Accounting (Basics) - Lecture 5
Lease


Contents
nClassification of leases
nFinance leases - financial statements of lessees and lessors
nOperating leases - financial statements of lessees and lessors
nSale and leaseback transactions
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Classification of leases
nA lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership. A lease is classified as an operating lease if it does not transfer
substantially all the risks and rewards incidental to ownership.
nWhether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the form of the contract. Examples of situations that individually or in
combination would normally lead to a lease being classified as a finance lease are:
a)the lease transfers ownership of the asset to the lessee by the end of the lease term.
b)the lessee has the option to purchase the asset at a price that is expected to be sufficiently
lower than the fair value at the date the option becomes exercisable for it to be reasonably
certain, at the inception of the lease, that the option will be exercised.
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Classification of leases
c)the lease term is for the major part of the economic life of the asset even if title is not
transferred.
d)at the inception of the lease the present value of the minimum lease payments amounts to at least
substantially all of the fair value of the leased asset.
e)gains or losses from the fluctuation in the residual value of the leased asset accrue to the
lessee (e.g. in the form of a rent rebate equaling most of the sales proceeds at the end of the
lease).
f)the lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.
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Classification of leases
nThese examples and indicators are not always conclusive. If it is clear from other features that
the lease does not transfer substantially all risks and rewards incidental to ownership, the lease
is classified as an operating lease.
nLease classification is made at the inception of the lease and is not changed during the term of
the lease unless the lessee and the lessor agree to change the provisions of the lease (other than
simply by renewing the lease), in which case the lease classification shall be re-evaluated.
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Finance leases - financial statements of lessees
nAt the commencement of the lease term, a lessee shall recognize its rights of use and obligations
under finance leases as assets and liabilities in its statement of financial position at amounts
equal to the fair value of the leased property or, if lower, the present value of the minimum lease
payments, determined at the inception of the lease. Any initial direct costs of the lessee are
added to the amount recognized as an asset. The present value of the minimum lease payments should
be calculated using the interest rate implicit in the lease. If this cannot be determined, lessee’s
incremental borrowing rate shall be used.
nA lessee shall apportion minimum lease payments between the finance charge and the reduction of
the outstanding liability using the effective interest method.
nA lessee shall depreciate an asset leased under a finance lease in accordance with the relevant
section of this IFRS for that type of asset. If there is no reasonable certainty that the lessee
will obtain
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Finance leases - financial statements of lessees
nownership by the end of the lease term, the asset shall be fully depreciated over the shorter of
the lease term and its useful life. A lessee shall also assess at each reporting date whether an
asset leased under a finance lease is impaired.
nA lessee shall make the following disclosures for finance leases:
a)for each class of asset, the net carrying amount at the end of the reporting period.
b)the total of future minimum lease payments at the end of the reporting period
c)a general description of the lessee’s significant leasing arrangements including, for example,
information about contingent rent, renewal or purchase options and restrictions imposed by lease
arrangements.
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Finance leases - financial statements of lessors
nA lessor shall recognize assets held under a finance lease in their statements of financial
position and present them as a receivable at an amount equal to the net investment in the lease.
The net investment in a lease is the lessor’s gross investment in the lease discounted at the
interest rate implicit in the lease. The gross investment in the lease is the aggregate of the
minimum lease payments receivable by the lessor under a finance lease, and any unguaranteed
residual value accruing to the lessor.
nFor finance leases other than those involving manufacturer or dealer lessors, initial direct costs
are included in the initial measurement of the finance lease receivable and reduce the amount of
income recognized over the lease term.
nThe recognition of finance income shall be based on a pattern reflecting a constant periodic rate
of return on the lessor’s net investment in the finance lease. Lease payments relating to the
period, excluding costs for services, are applied against the gross
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Finance leases - financial statements of lessors
ninvestment in the lease to reduce both the principal and the unearned finance income. If there is
an indication that the estimated unguaranteed residual value used in computing the lessor’s gross
investment in the lease has changed significantly, the income allocation over the lease term is
revised, and any reduction in respect of amounts accrued is recognized immediately in profit or
loss.
nA finance lease of an asset by a manufacturer or dealer lessor gives rise to two types of income:
a)profit or loss equivalent to the profit or loss resulting from an outright sale of the asset
being leased, at normal selling prices, reflecting any applicable volume or trade discounts, and
b)finance income over the lease term.
