
•
•
ACCOUNTING FOR A SALE AND LEASE-BACK
A sale and lease back is back is an arrangement whereby one party sells a property to another party and then immediately leases the property back from its new owner. Thus a seller becomes the lessee and the purchaser becomes the lessor.
•
The important consideration in the sale and lease back transaction is the recognition of two separate transactions, the sale the sale and the lease back . •
The accounting treatment of a sale depends upon the type of lease involved. For a sale and leaseback transaction that results in a finance lease, any excess of proceeds over the carrying carrying amount is deferred gain and amortized over the lease term and any excess of the carrying amount over the selling price shall be included as loss immediately.
•
•
The net carrying amount of each class of asset at the end of the reporting period. A reconciliation between the total future minimum lease payments at the end of the reporting reporting period and their present value. The total future minimum lease payments at the end of the reporting period and their present value for each of the following periods: Not later than one year ○ Later than one year and not later than 5 years ○ Later than 5 years ○ Contingent rents recognize as expense in the period. The total future minimum sublease payments expected to be received under non-cancellable subleases at the end of the reporting period. A general description of the lessee's material leasing arrangements.
FOR LESSORS: •
•
• •
•
•
For a transaction that results in an operating lease, the accounting treatment for the gain or loss depends upon the selling price and the fair value of the asset.
•
A reconciliation between the gross investment in the lease and the present value of the minimum lease payments receivable at the end of the reporting period. The gross investment in the lease and the present value of the minimum lease payments receivable at the end of the reporting period for each of the following periods: Not later than one year ○ Later than one year and not later than 5 years ○ Later than 5 years ○ Unearned finance income or unearned interest i ncome. Unguaranteed residual value accruing to the benefit of the lessor. Accumulated allowance for uncollectible minimum lease payments receivable. Contingent rents recognized as income in the period. A general description of the lessor's material leasing arrangements.
(a) If the transaction is clearly carried out at fair value, the profit or loss should be recognized immediately;
(b) If the selling price is below fair value , profit or loss should be recognized immediately. However, if a loss is compensated for by future rentals at below market price, the loss it should be amortized over the period of use.
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