Download Chapter 10

Chapter 10
Accounting for leases
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–1
Objectives
• Understand the differences between operating leases
and financial leases
• Understand how lessors and lessees should account
for financial leases
• Understand how lessors and lessees should account
for operating leases
• Understand the implications that lease recognition
will have for a reporting entity’s financial statements
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–2
Introduction to accounting for leases
Accounting for leases is governed by AASB 117
•
Applies to accounting for leases other than:
–
–
leases to explore for or use minerals, oil, natural gas and similar
non-regenerative assets
licensing agreements for such items as motion picture films, video
recordings, plays, manuscripts and copyrights
Lease defined (AASB 117, par. 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
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–3
Introduction to accounting for
leases (cont.)
Central accounting issue
• Whether or not the leased assets and the associated
commitments relating to the lease arrangement
should appear in the reporting entity’s balance sheet
• Should lack of legal ownership preclude the lessee’s
reporting of the asset and the related liability in the
balance sheet?
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–4
Introduction to accounting for
leases (cont.)
Question of ‘control’ and not ‘ownership’
• A firm may recognise assets it does not own as long
as it is able to control their use
• Do leases transfer control of the asset to the lessee?
–
–
Depends on the terms of the lease agreement
It is, in fact, possible for control of the asset to be vested in
the lessee
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–5
Introduction to accounting for
leases (cont.)
Central issue concerns whether lease is:
–
a finance lease; or
– an operating lease
Finance leases (under AASB 117) must be disclosed in the
balance sheet:
– Lease asset
– Corresponding lease liability
Finance lease
–
A lease that transfers substantially all the risks and rewards
incidental to ownership of an asset
– Title may or may not be eventually transferred
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–6
Introduction to accounting for
leases (cont.)
Risks and rewards of ownership central to the application of
AASB 117
–
If the lessee holds the risks and rewards of ownership, the
lessee’s risk exposure is basically what it would be if the lessee
acquired the asset by way of a purchase transaction
– If the risks and benefits of ownership are transferred in
substance to the lessee, the lessee’s risk exposure in relation to
holding the asset is basically equivalent to what it would have
been if the lessee had acquired the asset for cash or by way of a
loan
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–7
Introduction to accounting for
leases (cont.)
Risks and rewards of ownership (cont.)
–
Not always a straightforward exercise to determine whether the
risks and rewards incidental to ownership have passed
substantially to the lessee
– Often requires professional judgment
– Guidance offered in AASB 117 (pars 10–12) to determine
whether finance or operating lease
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–8
Introduction to accounting for
leases (cont.)
AASB 117 (par. 10)
Whether 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 a
finance lease are:
(a)
(b)
(c)
the lease transfers ownership of the asset to the lessee by the
end of the lease term
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
The lease term is for the major part of the economic life of the
asset even if the title is not transferred
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–9
Introduction to accounting for
leases (cont.)
AASB 117 (par. 11):
Indicators of situations that, individually or in combination, could
also lead to a lease being classified a finance lease are:
(a) If the lessee can cancel the lease, the lessor’s losses
associated with the cancellation are borne by the lessee
(b) gains or losses from the fluctuation in the fair value of the
residual accrue to the lessee (for example, in the form of a rent
rebate equalling most of the sale proceeds at the end of the
lease); and
(c) the lessee has the ability to continue the lease for a secondary
period at a rent that is substantially lower than the market rent.
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–10
Introduction to accounting for
leases (cont.)
Note (AASB 117, par. 12):
•
The examples and indicators in paragraphs 10 and 11 are not
always conclusive
•
If it is clear from other features of the lease that the lease does not
transfer all risks and rewards incidental to ownership, the lease is
classified an operating lease
•
This might be the case, for example, if ownership of the asset
transfers at the end of the lease for a variable payment equal to its
then fair value or if there are contingent rents, as a result of which
the lessee does not bear substantially all such risks and rewards
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–11
Introduction to accounting for
leases (cont.)
Operating vs finance lease
•
•
•
•
•
•
If lease is cancellable at limited cost to lessee, the lessee has limited risks
and the lease is considered an ‘operating’ lease
For the lessee to be considered to bear the risks associated with asset
ownership there should be costs for the lessee should the lessee choose
to cancel the lease
Thus, par. 11(a) is considered an important consideration in determining
whether a lease is a ‘finance’ lease
Classification of lease a matter of professional judgment, i.e. depends on
economic substance of the lease agreement
Leases that do not appear to satisfy any of the criteria of AASB 117
(paragraphs 10–12) will typically be classified and accounted for by the
lessee as ‘operating’ leases
They will not require disclosure within the balance sheet, lease payments
are typically treated as rental expenses
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–12
Introduction to accounting for
leases (cont.)
