2. • Introduction – Lease
• Types of Leases
• Method of determining a Lease
• Accounting for Lessee and Lessor
(i) Finance Lease
(ii) Operating Lease
• Examples
Content
3. 1. Introduction
IFRS – Certificate
• A lease is an agreement whereby the lessor conveys to the lessee, in return for a
payment of series of payment, the right to use an asset for an agreed period of
time.
A lease is:
Right to use property over a period of time
Lessor remains legal owner of the property
Lessee pays a fee to use the property over time
At the end of the lease term, the lessee has 3 options:
Purchase the equipment
Re-lease the equipment
Return the equipment to the lessor
For accounting purposes, leases are classified as finance leases or operating leases.
• Financing lease — used to finance equipment for the major part of its useful
life, when there is a reasonable assurance that the lessee will obtain
ownership of the equipment by the end of the lease term
• Operating lease — used to finance equipment for less than its useful life, and
at the end of the lease term the lessee can return the equipment to the lessor
without further obligation.
4. Classification of Lease
Finance Lease
Substantially all the risks
and rewards incidental to
ownership are transferred
Operating Lease
Substantially all the risks
and rewards are not
transferred
5. Meaning of Finance Lease:- it is the agreement by which risk and reward incidental to
ownership are transferred by lessor to lessee. In addition to definition at least one out
of five condition given below must be satisfied for the lease to become finance lease.
Meaning of operating Lease :- It is a lease other than a finance lease.
Lease transfer ownership of asset to lessee by end of lease term.
Lease has the option to purchase the asset at a price that is expected to be
sufficiently lower than fair value of asset at the date of option become
exercisable.
Lease assets are of such specialise nature that only the lessee can use them
without modification
Lease term is for major part of economic life of asset, even if not transferred.
At inception of lease, parent value of minimum lease payment (MLP)amounts
to at least substantially all of fair value of the leased asset.
6. Yes No
Operating Lease
Transfers title and rewards
incidental to ownership to lessee
Transfers title of
ownership to lessee
Does not transfer title of
ownership to lessee
Follow s principle of substance
over form
Finance Lease
Determine of the interest portion and the capital portion of the lease installment
The interest portion
The Capital portion
The Actuarial method:-
1. At the inception of the lease ( when the lease starts) the lessor is credited with an
amount equal to the fair value of the asset.
2. Any deposit paid to the lessor is then deducted from this amount.
3. The amount of capital repaid is deducted from the credit balance of the lessor’s
account every time a lease rental is paid.
4. The interest portion is calculated by applying the rate of interest to the balance in
lessor’s account each year (reducing balance method) .
7. Finance Lease
Asset Acquired
Reflect in
SOFP
( Balance
Sheet)
Depreciation
Lease Rentals
Paid
Interest
Portion
Capital
Repayment
Charge to
SOCI
(Income
Statement
Recognise
Asset
Reduced
balanced of
asset
Charged to
SOCI
Reduce
amount due
to lessor
Recognize
amount due
to lessor
8. (i) Assets on lease Accounts Dr. xxx
To Lessor A/c xxx
The journal entries to record the lease payment are ( inclusive of both the interest and capital
repayment portion)
(i) Lessor Dr. xxx
Cash/Bank xxx
(Being the total rental paid to the Lessor)
For Recording the interest:-
(ii) Lease Interest Dr. xxx
Lessor xxx
(Being the interest accrued on the total lease amount outstanding)
Example—Finance lease
•On 1/1/2001 enter into 5-yr non-cancellable lease over a machine.
•Machine’s cash cost = $100,000, economic life = 10 yrs and residual value = 0.
•Annual lease payments on 31/12; 4 × 23,000 & 23,539 at end of yr 5 when ownership
transfers to the lessee.
•The interest rate implicit in the lease is 5% p.a. which approximates lessee’s incremental
borrowing rate.
Required:- Spilt the lease rental payments into the interest and capital portions, by using
the actuarial method.
Entries in the book of Lessee:-
10. Finance Lease
Asset Transferred
Derecognise
Leased assets
Recognise
Receivables
Lease Rental Received
Capital
Repayment
Interest Portion
Recognise in SOCI
Revised Balance
receivable from
lessee
Reduce from
Amount
Receivable from
Lessee
11. IAS 17 require the release asset to be recognised in the lessor’s (balance sheet) as a
receivable and not as a fixed asset.
(i) The journal entry for recording this transaction is:
Receivable ( Lessee) Dr. xxx
To Fixed Asset xxx
(Being asset transferred by a finance lease)
(ii) The amount to be recognised is the present value of minimum lease payment :
Cash / Bank Dr. xxx
To Lessee xxx
(Being the total lease installment received from the lessee.)
(iii) For recording the interest:
Lessee Dr. xxx
To Lease interest received xxx
(The lease rental payment is spilt into the capital portion and the interest portion)
Entries in the book of Lessor:-
12. 1. The leased asset remains in the statement of financial position of the lessor.
2. Operating lease payments are usually recognised in profit or loss (SOCI) on a straight-line basis.
3. From the perspective of the lessee, if payments are subject to escalation, straight-line recognition is
profit or loss may give rise to a liability on the SOFP.
4. The liability reduce as future payments are made.
IFRS – Certificate
Accounting for Lessee/Lessor for Assets acquire under Operating Lease
Operating Lease
Charged to P & L A/c (SOCI)
Lease rentals paid
Not shown as fixed asset in
the balance sheet (SOFP)
Asset Used
Lease rental Dr. xxx
To Bank A/c xxx
(Being Amount Paid)
P/L (SOCI) A/c Dr. xxx
To Rental A/c
( Being Amount Transfer)
13. Ex 1: On 01.01.2001 A entered into a 5-year on-cancellable
operating lease over a building.
Rentals 2001–2004 = 0. Rental 2005 = 5,000.
Ex 2: Same as Ex 1 except lessor agrees to pay the lessee’s
relocation costs (i.e. 500) as an incentive to the lessee for entering
into the new lease
Ex 3: Operating lease payments increase by expected CPI (10%
p.a.) to compensate the lessor for expected inflation.
2001 = 1,000; 2002 = 1,100; 2003 = 1,210; etc.
Examples—operating leases
IFRS – Certificate
14. following entries are journalised:-
(i) Bank A/c Dr. Xxx
To Lease rental xxx
(Being amount received)
(ii) Rental A/c Dr. Xxx
To P & L (SOCI) A/c xxx
( Being amount transferred)
Note 1: Amount in P&L is recorded on straight line basis.
Note 2: Difference between SLM and actual receipt will be considered as rent receivable.
Accounting for Lessee/Lessor for Assets acquire under Operating Lease
Operating Lease
Credited to P & L A/c
Lease rentals paid
Reflected as fixed asset in the
balance sheet (SOFP)
Asset used
15. Example:- Nature of lease is operating lease rentals.
1st year $ 10,000 2nd year $20,000 3rd year $30,000
Pass the journal entry in the book of lessor .
Ans. SLM = (10000+20000+30000)/3 = $20,000
1st year
(i) Bank a/c Dr. $10,000
To Lease Rental $10,000
(ii) Lease rental a/c Dr. $10,000
Receivable Rent Dr. $10,000
To P&L (SOCI) a/c $20,000
2nd year
(i) Bank a/c Dr. $20,000
To Lease Rental a/c $20,000
(ii) Lease Rental a/c Dr. $20,000
To P&L (SOCI) a/c $20,000
3rd year
(i) Bank A/c Dr. $30,000
To Lease Rental $30,000
(ii) Lease rental A/c Dr. $30,000
To P&L (SOCI) A/c $20,000
To Receivable rent $10,000
