LEASE ACCOUNTING (PAS 17/PFRS 16)

LEASE ACCOUNTING
According to PAS 17, paragraph 4, a lease is defined as 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.

Lease accounting
Lessor Lessee
Either operating lease or finance lease

CLASSIFICATION OF LEASE LESSEE LESSOR

OPERATING LEASE – All other lease that are *Recognition of rental *Recognition of rental
not accounted for as finance lease. A expense. income.
simple type of lease close to a simple rental
approach.

FINANCE LEASE – There is transfer of *In the nature of *In nature of sale of
substantially all of the risks and rewards purchase of leased leased asset.
incident to ownership of the asset. asset.

*Recognition of lease *Recognition of lease

payable. receivable.

DEFINITION OF TERMS

Lease term is the non-cancelable period for which the lessee has the right to use the underlying
asset together with a period of both the option to extend the lease if reasonably certain to
exercise and option to terminate the lease if reasonably certain not to exercise by the lessee.

Inception date of the lease is the earlier of the (1) date of the lease agreement and the (2) date
of commitment by the parties to the principal provisions of the lease.

Commencement date is the date from which the lessee is entitled to exercise the right to use the
leased asset and is the date of initial recognition of the lease,

Guaranteed residual value is the part of the residual value which is guaranteed by the lessee or
by a party related to the lessee, the amount of guarantee being the maximum amounts that
could in any event become payable.

Unguaranteed residual value is the part of the residual value the realization of which by the lessor
is not assured or is guaranteed by a party related to the lessor not by the lessee.

Executory costs are ownership expenses such as maintenance, taxes and insurance related to
the asset, and are expensed immediately as incurred.

Initial direct costs are those incurred in connection with the negotiation and securing the lease
arrangements. Usually being part of the cost or capitalizable cost of the leased asset.

Gross investment in the lease is the aggregate of the (1) minimum lease payments receivable by
the lessor under a finance lease and (2) any unguaranteed residual value accruing to the lessor.

Net investment in the lease is the discounted value of the gross investment in the lease using the
implicit interest rate.

Unearned finance income the difference between the gross investment and net investment.

Implicit interest rate is the discount rate applicable to the lease at the inception date used to
discount the (1) minimum lease payments and the (2) unguaranteed residual value to be equal
to the sum of the (a) fair value of the leased asset and (b) any initial direct costs of the lessor.

Incremental borrowing rate is the rate of interest that the lessee would have to pay for similar lease
and the one be used in the absence of the implicit interest rate.

PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]

 LEASE ACCOUNTING (PAS 17/PFRS 16)
ACCOUNTING FOR LEASE (PAS 17 versus PFRS 16)

PAS 17
LESSEE LESSOR
Lease contracts should be determined either Lease contracts should be determined either
as operating lease or finance lease. as operating lease or finance lease.
PFRS 16
LESSEE LESSOR
All lease contracts are classified and Lease contracts should be determined either
determined only as finance lease. as operating lease or finance lease.

Operating lease is applicable exceptionally

for short-term lease and low value lease.

ACCOUNTING FOR OPERATING LEASE (requires no transfer of the leased asset)

- on all types of assets (PAS 17)
- on low value assets and short-term leases, an accounting policy permitted (PFRS 16)

LESSEE LESSOR
To record purchase of asset.
Asset (e.g. Building) xxx
- No journal entry -
Cash/Other proper accounts xxx
To record the lease.
Rent expense xxx Cash xxx
Cash xxx Rent income xxx
To record refundable deposits, if any.
Rent deposit xxx Cash xxx
Cash xxx Liability for rental deposit xxx
To record lease bonus, if any.
Prepaid rent xxx Cash xxx
Cash xxx Unearned rent income xxx
To record repairs and maintenance incurred.
Repairs and maintenance xxx
- No journal entry -
Cash xxx
To record initial direct costs directly attributable to negotiating and arranging the lease.
Deferred initial direct costs xxx
- No journal entry -
Cash xxx
To record amortization of lease bonus.
Rent expense xxx Unearned rent income xxx
Prepaid rent xxx Rent income xxx
To record depreciation of asset.
Depreciation expense xxx
- No journal entry -
Accumulated depreciation xxx
To record amortization of deferred initial direct costs.
Amortization of IDC xxx
- No journal entry -
Deferred initial direct costs xxx

Unequal Rental Payments

- as required by PAS 17, paragraph 33, total cash payments for the lease shall be amortized
uniformly on the straight-line basis.

