AC2101 S2 20132014 Seminar 4 Leases

5/26/2018 AC2101 S2 20132014 Seminar 4 Leases

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AC2101Accounting Recognition

and Measurement

Semester 2, AY 2013/2014

Seminar 4

Lease Accounting I


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Recap from Seminar 3

Comprehensive income as a bridge between economic

& accounting income

Presentation issues pertaining to

recycling/reclassification

Financial capital maintenance (nominal dollars)

concept

Assets: definition & general recognition criteria

Leases: a brief introduction

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Seminar 4 Agenda

- FRS 17 Technicalities

- Classification of Leases

- Operating LeasesLessee/Lessor

- Finance LeasesLessee/Lessor

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Bargain purchase option (BPO)

Bargain renewal option (BRO)

Lease term (incl. reasonably certain renewal period)

Minimum lease payments (MLP)

Annual lease payments (ALP): ordinary annuity or

annuity due

Residual value (RV): guaranteed vs unguaranteed

(note that only GRV is included in MLP)

Some Technicalities in FRS 17

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BPO

Bargain Purchase Option (BPO)

Option for lessee to purchase the asset at aprice that is expected to be sufficiently lower

than fair value at the date the option becomesexercisable

Reasonably certain, at the inception of the lease,

that the option will be exercised by the lessee

FRS 17 para 4

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BRO

Bargain Renewal Option (BRO)

Option for lessee to renew the lease over

periods in which the lease rentals aresignificantly lower than the expected market rate

Reasonably certain, at the inception of the lease,

that the option will be exercised by the lessee

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Lease Term

Lease Term

Non-cancellable lease term +

Further lease term under BRO or

Further lease term to exercise BPO

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What is the lease term?

Initial lease period= 5 yrs

RO

Normal renewal period= 2 yrs

81 2 3 4 5

0% 0% 0%0%0%

1. 2 years

2. 3 years

3. 5 years

4. 7 years5. 8 years


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BRO

Bargain renewal period= 3 yrs

91 2 3 4 5

0% 0% 0%0%0%

1. 2 years

2. 3 years

3. 5 years



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BPO


RO

Normal renewal period= 2 yrs

101 2 3 4 5

0% 0% 0%0%0%

1. 2 years

2. 3 years

3. 5 years



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MLPs

Minimum lease payments (MLPs) are payments overthe lease term that the lessee is or can be required to make

together with amounts guaranteed (FRS 17 para 4), i.e.

usually

Sum of Annual Lease Payments (ALPs) + BPO or Guaranteed Residual Value (GRV)

To Lessee: rep. future obligations for payments by the lessee

under the lease contract.To Lessor: rep. future economic benefits to the lessor under the

lease contract.

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ALPs

Pause and Think:Assume you are in the business of leasing printers. Id like to lease a

pr inter that yo u just bou ght for $200 over a 2-year lease. At the end

of th e 2 years, the ownership o f the pr inter wi l l be transferred to m e.

The effective interest rate youd like to earn is 10%. How would you

determ ine the ALP?

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ALP@Y2ALP@Y1

$200 = ALP/(1+r) + ALP/(1+r)2

$200 = ALP[1/(1+r) + 1/(1+r)2]

ALP = $200/[1/(1+r) + 1/(1+r)2]

ALP = $200/PV of annuity factor= $200/1.73554

= $115.23


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ALPs

Annual lease payments (ALPs): essentially a pricing decision

made by LESSOR!!!

= Fair value of the Asset at the start of lease term PV of est. recovery value at end of lease term

PV of annuity factor

Lessors estimated recovery value at end of lease term

BPO

GRV

unGRV

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Residual Value

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Residual value may be

a.Guaranteed(GRV),

By lessee, party related to lessee, or unrelated third

party

From the lesseespoint of view, GRV would be the

value guaranteed by lessee or a party related to lessee

From the lessorspoint of view, GRV would be thevalue guaranteed by lessee or a party related to lessee

or a third party unrelated to the lessor


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Residual Value

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Residual value may be

b. Unguaranteed(unGRV),

Is that portion of the residual value of the leased asset,

the realisation of which by the lessor is not assured, or

is guaranteed solely by a party RELATED to the lessor

c. Shared (SRV) (Not in syllabus) Proceeds from disposal shared by lessee & lessor in specified

ratio

Recall from earl ier:

Minimum lease payments (MLPs) -

Sum of Annual Lease Payments (ALPs) +

BPO or Guaranteed Residual Value (GRV)


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For lessor (R)a. MLPR= (Annual lease payments) + [GRVRor BPO]

b. GRVR= RV guaranteed by

Lessee, a party related to lessee OR a party unrelated to

lessor

For lessee (E)

a. MLPE= (Annual lease payments) + [GRVEor BPO]

b. GRVE= RV guaranteed by Lessee or a party related to lessee

Some Technicalities in FRS 17

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PV of Minimum lease payment (MLP)

=MLP discounted at

For lessor: implicit rate

For lessee: implicit rate or lessees

incremental borrowing rate, if implicit rate is

not known

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PV of MLPs


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Classification of Leases

Classification criteria (FRS 17 para 10):

1. End of lease: lessee gets asset?

(transfer of ownership)

2. Bargain purchase option (BPO)?

3. Most of useful life: lessee uses asset?

(leaseterm75% of useful life rule)

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Classification criteria (FRS 17 para 10):

4. PV of minimum lease payments (MLPs):

close to assets fair value?

(recovery of investment 90% rule)

5. Asset: specialised nature, only lessee canuse it?

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If any one of the classification criteria is met,

it is a finance lease.