Key terms
1. Fair value
–
The amount for which an asset could be exchanged or a
liability settled between knowledgeable, willing parties in an
arm’s length transaction
–
Necessary for determining the amount to be included for the
leased asset in the balance sheet of the lessee
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–13
Introduction to accounting for
leases (cont.)
Key terms (cont.)
2. Non-cancellability
A non-cancellable lease is a lease that is cancellable only:
(a) upon occurrence of some remote contingency
(b) with the permission of the lessor
(c) if the lessee enters into a new lease for the same or an
equivalent asset with the same lessor; or
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–14
Introduction to accounting for
leases (cont.)
Key terms (cont.)
(d) upon payment by the lessee of such an additional amount that at
inception of the lease, continuation of the lease is reasonably
certain.
•
Important because if the lessee was able to cancel the lease
at short notice with limited penalty the lessee would not be
considered to be holding the risks and rewards associated with
asset ownership—lease would be considered an operating lease
•
If lease cancellable—regardless of remaining terms the lease
would be considered to be an operating lease
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–15
Introduction to accounting for
leases (cont.)
Key terms (cont.)
3. Contingent rent (AASB 117, par. 4)
That portion of the lease payments that is not fixed in amount but
is based on the future amount of a factor that changes other than
with the passage of time (e.g. percentage of future sales, amount
of future use, future price indices, future market rates of interest)
Why important?
•
When the amount of rent paid by the lessee is contingent upon the
amount of future sales, future use, future interest rates, etc., there
is effectively a shift of some of the risks and rewards of ownership
back to the lessor
•
‘Contingent rent’ therefore decreases the likelihood that the lease
will be a ‘finance’ lease
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–16
Introduction to accounting for
leases (cont.)
Key terms (cont.)
4. Transfer of ownership
•
If lease transfers ownership of the asset to the lessee at the
end of the lease term it is considered a finance lease (AASB
117, par. 10a)
•
If the lease is also non-cancellable, the lease is really only
another type of debt agreement with title passing after last
payment is made
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–17
Introduction to accounting for
leases (cont.)
Key terms (cont.)
5. Bargain purchase option
Considered in AASB 117 (par. 10b)
•
A provision that allows a lessee to purchase a leased property for a price
expected to be far lower than the expected fair value of the property at the
date the option becomes exercisable
•
Difference between the option price and expected fair market value must
be large enough to make exercise of the option reasonably assured—
evaluation made at inception of lease
•
If exercise of option is likely (bargain) it is also likely that transfer of
ownership will occur—risks and rewards of ownership are assumed to be
transferred
•
Included in the calculation of minimum lease payments because the
exercise of a ‘bargain’ option is reasonably assured and it is therefore
probable that the amount will ultimately be paid by the lessee
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–18
Introduction to accounting for
leases (cont.)
Key terms (cont.)
6. Lease term
•
The non-cancellable period for which the lessee has contracted to
lease the asset, together with any further terms for which the
lessee has the option to continue to lease the asset with or without
further payment, when at the inception of the lease it is reasonably
certain that the lessee will exercise the option
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–19
Introduction to accounting for
leases (cont.)
Key terms (cont.)
7. Economic life
Either:
(a)
(b)
The period over which an asset is expected to be economically
usable by one or more users; or
the number of production or similar units expected to be
obtained from the asset by one or more users
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–20
Introduction to accounting for leases
(cont.)
Key terms (cont.)
7. Economic life (cont.)
Why important? AASB 117, par. 10(c)
•
If the non-cancellable lease term is for the major part of the
economic life of the asset the lease is generally considered a
finance lease
Note:
‘Major part’ not defined but generally accepted that if lease term is
greater than or equal to 75% of the economic life of the leased
asset risks and rewards are effectively transferred to the lessee
(finance lease)
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–21
Introduction to accounting for
leases (cont.)
Key terms (cont.)