LESSEE LESSOR
To record the lease.
Rent expense xxx Cash xxx
Cash xxx Rent receivable xxx
Rent payable xxx Rent income xxx
To record the lease payments.
Rent expense xxx Cash xxx
Rent payable xxx Rent receivable xxx
Cash xxx Rent income xxx

PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]

 LEASE ACCOUNTING (PAS 17/PFRS 16)
ACCOUNTING FOR FINANCE LEASE–LESSEE

Criteria to consider as FINANCE LEASE under PAS 17

1. There is transfer of ownership of the leased asset from lessor to lessee at the end of lease term.
2. The lessee has bargain purchase option to be reasonably exercised.
3. The lease term is major part of the economic life of the leased asset. USA GAAP is 75%.
4. The present value of the minimum lease payments are substantially all of the fair value of the
asset. USA GAAP is 90%.
5. If the lease is specialized in nature.
6. If the lease is cancellable by the lessee and the loss on cancellation is borne by the lessor.

Cancellability of the FINANCE LEASE

1. Conceptually, a finance lease is non-cancellable in nature, being able to transfer risks and
rewards associated with ownership on the asset.

2. However, if it is cancellable, the following shall be observed:

a. if the option to cancel is likely to be exercise by the lessee, consider as operating lease.
b. if the option to cancel is likely to be exercise by the lessee and the loss on cancellation is to
be borne by the lessor, consider as financing lease.

PAS 17 PFRS 16
Cost of the Asset Cost of the Right-of-use Asset
The LOWER of fair value of the leased asset at The right-of-use asset shall be measured at
the inception of the lease or the present value cost at commencement date. This shall mean
of the minimum lease payments. the amount of initial measurement of the
lease liability, which is the present value of the
Plus, initial direct costs incurred by the lessee. lease payments.

Plus, estimated cost of dismantling, removing Plus, lease payments made to lessor at or
and restoring the underlying asset for which before commencement date, such as lease
the lessee has a present obligation. bonus, less any lease incentives received.

Plus, initial direct costs incurred by the lessee.

Plus, estimated cost of dismantling, removing

and restoring the underlying asset for which
the lessee has a present obligation.
Component of the lease liability
PAS 17 PFRS 16
The LOWER of fair value of the leased asset at a. Fixed lease payments
the inception of the lease or the present value b. Variable lease payments
of the minimum lease payments. c. Exercise price of purchase option, if the
lessee is reasonable certain to exercise
Minimum lease payments shall mean: d. Amount expected to be paid by the lessee
a. Rental payments under a guaranteed residual value
b. Any bargain purchase option payments e. Termination penalties if there is termination
c. Any guaranteed residual value in the options
absence of bargain purchase option

PAS 17 PFRS 16
To record the lease.
Asset (e.g. Building) xxx Right-of-use Asset (e.g. Building) xxx
Lease liability xxx Lease liability xxx
To record depreciation related to the asset.
Depreciation expense xxx Depreciation expense xxx
Accumulated depreciation xxx Accumulated depreciation xxx
To record annual fixed payments.
Lease payable xxx Lease payable xxx
Interest expense xxx Interest expense xxx
Cash xxx Cash xxx

PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]

 LEASE ACCOUNTING (PAS 17/PFRS 16)
ACCOUNTING FOR THE LEASED ASSET

PAS 17 PFRS 16
Initial Measurement
Cost of the Asset Cost of the Right-of-use Asset
The LOWER of fair value of the leased asset at The right-of-use asset shall be measured at
the inception of the lease or the present value cost at commencement date. This shall mean
of the minimum lease payments. the amount of initial measurement of the
lease liability, which is the present value of the
Plus, initial direct costs incurred by the lessee. lease payments.

Plus, estimated cost of dismantling, removing Plus, lease payments made to lessor at or
and restoring the underlying asset for which before commencement date, such as lease
the lessee has a present obligation. bonus, less any lease incentives received.

Plus, initial direct costs incurred by the lessee.

Plus, estimated cost of dismantling, removing

and restoring the underlying asset for which
the lessee has a present obligation.
Subsequent Measurement
Cost of the Asset Cost of the Right-of-use Asset
Applying the cost model. Applying the cost model.

That is, the initial cost of the asset less any That is, the initial cost of the right-of-use asset
accumulated depreciation and less any less any accumulated depreciation and less
accumulated impairment losses plus/minus any accumulated impairment losses
any adjustment for any remeasurement of the plus/minus any adjustment for any
lease liability. remeasurement of the lease liability.

