topic 1 accounting_for_leases
TRANSCRIPT
Chapter Outline
BKAF3063 – A141 2
Nature and classification of leases.
Accounting by lessee:
operating lease
finance lease
Accounting by lessor:
operating lease
direct financing lease
Sales and leaseback transactions.
Disclosure requirement.
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 – A141 3
Definition of Lease
BKAF3063 – A141 4
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.
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.
Advantages of Lease
BKAF3063 – A141 5
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.
� Finance Lease if it transfers
substantially all the risks and rewards incidental to ownership.
DMart
� Operating Lease if it does not transfer
substantially all the risks and rewards incidental to ownership.
Classification of Lease
BKAF3063 – A141 6
Classification of Lease …cont.
BKAF3063 – A1417
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 expectation of profitable operation over the asset’s economic life and of gain from appreciation in value or realization of a residual value.
Ownership Transfer
BKAF3063 – A1418
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.
Classification of Lease: Para 10 - depends on the substance of the
transaction rather than the form of the contract.
BKAF3063 – A1419
Operating Lease
NO
NO
NO
NO
NO
YES
YES
YES
YES
YES
Ownership transfers at the end of the lease?
Bargain Purchase Option?
Lease term is for majority of economic life?75% or more
PV of MLP equals at least substantially all of FV of the leased asset? 90% or more
Leased asset(s) specialised?
Finance Lease
Finance Lease
Finance Lease
Finance Lease
Finance Lease
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:
BKAF3063 – A141 10
Operating Lease Finance Lease
NO
NO
NO
YES
YES
YES
Cancellation losses borne by lessee?
Changes in FV of residual borne by lessee?
Bargain lease renewal option?
Terms
BKAF3063 – A141 11
☺ 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.
Terms… (cont)
BKAF3063 – A141 12
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; orb) lessor: any residual value guaranteed by lessee or party
related to lessee, or third party.
(+) BPO (bargain purchase option)
Terms …(cont.)
BKAF3063 – A141 13
☺ 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.
Terms …(cont.)
BKAF3063 – A141 14
☺ 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.
Classification of Lease…cont.
BKAF3063 – A141 15
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 7–13.
☞ 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.
Classification of LeaseClassification of Lease
BKAF3063 – A141 16
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.
Classification of LeaseClassification of Lease
Criteria Satisfied? Y / N
Explanation
Transfer of title
N Not transferred.
BPO Y BPO = RM20,000
Length of lease term
Y useful life = 17 years;Lease term = 15 years.
PV of MLP Y FV = RM460,000;PV of MLP = RM450,000.
Specialised assets
N Not specified.BKAF3063 – A141 17
Solution to illustration 1:
Finance and operating leases: Differences (Lessee)
Finance Lease Operating Lease
Recognition of PPE and liabilities on the book
Recognition of rental expenses/revenue as incurred/earned
PPE subject to impairment and test
Not applicable
BKAF3063 – A141 18
Operating Lease:Accounting by Lessee
BKAF3063 – A141 20
Para 33 – 34:
☞ 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).
Operating Lease:Accounting by Lessee
BKAF3063 – A14121
Illustration 2:
Pajakan Company (lessor) leased an equipment costing RM450,000 to Trojan Company. The economic useful life of the asset is 20 years. The lease is classified as operating lease with the lease term of 5 years starting from 1/1/2011. Payments are made in advance as follows:
1/1/11 RM18,0001/1/12 RM16,0001/1/13 RM14,0001/1/14 RM12,0001/1/15 RM10,000
Asset is used evenly throughout the lease term. The accounting period of both parties ends on 31 December.
Operating Lease :Accounting by Lessee
BKAF3063 – A141 22
Solution to Illustration 2:
Total payment for the lease period:= RM18,000 +RM16,000 + RM14,000 + RM12,000 + RM10,000)= RM70,000
Expenses recognized per year = RM70,000/5 = RM14,000
Journal entries?
Date Particulars Debit Credit1/1/11
31/12/11
Dr. Prepaid rent Cr. CashDr. Rent expense Cr. Prepaid rent
18,000
14,00018,000
14,000
1/1/12
31/12/12
Dr. Prepaid rent Cr. CashDr. Rent expense Cr. Prepaid rent
16,000
14,00016,000
14,000
1/1/13
31/12/13
Dr. Prepaid rent Cr. CashDr. Rent expense Cr. Prepaid rent
14,000
14,00014,000
14,000
1/1/14
31/12/14
Dr. Prepaid rent Cr. CashDr. Rent expense Cr. Prepaid rent
12,000
14,00012,000
14,000
1/1/15
31/12/15
Dr. Prepaid rent Cr. CashDr. Rent expense Cr. Prepaid rent
10,000
14,00010,000
14,000
BKAF3063 – A14123
Operating Lease:Accounting by Lessor
BKAF3063 – A14125
Para 49 – 55:
☞ 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.
