What's the difference between Finance lease vs Operating lease?[IFRS 16 - ACCA Video Lectures by Https://tuonthi.com]

1. “LESSOR” ACCOUNTING
ACCA
Strategic Business Reporting
IFRS 16 LEASES - PART 4
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2. THE
GENERAL APPROACH
TO LESSOR ACCOUNTING
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3. • Finance Leases
• Operating Leases
2 types of leases:
Transfers substantially all the
risks and rewards incidental to
ownership of an underlying asset

4. (I) The lease transfers ownership to the lessee by the
end of the lease term
5 examples of a Finance lease

5. (II) The lessee has the option to purchase at a price
sufficiently lower than Fair value at the exercise date
5 examples of a Finance lease

6. (III) The lease term is for a major part of the economic
life of the underlying asset even if title is not
transferred
5 examples of a Finance lease

7. (IV) The present value of the lease payments at the
inception date amounts to at least substantially all of
the fair value of the underlying asset
5 examples of a Finance lease

8. (V) The underlying asset is of such specialised nature
that only the lessee can use it without major
modifications
5 examples of a Finance lease

9. • Any losses on cancellation are borne by the lessee
3 situations which could lead to a finance lease
•Gains or losses on changes in residual value accrue to
the lessee
•Continue to lease for a 2nd term at a rent substantially
lower than market rent

10. Finance
Lease
Operating
Lease

11. HOW TO ACCOUNT
FOR A FINANCE LEASE
UNDER IFRS 16 ?
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12. General principles
• De-recognizes the underlying asset
• Recognizes the lease receivable
• Recognizes the finance income over the lease term

13. Entry DEBIT Account CREDIT Account
[1]
Lease Receivable
(Net investment in the lease)
PPE
(Carrying amount of the underlying asset)
COGs
(Carrying amount - PV of unguaranteed
residual value)
Revenue
(FV or PV of lease payments if lower)
[2]
Lease Receivable
(Outstanding balance * % Interest)
Finance Income
[3] Cash Lease Receivable

14. Lease Receivable = The net investment in the lease
The lease payments receivable by a lessor
Any unguaranteed residual value
Any initial direct costs
The Present Value
(discounted at the interest
rate implicit)

15. EXAMPLE 1 - FINANCE LEASE
•1.1.20X1: A Co (lessor) enters into a 5 year lease contract with B Co
•Annual lease payments of $20,000 are made at year end
•Fair value: $95,000 & Carrying amount: $90,000
•Economic useful life of the equipment: 7 years
•The estimated residual value: $25,000
•In which $15,000 is guaranteed by B Co
•The interest rate implicit in the lease: 8.66%

16. Step 1. Calculate the net investment in the lease
Term Date Payment Discount factor Present value
1 31/12/20X1 20,000 0.9205 18,410
2 31/12/20X2 20,000 0.8471 16,943
3 31/12/20X3 20,000 0.7796 15,593
4 31/12/20X4 20,000 0.7173 14,347
5 31/12/20X5 20,000 0.6602 13,203
5 31/12/20X5 15,000 0.6602 9,902
5 31/12/20X5 10,000 0.6602 6,602
Total 95,000
88,398

17. Step 2. Initial recognition
Debit Credit
Lease Receivable: 95,000 PPE: 90,000
COGs: 83,398 Revenue: 88,398

18. Step 3. Calculate interest income
Term Opening date Interest income Payment Closing date
20X1 95,000 8,227 -20,000 83,227
20X2 83,227 7,207 -20,000 70,434
20X3 70,434 6,100 -20,000 56,534
20X4 56,534 4,896 -20,000 41,430
20X5 41,430 3,570 -20,000 25,000

19. Step 4. Subsequent recognition
Entry DEBIT Account CREDIT Account Amount
[3] Lease Receivable Interest income 8,227
[4] Cash Lease Receivable 20,000

20. HOW TO ACCOUNT
FOR AN OPERATING LEASE
UNDER IFRS 16 ?
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21. General principles
•Keeps recognizing the leased asset in BS
•Lease income shall be recognized as an income on a
straight-line basis over the lease term

22. EXAMPLE 2 - OPERATING LEASE
•A Co enters into a 3-year lease agreement for its motor vehicles
•Customer decides how to use the vehicle within certain limitations
•The maximum mileage is 10,000 miles/year without penalty
•A Co is responsible for the maintenance
•The vehicle cannot be modified in any way
•At the end, the customer can purchase at a price > market price
•If the vehicle is returned, A Co will then sell on to the public

23. Step 1. Classify the contract into finance lease or operating lease
Step 2. Explain how the lease should be accounted for
•What is a finance lease? a operating lease?
•Analyze information to make a conclusion
•Initial recognition
•Subsequent recognition

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