8. Minimum lease payments
AASB 117 (par. 4)
The payments over the lease term what the lessee is or can be
required to make, excluding contingent rent, costs for services and
taxes paid by and reimbursed to the lessor together with:
(a)
(b)
For the lessee, any amounts guaranteed by the lessee or by a party
related to the lessee; or
for a lessor, any residual value guaranteed to the lessor by:
(i)
the lessee
(ii) a party related to the lessee; or
(iii) a third party unrelated to the lessor that is financially capable of
discharging the obligations under the guarantee
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–22
Introduction to accounting for
leases (cont.)
Key terms (cont.)
8. Minimum lease payments (cont.)
Why important?
•
The present value of the minimum lease payments is used to
determine whether a lease is a finance or operating lease—AASB
117, par. 10(d):
•
•
If at the inception of the lease the present value of the minimum lease
payments amounts to at lease substantially all of the fair value of the
asset—normally leads to lease classified as ‘finance’-type lease
If a finance lease the amount to be initially recognised in the balance
sheet for the asset and liability is (par. 20) the fair value of the leased
property or, if lower, the present value of the minimum lease payments
as determined at inception of lease
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–23
Introduction to accounting for
leases (cont.)
Key terms (cont.)
8. Minimum lease payments (cont.)
•
Expressly exclude contingent rent
•
Include guaranteed residual values
(a) Guaranteed residual value defined for the lessee
•
That part of the residual value that is guaranteed by the
lessee or by a party related to the lessee (the amount of the
guarantee being the maximum amount that could in any
event become payable
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–24
Introduction to accounting for
leases (cont.)
Key terms (cont.)
8. Minimum lease payments (cont.)
(b) Guaranteed residual value defined for the lessor:
•
That part of the residual value that is guaranteed by the
lessee or by a third party unrelated to the lessor that is
financially capable of discharging the obligations under the
guarantee
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–25
Introduction to accounting for
leases (cont.)
(c) Amount of a guaranteed residual value
• The amount that the lessor has the right to require the lessee or a
related party to the lessee to pay at the end of the lease term
• Payment of this residual will often lead to the asset being legally
transferred to the lessee
Minimum lease payments
• Do not include costs for services and taxes (executory costs) that are
paid to the lessor in reimbursement
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–26
Introduction to accounting for
leases (cont.)
Key terms (cont.)
9. Guaranteed/Unguaranteed residual
(a) Guaranteed residual
•
The maximum amount that could become payable— included in
the minimum lease payments as its payment is reasonably
assured
(b) Unguaranteed residual
•
Not included in minimum lease payments as there is not sufficient
certainty that the amount will be paid
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–27
Interest rate for determining the present value of
minimum lease payments
Why interest in present value of minimum lease payments?
AASB 117 (par. 20):
At commencement of lease term lessees are to recognise finance
leases as assets and liabilities in their balance sheets at amounts
equal to the fair value of the leased property or, if lower, the present
value of the minimum lease payments
Discount rate to be used in calculating present value:
–
interest rate implicit in the lease (if this is practical to determine);
or
–
if not, the lessee’s incremental borrowing rate to be used
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–28
Interest rate for determining the present value of
minimum lease payments (cont.)
Interest rate implicit in the lease (AASB 117):
The discount rate that, at the commencement of the lease
term, causes the aggregate present value of:
(a)
(b)
the minimum lease payments; and
the unguaranteed residual value to be equal to the sum of:
(i) the fair value of the leased asset; and
(ii) any initial direct costs of the lessor.
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–29
Interest rate for determining the present value of
minimum lease payments (cont.)
Fair value of asset cannot be determined by lessee at inception of lease:
–
–
Implicit interest rate cannot then be determined
Lessee to discount the minimum lease payments by using incremental
borrowing rates
Incremental borrowing rate defined:
–
The rate of interest the lessee would have to pay on a similar lease or, if
not determinable, the rate that, at the inception of the lease, the lessee
would incur to borrow over a similar term, with similar security, the funds
necessary to purchase the asset
Refer to Worked Example 10.1 on page 388—Example of computing discount
rate
Refer to Worked Example 10.2 on page 389—Classification of a lease as a
finance or operating lease
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–30
Lessee accounting for
finance leases
Overview
• Essentially the same as acquiring the asset by way of a longterm loan
• Lessee records an asset (leased) and a lease liability
• Asset and liability recorded at the fair value of the leased
property or, where lower, at the present value of the minimum
lease payments
• Consideration to be given to present value of future cash
flows
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–31
Lessee accounting for
finance leases (cont.)