Operating Lease:Accounting by Lessor
Operating Lease:Accounting by Lessor
BKAF3063 – A141 26
Refer to Illustration 2:
Total payment for the lease period:= RM18,000 +RM16,000 + RM14,000 + RM12,000 + RM10,000= RM70,000
Expenses recognized per year = RM70,000/5 = RM14,000
Depreciation expense recognized per year = RM450,000/20= RM22,500
Journal entries?
Operating Lease : Accounting by Lessor
Date Particulars Debit Credit1/1/11
31/12/11
Dr. Cash
Cr. Unearned rent revenue
Dr. Unearned rent revenue
Cr. Rent revenue
Dr. Depreciation expense
Cr. Accumulated depreciation
18,000
14,000
22,500
18,000
14,000
22,500
1/1/12
31/12/12
Dr. Cash
Cr. Unearned rent revenue
Dr. Unearned rent revenue
Cr. Rent revenue
Dr. Depreciation expense
Cr. Accumulated depreciation
16,000
14,000
22,500
16,000
14,000
22,500
BKAF3063 – A14127
Finance Lease : Accounting by Lessee
BKAF3063 – A14129
Para 20 – 30:
☞ 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 lessee’s book:
The lower of:Fair value at inception date.
PV of MLP at inception date.
ORReason: the leasedasset should not berecorded for more thanits fair value.
Finance Lease : Accounting by Lessee
Finance Lease : Accounting by Lessee
BKAF3063 – A141 30
Dr. Leased asset xxx *Cr. Lease Liability xxx *
☞ The discount rate (to be used in calculating PV of MLP): implicit in the lease. IF impracticable to determine, use lessee’s incremental
borrowing rate.
☞ MFRS 117 requires the lessee to record the obligation arising from finance lease at then same amount as the leased asset ( para 22)
☞ Journal entries :
* The lower of fair value or PV of MLP
Finance Lease : Accounting by Lessee
Finance Lease : Accounting by Lessee
BKAF3063 – A141 31
☞ Interest: MLP − Lease Liabilities/FV of asset :
► Lease payment should be apportioned between the finance charge and the reduction of the outstanding liability.
► Finance charge – allocated to periods during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period [ Para 27].
☞ Contingent rents: charged as expense as incurred.
Finance Lease : Accounting by Lessee
Finance Lease : Accounting by Lessee
BKAF3063 – A141 32
☞ Depreciation (Para 27):► Depreciation policy should be consistent with that for depreciable
assets which are owned by the lessee (in accordance with MFRS116).
► Use economic useful life, if the lease:
i. transferred rights at the end of lease term; OR
ii. contains BPO.
► Otherwise, use:
The lower of:
Lease term
Economic useful life
OR
Finance Lease : Accounting by Lessee
Finance Lease : Accounting by Lessee
BKAF3063 – A14133
Illustration 3:
Assume that Pajakan Company (lessor) and Trojan Company (lessee) sign a lease agreement dated 1 January 2012. The terms are as follows:
Term of lease is 5 years, it is non-cancellable, requiring equal rental payments of RM20,000 at the end of each year.
1. The FV = RM75,816 at the inception date, estimated useful life of 5 years, and no residual value.
2. The lease contains no renewal options, and the equipment reverts to Pajakan Co. at the termination of the lease.
3. Discount rate agreed by both parties is 10%.
4. Trojan Co. depreciates on a straight line basis, similar equipment that it owns.
Finance Lease :Accounting by Lessee
Finance Lease :Accounting by Lessee
BKAF3063 – A141 34
Solution to Illustration 3:
Type of lease: Finance lease
MLP = 20,000 x 5 years = RM100,000
PV of MLP = 20,000 x PVOA(5, 10%)²= 20,000 x 3.7908= 75,816 FV = 75,816.