If the asset/right-of-use asset qualifies as an investment property accounted for under fair value
model under PAS 40, the same rules under PAS 40 shall apply.

If the asset/right-of-use asset qualifies as a PPE accounted for under the revaluation model of
PAS 16, the same rules under PAS 16 shall apply.

Depreciation of the Leased Asset

Cost of the Asset Cost of the Right-of-use Asset
If there is a reasonable certainty that the If there is a reasonable certainty that the
ownership of the leased asset will transfer to ownership of the leased asset will transfer to
the lessee at the end of lease term, meaning the lessee at the end of lease term, meaning
under transfer of ownership and bargain under transfer of ownership and bargain
purchase option criteria, depreciation is purchase option criteria, depreciation is
based on asset’s useful life. based on asset’s useful life.

If only under the major part or 75% and If there is no reasonable certainty of transfer of
substantially all or 90% criteria, depreciation is ownership over the asset, depreciation is
based on the SHORTER of the lease term or based on the SHORTER of the lease term or
useful life of the asset. useful life of the asset.

ACCOUNTING FOR THE LEASE LIABILITY

Component of the lease liability – Initial Measurement

PAS 17 PFRS 16
The LOWER of fair value of the leased asset at Present value of all payments:
the inception of the lease or the present value a. Fixed lease payments
of the minimum lease payments. b. Variable lease payments
c. Exercise price of purchase option, if the
Minimum lease payments shall mean: lessee is reasonable certain to exercise
a. Rental payments d. Amount expected to be paid by the lessee
b. Any bargain purchase option payments under a guaranteed residual value
c. Any guaranteed residual value in the e. Termination penalties if there is termination
absence of bargain purchase option options
PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]
 LEASE ACCOUNTING (PAS 17/PFRS 16)
The lease payments should be discounted using the implicit interest rate for the lease if the same
is determinable. Otherwise, use the lessee’s incremental borrowing rate in the absence of the
implicit interest rate.

Subsequent Measurement
PAS 17 PFRS 16
At amortized cost accounted using the effective interest method of amortization under PFRS 9.

ACCOUNTING FOR FINANCE LEASE–LESSOR

PAS 17 PFRS 16
To record the lease.
Lease receivable xxx Lease receivable xxx
Asset xxx Asset xxx
Unearned interest income xxx Unearned interest income xxx
To record annual lease collections.
Cash xxx Cash xxx
Lease receivable xxx Lease receivable xxx
To record amortization of unearned interest income.
Unearned interest income xxx Unearned interest income xxx
Interest income xxx Interest income xxx

Specific Considerations and Computations

Direct Financing Lease – Normal:

Gross investment in the lease = Total gross lease payments xxx

Net investment in the lease = Present value of the gross lease payments xxx

Unearned interest income:

Gross investment in the lease xxx
Net investment in the lease xxx
xxx

Carrying value of the lease receivable:

Lease receivable xxx
Less: Unearned interest income (xxx)
xxx

Direct Financing Lease – with Initial Direct Cost:

Gross investment in the lease = Total gross lease payments xxx

Net investment in the lease:

Cost of the leased asset which is the present value of the gross lease payments xxx
Add: Initial direct cost xxx
xxx

Unearned interest income:

Gross investment in the lease xxx
Net investment in the lease xxx
xxx

Carrying value of the lease receivable:

Lease receivable xxx
Less: Unearned interest income (xxx)
xxx

PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]

 LEASE ACCOUNTING (PAS 17/PFRS 16)
Direct Financing Lease – with Residual Value:

Gross investment in the lease:

Total gross lease payments xxx
Add: Residual value, whether guaranteed or unguaranteed xxx
xxx

Net investment in the lease:

Cost of the leased asset which is the present value of the gross lease payments xxx
Less: Present value of the residual value (xxx)
xxx

Unearned interest income:

Gross investment in the lease xxx
Net investment in the lease xxx
xxx

Carrying value of the lease receivable:

Lease receivable xxx
Less: Unearned interest income (xxx)
xxx

Annual lease payments/rentals:

Cost of the leased asset which is the present value of the gross lease payments xxx
Less: Present value of the residual value (xxx)
Net investment in the lease xxx
Divided by: Present value multiplier/factor xxx
xxx

PAS 17 PFRS 16
When the lease expires and there is a residual value whether guaranteed or unguaranteed.
Asset xxx Asset xxx
Lease receivable xxx Lease receivable xxx

Residual Value is GREATER than the Fair Value of the Asset upon expiration of the finance lease.