Overview (cont.):
• Unguaranteed residual excluded from the amount recognised
for the lease asset and lease liability in financial statements of
lessee
• Rental payments to lessor include payment of principal plus
interest—to be apportioned by lessee
• Interest expense calculated by applying the interest rate
implicit in the lease to outstanding lease liability at beginning
of each lease period
• Balance of payment represents a reduction of principal of
lease liability
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–32
Lessee accounting for
finance leases (cont.)
Amortisation of leased assets
•
•
•
Leased assets should be amortised using the depreciation
(amortisation) policies normally followed by the lessee
Period of amortisation—number of accounting periods that are
expected to benefit from the asset’s use
Amortisation can be over useful life of asset, i.e. when reasonable
assurance that lessee will obtain ownership at end of lease term
(e.g. bargain purchase option), otherwise amortisation over lease
term
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–33
Lessee accounting for
finance leases (cont.)
Journal entries
• To record the leased asset and lease liability (at PV of minimum
lease payments):
Dr Leased asset
Cr
Lease liability
•
To record lease amortisation expense:
Dr Lease amortisation expense
Cr
Accumulated amortisation
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–34
Lessee accounting for
finance leases (cont.)
Journal entries (cont.)
• To record the lease payment, with the payment being allocated
between principal and interest:
Dr
Lease liability
Dr
Interest expense
Cr
Cash
• To record payment of executory costs:
Dr
Executory expenses
Cr
Cash
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–35
Lessee accounting for
finance leases (cont.)
Initial indirect costs (AASB 117):
• Costs directly associated with negotiating and executing a lease
agreement
• Include commissions, legal fees, costs of preparing and
processing documentation
• Initial direct costs relating to a finance lease must be capitalised
as part of the leased asset
• Where such costs are incurred the lease asset comprises the
present value of the minimum lease payments and the amount
of the initial direct costs incurred—total amount subject to
amortisation
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–36
Lessee accounting for
operating leases
• A lease that does not substantially transfer all the
risks and rewards incidental to ownership of the
asset to the lessee
• Lease payments are expensed on a basis
representative of the pattern of benefits derived
from the leased asset
• If lease payments do not represent prepayments,
they should be expensed in the period made
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–37
Lessee accounting for
operating leases (cont.)
AASB 117 (par. 33):
Lease payments under an operating lease are to be recognised as
an expense on a straight-line basis over the lease term, unless
another systematic basis is more representative of the time pattern
of the user’s benefits
•
Journal entry:
Dr
Rental expense
Cr
Cash
Refer to Worked Example 10.3 on page 394—Example of
accounting for an operating lease
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–38
Lessee accounting for sale and
leaseback transactions
• Occurs when the owner of a property
(seller/lessee) sells the property to another party
and simultaneously leases it back from the
purchaser/lessor (the legal owner)
• Seller does not lose control of the asset if a finance
lease
• Property often sold at a price equal to or greater
than current market value—leased back for a term
approximating useful life
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–39
Lessee accounting for sale and leaseback
transactions (cont.)
•
•
•
Lease payments sufficient to repay the buyer for cash
invested plus reasonable return on investment
Lessee typically pays all executory costs as if title remained
with lessee
Often considered a useful way of obtaining funds while
allowing recipient of the funds to maintain control of the asset
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–40
Lessee accounting for sale and leaseback
transactions (cont.)
Finance lease
• Where substantially all risks and rewards incidental to
ownership remain with lessee—represents refinancing of an
asset
• Any profit or loss on sale deferred in the balance sheet and
amortised to the profit and loss over the term of the lease
(AASB 117, par. 59)
• Asset considered not to have been ‘sold’ to lessor, therefore
inappropriate to recognise profit or loss (AASB 117, par. 60)
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–41
Lessee accounting for sale and leaseback
transactions (cont.)
Operating lease
•
Where substantially all risks and rewards incidental to ownership effectively
pass to lessor
AASB 117 (par. 61)
•
If a sale and leaseback transaction results in an operating lease, and it is
clear that the transaction is established at fair value, any profit and loss shall
be recognised immediately
•
If the sale price is below fair value, any profit or loss shall be recognised
immediately, except that, if the loss is compensated for by future lease
payments at below market price, it shall be deferred and amortised 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 excess over fair value shall be
deferred and amortised over the period for which the asset is expected to be
used
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–42
Lessee accounting for sale and leaseback
transactions (cont.)
Operating lease (cont.)