Journal entry on 1 Jan 2012
Dr. Leased asset 75,816 Cr. Lease Liability 75,816(to recognise the asset leased)
Finance Lease :Accounting by Lessee
Finance Lease :Accounting by Lessee
Date Annual lease payment
(A)
Interest (10%)
(B)
Principal payment
(C)
Lease liability
(D)
1 Jan 12 - - - 75,816
31 Dec 12 20,000 7,582 12,418 63,398
31 Dec 13 20,000 6,340 13,660 49,738
31 Dec 14 20,000 4,974 15,026 34,712
31 Dec 15 20,000 3,471 16,529 18,183
31 Dec 16 20,000 1,818 18,182 0
(D) X 10% (A) - (B) Preceeding
- (C)
BKAF3063 – A141 35
Lease amortization schedule: Effective interest method
Finance Lease :Accounting by Lessee
Date Particulars Debit Credit31/12/12 Dr. Lease liability
Interest expense Cr. Cash
Dr. Depreciation expense Cr. Accumulated depreciation
12,4187,582
15,163
20,000
15,16331/12/13 Dr. Lease liability
Interest expense Cr. Cash
Dr. Depreciation expense Cr. Accumulated depreciation
13,6606,340
15,163
20,000
15,163
BKAF3063 – A141 36
Journal entries:
Finance Lease :Accounting by Lessee
Date Particulars Debit Credit31/12/14 Dr. Lease liability
Interest expense Cr. Cash
Dr. Depreciation expense Cr. Accumulated depreciation
15,0264,974
15,163
20,000
15,16331/12/15 Dr. Lease liability
Interest expense Cr. Cash
Dr. Depreciation expense Cr. Accumulated depreciation
16,5293,471
15,163
20,000
15,163
BKAF3063 – A141 37
Journal entries:
Finance Lease :Accounting by Lessee
Date Particulars Debit Credit31/12/16 Dr. Lease liability
Interest expense Cr. Cash
Dr. Depreciation expense Cr. Accumulated depreciation
20,0001,818
15,163
20,000
15,163Dr. Accumulated depreciation Cr. Leased assets(to record the return of the assets)
75,81675,816
BKAF3063 – A141 38
Journal entries:
Finance Lease : Accounting by Lessor
BKAF3063 – A14140
Para 36 – 40:
☞ The receivable to be presented in the Balance Sheet at an amount equal to the net investment in the lease [Para 36], which is defined in para 4 as “the gross investment in the lease less unearned finance income”
☞ Initial direct cost – included in the initial measurement of finance lease receivable and reduce the amount of income recognised over the lease term [para 38].
Finance Lease :Accounting by Lessor
Finance Lease :Accounting by Lessor
BKAF3063 – A141 41
Refer to Illustration 3:
Gross investment = 20,000 x 5 years = RM100,000
Net investment = PV of gross investment = 20,000 x PVOA(5, 10%) = 20,000 x 3.7908 = 75,816
Unearned finance income = 100,000 – 75,816 = 24,184
Amortization schedule?
Journal entries?
Finance Lease :Accounting by Lessor
Date Particulars Debit Credit
01/01/05 Dr. Lease receivable Cr. Fixed assets Unearned interest revenue
100,00075,81624,184
31/12/05 Dr. Cash Cr. Lease receivable
Dr. Unearned interest revenue Cr. Interest revenue
20,000
7,582
20,000
7,58231/12/06 Dr. Cash
Cr. Lease receivable
Dr. Unearned interest revenue Cr. Interest revenue
20,000
6,340
20,000
6,340BKAF3063 – A141 42
Journal entries:
Bargain Purchase Option
MLP will be increased by the exercise price
Useful life will be used as basis for depreciation charge.
Example:
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%.BKAF3063 – A141 43
Bargain Purchase OptionSolution - Lesse:MLP = (10,000 x 4) + 1,000 = 41,000
PV of MLP = (10,000 x PVAn=4,i=5%) + (1,000 x PV n=4,i=5%) = 36,282
1/1/11 : Dr. Leased Equipment 36,282Cr. Lease Payable 36,282
Depreciation exp = 36,282 / 5 = RM7,256.40
31/12/14 - exercise of BPO:Dr. Lease Payable 1,000
Cr. Cash 1,000
BKAF3063 – A141 44
Bargain Purchase Option
Solution - Lessor:
Gross Investment = (10,000 x 4) + 1,000 = 41,000
PV of MLP = (10,000 x PV OAn=4,i=5%) + (1,000 x PV n=4,i=5%)
= 36,282
1/1/11 : Dr. Leased Receivable 41,000
Cr. Equipment 36,282
Unearned interest revenue 4,718
31/12/14 - exercise of BPO:
Dr. Cash 1,000
Cr. Leased Receivable 1,000
BKAF3063 – A141 45
Guaranteed Residual Value
• MLP will be increased by GRV• GRV will be deducted from the depreciable amount
of leased asset.• At the end of lease term,
the lease liability will have a balance equal with GRV
If FV of leased asset < GRV , recognise loss (lessee)
BKAF3063 – A141 46
Guaranteed Residual Value
Example: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 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.