Guaranteed Unguaranteed
Cash xxx Loss on finance lease xxx
Asset xxx Asset xxx
Lease receivable xxx Lease receivable xxx

ACCOUNTING FOR SALES-TYPE LEASE BY LESSOR

Sales-Type Lease – Normal:

Gross investment in the lease = Total gross lease payments xxx

Net investment in the lease = Present value of the gross lease payments xxx

Unearned interest income:

Gross investment in the lease xxx
Net investment in the lease xxx
xxx

Sales/Selling Price
Fair value of the asset xxx
Present value of the lease payments xxx
LOWER xxx

Cost of Sale/Cost of Goods Sold = Cost of the Asset provided xxx

PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]

 LEASE ACCOUNTING (PAS 17/PFRS 16)
Gross Profit on Sale
Sales/Selling Price xxx
Less: Cost of Sale/Cost of Goods Sold (xxx)
xxx

Sales-Type Lease – with Initial Direct Costs:

Gross investment in the lease = Total gross lease payments xxx

Net investment in the lease = Present value of the gross lease payments xxx

Unearned interest income:

Gross investment in the lease xxx
Net investment in the lease xxx
xxx

Sales/Selling Price
Fair value of the asset xxx
Present value of the lease payments xxx
LOWER xxx

Cost of Sale/Cost of Goods Sold

Cost of the Asset provided xxx
Initial direct costs xxx
xxx

Gross Profit on Sale

Sales/Selling Price xxx
Less: Cost of Sale/Cost of Goods Sold (xxx)
xxx

Sales-Type Lease – with Guaranteed Residual Value:

Gross investment in the lease:

Total gross lease payments xxx
Add: Residual value, guaranteed xxx
xxx

Net investment in the lease:

Present value of the gross lease payments xxx
Add: Present value of the residual value, guaranteed (xxx)
xxx

Unearned interest income:

Gross investment in the lease xxx
Net investment in the lease xxx
xxx

Sales/Selling Price = Net investment in the lease xxx

Cost of Sale/Cost of Goods Sold

Cost of the Asset provided xxx
Initial direct costs, if any xxx
xxx

Gross Profit on Sale

Sales/Selling Price xxx
Less: Cost of Sale/Cost of Goods Sold (xxx)
xxx

The initial direct costs are charged directly to cost of sale/cost of goods sold account.

PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]

 LEASE ACCOUNTING (PAS 17/PFRS 16)
Sales-Type Lease – with Unguaranteed Residual Value:

Gross investment in the lease:

Total gross lease payments xxx
Add: Residual value, unguaranteed xxx
xxx

Net investment in the lease:

Present value of the gross lease payments xxx
Add: Present value of the residual value, unguaranteed (xxx)
xxx

Unearned interest income:

Gross investment in the lease xxx
Net investment in the lease xxx
xxx

Sales/Selling Price = Present value of the gross lease payments xxx

Cost of Sale/Cost of Goods Sold

Cost of the Asset provided xxx
Add: Initial direct costs, if any xxx
Less: Present value of the residual value, unguaranteed (xxx)
xxx

Gross Profit on Sale

Sales/Selling Price xxx
Less: Cost of Sale/Cost of Goods Sold (xxx)
xxx

The initial direct costs are charged directly to cost of sale/cost of goods sold account.

Whether the residual value is guaranteed or unguaranteed, the resulting gross profit is the same.

Sales-Type Lease – with Purchase Option:

Gross investment in the lease:

Total gross lease payments xxx
Add: Purchase option xxx
xxx

Net investment in the lease:

Present value of the gross lease payments xxx
Add: Present value of the purchase option (xxx)
xxx

Unearned interest income:

Gross investment in the lease xxx
Net investment in the lease xxx
xxx

Sales/Selling Price = Net investment in the lease xxx

Cost of Sale/Cost of Goods Sold

Cost of the Asset provided xxx
Indirect costs xxx
xxx

Gross Profit on Sale

Sales/Selling Price xxx
Less: Cost of Sale/Cost of Goods Sold (xxx)
xxx

The initial direct costs are charged directly to cost of sale/cost of goods sold account.
PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]
 LEASE ACCOUNTING (PAS 17/PFRS 16)
ACCOUNTING FOR SALE-AND-LEASEBACK
- happens when there is a sale of an asset by a selling company to a buying company with the
simultaneous leaseback by the selling company from the buying company of the asset sold.
- there is no physical transfer of asset though the buying company is the new owner of the asset.