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Finance leases - financial statements of lessors
nThe sales revenue recognized at the commencement of the lease term by a manufacturer or dealer
lessor is the fair value of the asset or, if lower, the present value of the minimum lease payments
accruing to the lessor, computed at a market rate of interest. The cost of sale recognized at the
commencement of the lease term is the cost, or carrying amount if different, of the leased property
less the present value of the unguaranteed residual value. The difference between the sales revenue
and the cost of sale is the selling profit. Costs incurred by manufacturer or dealer lessors in
connection with negotiating and arranging a lease shall be recognized as an expense when the
selling profit is recognized.
nA lessor shall make the following disclosures for finance leases:
a)a reconciliation between the gross investment in the lease at the end of the reporting period,
and the present value of minimum lease payments receivable at the end of the reporting period. In
addition, a lessor shall disclose the gross
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Finance leases - financial statements of lessors
ninvestment in the lease and the present value of minimum lease payments receivable at the end of
the reporting period
b)unearned finance income.
c)the unguaranteed residual values accruing to the benefit of the lessor.
d)the accumulated allowance for uncollectible minimum lease payments receivable.
e)contingent rents recognized as income in the period.
f)a general description of the lessor’s significant leasing arrangements, including, for example,
information about contingent rent, renewal or purchase options, restrictions imposed by lease
arrangements.
n
n
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Operating leases - financial statements of lessees
nA lessee shall recognize lease payments under operating leases (excluding costs for services such
as insurance and maintenance) as an expense on a straight-line basis unless either:
a)another systematic basis is representative of the time pattern of the user’s benefit, even if the
payments are not on that basis, or
b)the payments to the lessor are structured to increase in line with expected general inflation to
compensate for the lessor’s expected inflationary cost increases. If payments to the lessor vary
because of factors other than general inflation, then this condition (b) is not met.
nA lessee shall make the following disclosures for operating leases:
a)the total of future minimum lease payments under non-cancellable operating leases
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Operating leases - financial statements of lessees
b)lease payments recognized as an expense.
c)a general description of the lessee’s significant leasing arrangements including, for example,
information about contingent rent, renewal or purchase options and escalation clauses, subleases,
and restrictions imposed by lease arrangements.
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Operating leases - financial statements of lessors
nA lessor shall present assets subject to operating leases in its statement of financial position
according to the nature of the asset.
nA lessor shall recognize lease income from operating leases (excluding amounts for services such
as insurance and maintenance) in profit or loss on a straight-line basis over the lease term,
unless either
a)another systematic basis is representative of the time pattern of the lessee’s benefit from the
leased asset, even if the receipt of payments is not on that basis, or
b)the payments to the lessor are structured to increase in line with expected general inflation to
compensate for the lessor’s expected inflationary cost increases. If payments to the lessor vary
according to factors other than inflation, then condition (b) is not met.
n
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Operating leases - financial statements of lessors
nA lessor shall recognize as an expense costs, including depreciation, incurred in earning the
lease income. The depreciation policy for depreciable leased assets shall be consistent with the
lessor’s normal depreciation policy for similar assets.
nTo determine whether a leased asset has become impaired, a lessor shall apply Section “Impairment
of Assers”.
nA manufacturer or dealer lessor does not recognize any selling profit on entering into an
operating lease because it is not the equivalent of a sale.
nA lessor shall disclose the following for operating leases:
a)the future minimum lease payments under non-cancellable operating leases
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Operating leases - financial statements of lessors
b)total contingent rents recognized as income.
c)a general description of the lessor’s significant leasing arrangements, including, for example,
information about contingent rent, renewal or purchase options and escalation clauses, and
restrictions imposed by lease arrangements.
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Sale and leaseback transactions
nA sale and leaseback transaction involves the sale of an asset and the leasing back of the same
asset. The lease payment and the sale price are usually interdependent because they are negotiated
as a package. The accounting treatment of a sale and leaseback transaction depends on the type of
lease:
a)if a sale and leaseback transaction results in a finance lease - the seller-lessee shall not
recognize immediately, as income, any excess of sales proceeds over the carrying amount. Instead,
the seller-lessee shall defer such excess and amortize it over the lease term.
b)if a sale and leaseback transaction results in an operating lease and it is clear that the
transaction is established at fair value - the seller-lessee shall recognize any profit or loss
immediately. If the sale price is below fair value, the seller-lessee shall recognize any profit or
loss immediately unless the loss is compensated for by future lease payments at below
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Sale and leaseback transactions
nmarket price. In that case the seller-lessee shall defer and amortize such loss in proportion to
the lease payments over the period for which the asset is expected to be used. If the sale price is
above fair value, the seller-lessee shall defer the excess over fair value and amortize it over the
period for which the asset is expected to be used.
nDisclosure requirements for lessees and lessors apply equally to sale and leaseback transactions.
The required description of significant leasing arrangements includes description of unique or
unusual provisions of the agreement or terms of the sale and leaseback transactions.
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