BKAF3063 – A141 47
Guaranteed Residual Value
BKAF3063 – A141 48
Solution – Lessee:MLP = (10,000 x 4) + 5,000 = 45,000PV of MLP = (10,000 x PV OAn=4,i=5%) + (5,000 x PV n=4,i=5%)
= 39,572
1/1/11 : Dr. Leased Equipment 39,572Cr. Lease Payable 39,572
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 34,572
Cr. Leased Equipment 39,572
Dr. Loss on finance lease 2,000Cr. Cash 2,000
Guaranteed Residual Value
BKAF3063 – A141 49
Solution – Lessor:
GI = (10,000 x 4) + 7,000 = 47,000PV of GI = (10,000 x PVOA n=4,i=5%) + (7,000 x PV n=4,i=5%)
= 41,218
1/1/11 : Dr. Leased Receivable 47,000 Cr. Equipment 41,218
Unearned interest revenue 5,782
31/12/14, if FV of leased asset is RM3,000,
Dr. Equipment 3,000 Cash 2,000 Loss on finance lease 2,000
Cr. Leased Receivable 7,000
Sales and LeasebackSales and Leaseback
BKAF3063 – A14150
☞ Transaction in which the owner of the asset (seller, lessee) sells the asset to another and simultaneously leases it back from the new owner.
?In the book of Buyer/lessor:- Same as lessor as discuss before.
In the book of seller/lessee:-To recognize gain from sales of asset: immediate or defer.
Sales and LeasebackSales and Leaseback
BKAF3063 – A141 51
Para 59: for Finance lease
Should not be recognized immediately, instead, should be deferred and amortized over the lease term.
Profit = Sales proceed – Carrying amount
Sales and LeasebackSales and Leaseback
BKAF3063 – A141 52
Para 61: for Operating lease.
Should be recognized immediately.
Profit = Sales proceed – Carrying amount
(a) If Selling price = FV
Sales and LeasebackSales and Leaseback
BKAF3063 – A141 53
Para 61: for Operating lease
Should be recognized immediately EXCEPT THAT if the loss is compensated by future lease payments at below
market price, it should be deferred and amortized.
Profit = Sales proceed – Carrying amount
(b) If Selling price < FV
Sales and LeasebackSales and Leaseback
BKAF3063 – A14154
Para 61: for Operating lease
deferred and amortized.
Profit = Sales proceed – FV
(c) If Selling price > FV (FV > carrying amount)
recognized immediately.
Profit = FV - Carrying amount
Profit = Sales proceed – Carrying amount
Sales and LeasebackSales and Leaseback
BKAF3063 – A141 55
Illustration 5:Chocolate Company sold an equipment to Chips Company and
lease back the asset. The carrying amount (book value) of the asset is RM60,000. The asset has a fair value of RM70,000.
How to recognize profit/loss if the selling price:
1. RM70,0002. RM55,0003. RM50,000 (with lower lease payment)4. RM90,000
Sales and LeasebackSales and Leaseback
BKAF3063 – A141 56
Solution to Illustration 11:
1. SP = FV (SP > CA) =
Profit = 70,000 - 60,000 = 10,000
2. SP < FV (SP < CA)
Loss = 55,000 – 60,000 = 5,000 loss
3. SP < FV (SP < CA with lower lease payment)
Loss = 50,000 – 60,000 = 10,000 loss
recognize immediately
recognize immediately
defer & amortize
Sales and LeasebackSales and Leaseback
BKAF3063 – A141 57
Solution to Illustration 11:
4. SP > FV =
Profit = 90,000 – 60,000 = 30,000
FV – CA= 70,000 – 60,000= 10,000 recognize immediately
SP – FV= 90,000 – 70,000= 20,000 defer & amortize
Disclosure RequirementsDisclosure Requirements
BKAF3063 – A141 58
For Lessee:Para 31: Finance lease. Para 35: Operating lease.
For Lessor:Para 47: Finance lease. Para 56: Operating lease.