See flowchart in p. 269 of NCKL

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Other Indicators of Substantial Transferof Ownership Risks & Rewards

1. Lessors losses borne by lessee upon lessees

cancellation

2. Gains/Losses from fluctuation of residual fair

value accrues to lessee

3. BRO exists

If any oneof the indicators is present, it is a finance lease.

FRS 17:11

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Operating Lease

An operating lease will be accounted for as if it is a rental

transaction

Refer to write-up on operating leases in seminar

outline

Take note of JEs for lessee & lessor!

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Accounting Operating Lease (Rental)

Lessors books

Dr Cash

Cr Rental income

Dr Depr expense

Cr Accum Depr

Lessees books

Dr Rental expense

Cr Cash

No depreciation charge

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Seminar Question

- Question 1

- Application of FRS 17

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Summary of Note on Operating Lease in the Seminar

Outline

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Summary for Operating Lease

Lessor Lessee

Balance Sheet Asset under lease=> Accumulated

Depreciation

No asset

Income

Statement

Rental Income,

Depreciation

Rental expense


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Finance Lease

A finance lease will be accounted for as iflessee buys

over the asset with financing provided for by lessor

Refer to write-up on finance leases in seminar outline

Take note of JEs for lessee & lessor!

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Finance Lease - Lessee

Lessee Lease asset

Capitalise: at Fair Value or if lower, the PV (MLPs)

May include Initial Direct Costs (i.e. costs that are

directly attributable to negotiating and arranging alease. )

Depreciation

Useful life (if there is reasonable certainty that the

lessee will obtain ownership) or lease term (ifotherwise)

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See FRS 17 paras 27, 28 for more details.


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FRS 17 Finance Lease for Lessee

27. A finance lease gives rise to depreciation expense for

depreciable assets as well as finance expense for each

accounting period. 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 FRS 16 Property, Plant andEquipment and FRS 38 Intangible Assets. If there is no

reasonable certainty that the lessee will obtain ownership by

the end of the lease term, the asset shall be fully depreciated

over the shorterof the lease term and its useful life.

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If it is a finance lease and the leasedassets title DOES NOT pass to lessee bythe end of the lease.

Lessee should depreciate leased

asset over?

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Usually the lease term

1 2 3 4

0% 0%0%0%

1. Leased assets useful life

2. Lease term

3. Shorter of useful life and lease term

4. Longer of useful life and lease term


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FRS 17 Finance Lease for Lessee

28. The depreciable amount of a leased asset is allocated to each

accounting period during the period of expected use on a

systematic basis consistent with the depreciation policy the

lessee adopts for depreciable assets that are owned. If there

is reasonable certainty that the lessee will obtain ownership

by the end of the lease term, the period of expected use isthe useful lifeof the asset; otherwisethe asset is depreciated

over the shorterof the lease term and its useful life.

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If it is a finance lease and the leasedassets title passes to lessee by the endof the lease.

Lessee should depreciate leased

asset over?

341 2 3 4

0% 0%0%0%

1. Leased assets useful life

2. Lease term

3. Shorter of useful life and lease term

4. Longer of useful life and lease term


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Finance Lease - Lessee

Lessee Lease payable

Also at Fair Value or if lower, PV (MLPs)

Interest expense

Usually using effective interest rate method (i.e.,amortization schedule)

Discount rate = lessors implicit interest rate if

known, otherwise, lessees incremental borrowing

rate

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See FRS 17 paras 20, 25 for more details.


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Accounting for Finance Lease

Lessors books Lessees books

At the start of the lease:

Dr Leased asset X

Cr Lease payable (X1)

Cr Cash/Payable (X2)

X= X1+X2

X1 = Lower[FV or PV(MLPs)]

X2 = Lessees initial direct costs*

During the lease:

Dr Lease payableDr Interest expense

Cr Cash (= ALP)

Dr Depreciation expense

Cr Accumulated Depreciation36*IDC = costs that are directly attributableto negotiating and arranging a lease.


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Finance Lease LessorMore Technicalities

Lessorrecords a LEASE RECEIVABLE@GrossInvestment (G)

Gross investment in the lease or G=

MLPs + unGRV

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Contractual benefits

during the leaseterm, includingBPO or GRV

Benefits afterlease term(risky)

Note that the MLPs and unGRV are UNdiscountedvalues.


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Finance Lease LessorMore Technicalities

Present Value of the Gross Investment (G) discounted at

the lessors implicit interest rate is the Net Investment

(N),

i.e. PV (G) = N

Hence, GN = GPV(G) = Unearned Interest

Income (I)

In other words, I = GPV(G)

Interest income- Usually amortised using effective interest rate

method.

No depreciation!

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Finance Lease - Lessor

Lessor Lease receivable

- Gross investmentin the lease (G)

Unearned interest income(I)

- Difference between G and PV(G)

Net investmentin the lease (N)

- G less I

- Equal to PV(G)- In armslength trans., equal to assetsFV

- Note Statement of Financial Position presentation

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Accounting for Finance Lease (Asset sale)

Lessorsbooks Lesseesbooks


Dr Leased asset X

Cr Lease payable (X1)

Cr Cash/Payable (X2)

X= X1+X2X1 = Lower[FV or PV(MLPs)]

X2 = Lessees initial direct costs*

During the lease:

Dr Lease payableDr Interest expense

Cr Cash (= ALP)

Dr Depreciation expense

Cr Accumulated Depreciation40

*IDC = costs that are directly attributable

to negotiating and arranging a lease.


Dr Lease receivable (=G)

Cr Asset (=N)

Cr Unearned interest income

During the lease:

Dr Cash (= ALP)

Cr Lease receivable

Dr Unearned interest income

Cr Interest income

No depreciation charge


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Seminar Question

- Question 2

- Application of FRS 17

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AC2101 S2 20132014 Seminar 4 Leases

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