AASB 117 (par. 63)
• For operating leases, if the fair value at the time of the sale
and leaseback transaction is less than the carrying amount of
the asset, a loss equal to the amount of the difference
between the carrying amount and fair value is to be
recognised immediately
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–43
Lessee accounting for sale and leaseback
transactions (cont.)
Journal entries
• To record the sale of an asset (any profit on sale is
deferred and recognised throughout lease term):
Dr
Cash
Dr
Accumulated depreciation
Cr Asset
Cr Deferred gain
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–44
Lessee accounting for sale and leaseback
transactions (cont.)
Journal entries (cont.)
• To record finance lease:
Dr
Leased asset
Cr Lease liability
• To recognise periodic lease repayment:
Dr
Dr
Interest expense
Lease liability
Cr Cash
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
PPTs t/a Australian Financial Accounting 4e by Craig Deegan
10–45
Lessee accounting for sale and leaseback
transactions (cont.)
Journal entries (cont.)
• To record amortisation of leased asset:
Dr
Amortisation of leased asset
Cr
Accumulated lease amortisation
•
Recognition of deferred gain (on straight-line basis):
Dr
Deferred gain
Cr
Profit on sale of leased asset
Refer to Worked Example 10.4 on page 397—Example of
sale and leaseback transaction
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–46
Lessee disclosure requirements
Finance lease
• Numerous disclosures required—Refer to AASB 117, par. 31
Operating lease
• Numerous disclosures required—Refer to AASB 117, par. 35
Refer to Exhibit 10.2 on page 399—Lease commitment note: BHP
Billiton Ltd
Refer to Worked Example 10.5 on page 400—Comprehensive
example of accounting for leases by a lessee
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–47
Accounting by lessors
Lessor’s perspective
• Leases classified either as operating leases or finance leases
• Adoption of same criteria for non-cancellable lease as for lessee
• Factors addressed in AASB 117, pars 10–12
Finance leases can be further classified into:
• Leases involving manufacturers or dealers
• Direct finance leases
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–48
Lessor accounting for
direct financing leases
Direct financing lease
• A lease where the lessor provides the financial resources to
acquire the asset
• Lessor typically acquires the asset, giving the lessor legal
title, then enters a lease agreement to lease the asset to the
lessee, who subsequently controls the asset
• No sale is recorded
• Lessor derives income through periodic interest revenue
• Where risks and rewards of ownership are held by lessee, the
lessor substitutes lease receivable for the underlying asset
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–49
Lessor accounting for direct-financing
leases (cont.)
Direct financing lease (cont.)
AASB 117 (par. 36)
• Lessors are to recognise assets held under a finance lease in
their respective balance sheets and present them as a
receivable at an amount equal to the net investment in the
lease
Net investment in lease (AASB 117, par. 4)
The gross investment in the lease discounted at the interest
rate implicit in the lease
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–50
Lessor accounting for direct financing
leases (cont.)
Direct financing lease (cont.)
Gross investment in the lease
The aggregate of:
(a) the minimum lease payments receivable by the lessor under a
finance lease; and
(b) any unregulated residual value accruing to the lessor.
Interest earned by lessor over lease term
• Difference between fair value of leased asset and sum of the
undiscounted minimum lease payments and any unregulated
residual value
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–51
Lessor accounting for direct financing
leases (cont.)
Direct financing lease (cont.)
• Initial indirect costs incurred by lessor
–
Incremental costs that are directly attributable to negotiating and
arranging a lease, except for such costs incurred by manufacturer or
dealer lessors
– Includes commissions, legal fees, and costs associated with processing
new leases
– If material, are to be included in the lessor’s investment in the lease
(refer to AASB 117, par. 38)
Recovery of executory costs
Costs that are related specifically to the operation and maintenance of
the leased property, e.g. insurance, maintenance and repairs
– Should be treated as revenue by lessor in financial years in which
related costs are incurred
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–52
Lessor accounting for direct financing
leases (cont.)
Direct financing lease—Net vs gross method
• Either net method or gross method can be used to
record the lease
• Net method
–
–
Most commonly used
Lease receivable recorded at its present value and does
not use contra account (unearned interest revenue)
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–53
Lessor accounting for direct financing
leases (cont.)
Direct financing lease—Net vs gross method (cont.)
• Gross method
–
Lease receivable recorded at the sum of the undiscounted
minimum lease payments and the unguaranteed residual
– Unearned interest revenue also recorded (contra account) and
amortised to interest revenue over the lease term
– Unearned interest revenue is subtracted from lease receivable
to determined carrying (present value) of the lease receivable
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–54
Lessor accounting for direct financing
leases (cont.)
