PAS 17: Leases
PAS 17: Leases
PAS 17: Leases
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The implicit interest rate in the lease is the discount rate that causes 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 that the lessee
would incur by borrowing funds to purchase the asset over a similar term
and similar security.
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.
(6.) If the lessee is entitled to cancel the lease, the lessor's losses associated with
the cancellation are borne by the 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 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 lower than market rent.
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 building 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 risks and rewards are transferred to the lessee
and the present value of the leased asset is 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
Deferred IDC
Cash
#
(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 to be obtained
from the asset by one or more users.
Useful life is the estimated remaining period, from the 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.
(4.) The present value of the minimum lease payments amounts to at least
substantially all of the fair value of the leased asset at the 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 practically determinable;
otherwise, the lessee's incremental borrowing rate must be used.
XX
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
Cash
XX
Unearned Rent Income XX
#
XX
XX
Cash
XX
Liability for rent deposit XX
#
XX
XX
Cash
Rent income
#
XX
XX
XX
(XX)
XX
XX
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, 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.
CITERIA
XX
Expense account
Cash
#
XX
XX
Interest
Expense
XX
(CV x
interest
rate)
At commencement
XX
At payment
Interest expense
Lease liability
Cash
XX
XX
#
(payment interest)
(CV amortization)
XX
XX
XX
XX
Depreciation expense
XX
Acc. Depreciation
XX
#
The accrued interest is a portion of the interest expense from the
commencement of the lease or from the last payment to the date of the next
payment.
Interest expense
XX
Interest payable
XX
#
AT ACTUAL PURCHASE OF 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 minus the
balance of the lease liability.
Carrying value of leased asset
Add: Any cash payment
XX
XX
(XX)
XX
Asset
XX
Lease Liability
XX
Acc. Depreciation
XX
Asset under finance lease
Cash
#
Lease liability
Cash
XX
#
XX
XX
XX
XX
(XX)
AT PAYMENT OF RENTAL. In this date, the lessee must apportion its payment
of rental - first to the finance cost and the remaining as payment for the
principal lease liability. An amortization table maybe necessary.
Payments
3-8
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
Any initial direct costs paid by the lessee must be recognized by the lessee as
part of the leased asset.
Date
Useful Life
BASIS OF DEPRECIATION
1-2
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 with the end of the reporting period.
Lease liability
XX
Loss on finance lease
XX
Acc. Depreciation
XX
Asset under finance lease
#
XX
XX
AT THE END OF THE LEASE 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 than 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
Sales price
Cash
XX
Unearned interest income XX
Lease receivable
Gain on finance lease
#
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 initial 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)
Cash
XX
Asset account (@FV)
XX
Lease receivable
#
XX
(XX)
XX
XX
Annual rental
XX
XX
XX
Annual rental
XX
Payments
Interest
income
Amortization
At commencement
At payment
Cash
Present Value
of Receivable
XX
XX
Lease receivable
#
(PV x
interest
rate)
XX
(payments interest)
(PV amortization)
Rent Income
#
XX
XX
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 of the
lease. Because the lease is accounted 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 charged, selling profit should be
restricted to that which would apply if a commercial rate of interest were
charged.
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. (same in direct-financing)
XX
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
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
Upon the receipt of the rental payment, the lessor will just credit its 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) of the leased asset is
greater than the amount guaranteed by the lessee, a gain on finance lease is
to be recognized.
XX
However, if the lessee has guaranteed the residual value of the leased
asset, the lessor will received cash payment from the lessee to compensate
the deficiency of the fair value and therefore, no more loss shall be
recognized.
XX
(XX)
XX
XX
XX
XX
XX
XX
(XX)
(XX)
AT THE END OF THE LEASE TERM. At end of the lease term, the lessor
will simply close all accounts related to the lease, but any difference
between the carrying value of the lease receivable and the fair value of the
asset shall be accounted for as gain or loss on finance lease.
XX
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
#
XX
XX
(XX)
XX
XX
(If the lessee does not guaranteed the residual value:)
XX
XX
(XX)
XX
XX
(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 transaction and the
carrying amount should be recognized immediately in the profit or
loss.
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 initial 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)
DISCLOSURES:
FOR LESSEES:
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) 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.