Sale price EQUALS Fair Value of the Asset:

Measurement of Lease Liability

- the leaseback is accounted as finance lease.
- present value of the lease liability accounted using the effective interest method.

Measurement of Right-of-use Asset

- carrying amount of the asset x (present value of the lease liability ÷ sale price)

Recognition of Gain or Loss

- gain or loss that pertains to the right retained by the seller-lessee is not recognized
- gain or loss that pertains to the right transferred to the buyer-lessor is recognized

- right retained by the seller-lessee equals to the present value of the lease liability

Sales price at fair value xxx

Less: Carrying amount of the asset (xxx)
Total gain or loss xxx

Sales price at fair value xxx

Less: Right retained by the seller-lessee (xxx)
Right transferred to the buyer-lessor xxx

Total gain or loss xxx

Multiplied by: (right retained/sales price at fair value) xxx
Gain or loss not to be recognized xxx
Gain or loss to be recognized (work back) xxx
Total gain or loss xxx

Sale price ABOVE Fair Value of the Asset:

- here, the seller-lessee shall make adjustments to equate the sales price equal to fair value.

Measurement of Lease Liability

- the leaseback is accounted as finance lease.
- present value of the lease liability accounted using the effective interest method.

Measurement of Right-of-use Asset

- carrying amount of the asset x (present value of the lease liability minus additional financing ÷
sale price equal to fair value of the asset or simply the fair value of the asset)

Recognition of Gain or Loss

- gain or loss should be based on the adjusted amounts
- gain or loss that pertains to the right retained by the seller-lessee is not recognized
- gain or loss that pertains to the right transferred to the buyer-lessor is recognized

- right retained by the seller-lessee equals to the present value of the lease liability excluding the
additional financing

Sales price xxx

Fair value of the asset xxx
Additional financing/Excess sale price over fair value xxx

Present value of the lease payments xxx

Less: Additional financing (xxx)
Present value of the lease payments related to rentals/Adjusted lease liability xxx

PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]

 LEASE ACCOUNTING (PAS 17/PFRS 16)
Sale price equal to fair value of the asset or simply the fair value of the asset xxx
Less: Carrying amount of the asset (xxx)
Total gain or loss, adjusted xxx

Sale price equal to fair value of the asset or simply the fair value of the asset xxx
Less: Right retained by the seller-lessee (xxx)
Right transferred to the buyer-lessor xxx

Total gain or loss, adjusted xxx

Multiplied by: (right retained/sales price at fair value) xxx
Gain or loss not to be recognized xxx
Gain or loss to be recognized (work back) xxx
Total gain or loss, adjusted xxx

Sale price BELOW Fair Value of the Asset:

- here, the seller-lessee shall make adjustments to equate the sales price equal to fair value.

Measurement of Lease Liability

- the leaseback is accounted as finance lease.
- present value of the lease liability accounted using the effective interest method.

Measurement of Right-of-use Asset

- carrying amount of the asset x (present value of the lease liability plus prepayments ÷ sale price
equal to fair value of the asset or simply the fair value of the asset)

Recognition of Gain or Loss

- gain or loss should be based on the adjusted amounts
- gain or loss that pertains to the right retained by the seller-lessee is not recognized
- gain or loss that pertains to the right transferred to the buyer-lessor is recognized

- right retained by the seller-lessee equals to the present value of the lease liability including the
prepayments

Sales price xxx

Fair value of the asset xxx
Prepayments/Excess fair value over sale price xxx

Present value of the lease payments xxx

Add: prepayments xxx
Total lease liability/Adjusted lease liability xxx

Sale price equal to fair value of the asset or simply the fair value of the asset xxx
Less: Carrying amount of the asset (xxx)
Total gain or loss, adjusted xxx

Sale price equal to fair value of the asset or simply the fair value of the asset xxx
Less: Right retained by the seller-lessee (xxx)
Right transferred to the buyer-lessor xxx

Total gain or loss, adjusted xxx

Multiplied by: (right retained/sales price at fair value) xxx
Gain or loss not to be recognized xxx
Gain or loss to be recognized (work back) xxx
Total gain or loss, adjusted xxx

PREPARED BY: REMI MARTIN R. GABON, CPA / [email protected]