Net method
• To record initial acquisition of asset:
Dr
Asset
Cr Cash/Payables etc.
• To record lease receivable at inception:
Dr
Lease receivable
Cr Asset
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–55
Lessor accounting for direct financing
leases (cont.)
Net method (cont.)
• To record receipt of lease payment:
Dr
Cash
Cr Lease receivable
Cr Interest revenue
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–56
Lessor accounting for direct financing
leases (cont.)
Gross method
• To record initial acquisition of asset:
Dr
Asset
Cr Cash/Payables etc.
• To record lease receivable:
Dr
Lease receivable
Cr Asset
Cr Unearned interest revenue
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–57
Lessor accounting for direct financing
leases (cont.)
Gross method (cont.)
• To record receipt of lease payment:
Dr
Cash
Cr Lease receivable
Dr
Unearned interest revenue
Cr Interest revenue
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–58
Lessor accounting for direct financing
leases (cont.)
Lessor disclosure requirements for finance lease
AASB 117, par. 47
•
Lessors, in addition to meeting the requirements in AASB 132,
disclose the following for finance leases:
(a)
A reconciliation between the gross investment in the lease at the
balance sheet date, and present value of minimum lease payments
receivable at the balance sheet date. In addition, an entity shall
disclose the gross investment in the lease and the present value of
minimum lease payments receivable at the balance sheet date, for
each of the following periods:
(i)
not later than one year
(ii) later than one year and not later than five years
(iii) later than five years
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–59
Lessor accounting for direct financing
leases (cont.)
Lessor disclosure requirements for finance lease (cont.):
(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 recognised as income in the period
(f)
A general description of the lessor’s material leasing arrangements
Refer to Worked Example 10.6 on page 405—Accounting for
leases by lessor
(continues)
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10–60
Accounting for lessors that are manufacturers or
dealers of the leased asset
•
•
Where fair value of the property at the inception of the lease
differs from its cost to the lessor (dealer or manufacturer)
Represents a finance lease
•
Two parts of the transaction:
A sale with a resulting gain (fair value vs cost to
dealer/manufacturer)
2. A lease transaction that will provide interest revenue over the
period of the lease
1.
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–61
Accounting for lessors that are manufacturers or
dealers of the leased asset (cont.)
Lessor’s investment in lease accounted for in same manner
as direct financing lease:
–
Value of sale recorded as fair value of asset at date of sale
(equal to present value of minimum lease payments)
– Indirect costs (e.g. commissions, legal fees, etc.) accounted for
by lessor as a cost of sales in year in which transaction occurs—
not as part of net investment in lease receivable (AASB 117, par.
38)
– Lease rentals representing a recovery of executory costs (if
material) to be treated by lessor as revenue in year in which
costs incurred
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–62
Accounting for lessors that are manufacturers or
dealers of the leased asset (cont.)
Lessor’s journal entries for a lease involving a dealer
or manufacturer—Net method
• To record receipt of lease payment:
Dr Cash
Cr
Lease receivable
Cr
Interest revenue
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–63
Accounting for lessors that are manufacturers or
dealers of the leased asset (cont.)
Lessor’s journal entries for a lease involving a dealer or
manufacturer—Net method (cont.)
• To record sale and lease receivable:
Dr Lease receivable
Dr Cost of goods sold
Cr
Inventory
Cr
Sales
Cost of sales will represent the cost of the asset to the
lessor—assumed that asset being sold was part of the
inventory of the lessor
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–64
Accounting for lessors that are manufacturers or
dealers of the leased asset (cont.)
Lessor’s journal entries for a lease involving a dealer or
manufacturer—Gross method
• To record sale and lease receivable:
Dr
Lease receivable
Dr
Cost of goods sold
Cr
Inventory
Cr
Sales
Cr
Unearned interest revenue
Cost of sales represents the cost of the asset to the lessor—unearned
interest revenue represents the gross amount of interest to be earned
throughout the term of the lease
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–65
Accounting for lessors that are manufacturers or
dealers of the leased asset (cont.)
Lessor’s journal entries for a lease involving a dealer or
manufacturer—Gross method (cont.)
• To record receipt of lease payment:
Dr
Cash
Cr
Lease receivable
Dr
Unearned interest revenue
Cr
Interest revenue
Refer to Worked Example 10.7 on page 409—Example of lease
involving a dealer or manufacturer
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–66
Lessor accounting for
operating leases
•
•
•
Leased property accounted for as a non-current asset
Required to depreciate if a depreciable asset
Lease receipts treated as rental revenue
AASB 117 (par. 53)
The depreciation policy for depreciable leased assets is to be
consistent with the lessor’s normal depreciation policy for
similar assets, and depreciation is to be calculated in
accordance with AASB 116 and AASB 138
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–67
Leases involving land
and buildings
• Land is an asset with an indefinite life
• Risks and benefits of land cannot be transferred to
lessee unless the lease will, at completion, transfer
ownership or has a bargain purchase option
• Treated as operating lease unless reasonably
assured of transferring ownership
• Refer to AASB 117 (par. 14)
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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Leases involving land
and buildings (cont.)
•
•
•
Minimum lease payments must be allocated between land
and buildings in proportion to their relative fair values at lease
inception
If lease not assured of transferring ownership of land and
buildings at end of lease, lease payments allocated to land to
be treated as operating lease
Payments allocated to building (operating or finance lease)
will depend on whether lease transfers risks and benefits of
ownership to lessee (normal tests apply)
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–69
Leases involving land
and buildings (cont.)
•
Exception: Where fair value of land is immaterial in relation to the
fair value of total property, it may be treated as a unit for
classification purposes and so land component may be ignored
•
If lease then appears to transfer risks and benefits of ownership the
total lease for land and buildings may be treated as a finance lease
otherwise operating (refer to AASB 117, par. 17)
Refer to Worked Example 10.8 on page 412—Accounting by the
lessee for a lease involving land and buildings
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Lessee accounting for lease incentives under a
non-cancellable operating lease
Incentives by lessor
• May offer incentives to enter non-cancellable operating leases
(particularly for buildings)
–
Initial rent-free periods
– Financial assistance for fitting out offices
– Up-front cash incentives
– Financial assistance to terminate existing lease agreements
•
Lease incentives not specifically dealt with under AASB 117
(continues)
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10–71
Lessee accounting for lease incentives under a
non-cancellable operating lease (cont.)
Incentives by lessee
• Generally in exchange for benefits, lessee pays higher lease
payments than if no lease incentive were provided
• UIG Abstract 3 states that incentives are to be treated as
borrowings (liability), which will be repaid by the lessee as
part of future lease rentals
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–72
Implications for
accounting-based contracts
• Classification as finance rather than operating
lease will affect debt–asset constraints
• Introduction of accounting standards requiring
capitalisation of finance leases have negative
cash-flow effects on firms
• Negative cash-flow effects found to have negative
impact on security prices
Copyright  2005 McGraw-Hill Australia Pty Ltd
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Summary
• The chapter has addressed the treatment of
accounting for leases
• A major issue in accounting for leases is whether the
leased asset-related liability should appear on the
balance sheet of the lessee
• Leases are classified as either operating leases or
financial leases
(continues)
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Summary (cont.)
•
Finance lease
• Transfers the risks and rewards of ownership from the lessor
to the lessee
• The leased asset and lease liability must appear in the
balance sheet of the lessee
• Where the lease is capitalised (on balance sheet) the
amount to be capitalised is the present value of the minimum
lease payments or the fair value of the leased asset,
whichever is the lower
• Where the lessee has capitalised a lease, the lease
payments are to be apportioned between interest expense
and the repayment of the lease liability, and the lessee must
amortise the leased asset over its expected useful life to the
lessee
(continues)
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Summary (cont.)
•
Operating lease
– Does not transfer the risks and rewards of ownership to the
lessee
– No asset or liability is recognised in the accounts of the
lessee (unless periodic lease payments are made in
advance or in arrears)
– Periodic lease payments are treated as an expense in the
accounts of a lessee and as revenue in the accounts of the
lessor
(continues)
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–76
Summary (cont.)
•
From the perspective of the lessor
▪ Leases must be classified as either operating or
financing
▪ Finance leases can be further broken down into leases
involving dealers or manufacturers or direct finance
leases
▪ If a finance lease, the underlying asset is removed from
the balance sheet and the asset is replaced with a lease
receivable
▪ Periodic lease receipts from the lessee will be
apportioned between interest revenue and the
recoupment of the lease receivable
Copyright  2005 McGraw-Hill Australia Pty Ltd
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10–77