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LKAS 17
ORIENTATION
Objective Scope Definition Classification of Leases Finance Lease Operating Lease Finance Leases and Operating Leases Calculations Sale and lease back Disclosures
OBJECTIVE
The objective of this Standard
is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to leases.
Where can this stand apply?
Where shall not be applied?
DEFINITION OF A LEASE
Finance lease
Operating lease
A lease is an 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
FINANCE LEASES V OPERATING LEASES
A lease is a finance lease if it transfers substantially all the risks and rewards incident to ownership
A lease is an operating lease if it does not transfer substantially all the risks and rewards incident to ownership
Finance Lease Operating Lease
Substance over Form
RISKS AND REWARDS INCIDENT TO OWNERSHIP
Losses from idle capacity
Technological obsolescence
Changes in value due to changing economic conditions etc.
Expectation of service potential or profitable operation over the asset’s economic life
Gain from appreciation in value
Realisation of a residual value etc.
Risks Rewards
FINANCE LEASE OR OPERATING LEASE? (4) Conclude on whether
substantially all the risks and rewards have been transferred from the lessor to the lessee
(1) Identify the business purpose behind the lease and its economic impact together with the economic issues at the end of the lease term
(2) Determine the lease term
(3) Determine the net present value (NPV) of the minimum lease payments
Cancellation provisions
Rights and obligations at end of lease
Renewal options
FINANCE LEASE OR OPERATING LEASE?
Examples of situations which would normally lead to a lease being classified as a finance lease: The lessor transfers ownership of the asset to the
lessee at the end of the lease term
The lessee has the option to purchase the asset at a price, which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised
FINANCE LEASE OR OPERATING LEASE?
Examples of situations which would normally lead to a lease being classified as a finance lease (cont’d): The lease term is for the major part of the economic
life of the asset even if title is not transferred The leased assets are of a specialised nature such
that only the lessee can use them without major modifications being made
The leased assets cannot be easily replaced At the inception of the lease, the present value of
the minimum lease payments (MLP) amounts to at least substantially all of the fair value of the leased asset
FINANCE LEASE OR OPERATING LEASE?
Other indicators which individually or in combination could also lead to a lease being classified as a finance lease: If the lessee can cancel the lease, the lessor’s
losses associated with the cancellation are borne by the lessee
The lessee bears gains/losses from changes in the fair value of the residual
The lessee has the ability to continue the lease for a secondary period at a rate which is substantially lower than market rate
ACCOUNTING FOR FINANCE LEASE
FINANCE LEASE – ACCOUNTING BY LESSEE
Substance of the transaction should be considered. At the beginning of the lease term, the lessee
recognizes, The leased asset and The obligation to make lease payments as
a liability The asset and liability are measured at the lower
of The fair value of the asset The present value of the minimum lease
payments
FINANCE LEASE – ACCOUNTING BY LESSEE CONT..
Lease payments are split between finance charge and the repayment of the outstanding liability.
The depreciation policy for assets held under finance leases should be consistent with that for owned assets. If the lessee will obtain ownership of the asset
at the end of the lease, depreciation is made over the useful life of the asset.
Otherwise the asset should be depreciated over the shorter of the lease term or the life of the asset.
DOUBLE ENTRIES IN THE BOOKS OF THE LESSEE – FINANCE LEASE
Recognize the assetNon-Current asset DrLessor Cr
Lease rental repaymentLessor DrCash/ Bank Cr
Annual InterestInterest Expense (P&L) DrLessor Cr
DOUBLE ENTRIES IN THE BOOKS OF THE LESSOR – FINANCE LEASE
Asset transferredReceivable DrNon-current asset Cr
For the lease installment receivedCash/Bank DrLessee Cr
For the interestLessee DrInterest income Cr
OPERATING LEASE
DEFINITION
An operating lease is a lease other than finance lease
Lease that does not transfer substantially all of the risks and rewards to the lessee.
LessorRight to use asset
Lessee
Asset
OPERATING LEASE – ACCOUNTING BY LESSEE / LESSOR
Lessee LessorStatement of financial position
Prepaid/accrued lease rental payable
Leased assetAccrued/deferred lease rental receivable
Statement of comprehensive income
Lease rental expense
Depreciation expense
Lease rental income
ACCOUNTING BY LESSEE
An asset is not recognized Rental under operating lease are charged to
the income statement on a straight line basis over the term of lease, unless another systematic and rational basis is more appropriate.
Any difference between amount charged and amounts paid will be prepayments or accruals.
ACCOUNTING BY LESSOR
Lease income from operating leases shall be recognized in income on straight line basis over the lease term, Unless another systematic basis is more representative of the time pattern in which use benefit derived from the leased asset diminished.
The depreciation policy for depreciable leased assets shall be consistent with the lessor’s normal depreciation policy for similar assets and depreciation shall be calculated in accordance with LKAS 16.
DOUBLE ENTRIES IN THE BOOKS OF THE LESSEE – OPERATING LEASE
Lease rental repayment
Rental expense DrCash or accrued lease rental payable Cr
DOUBLE ENTRIES IN THE BOOKS OF THE LESSOR – OPERATING LEASE
At the Beginning
Leased asset DrCash or creditor Cr
At the end of the year
Depreciation expense DrLeased asset Cr
Cash or accrued lease rental DrLease rental income Cr
26
OPERATING LEASE - EXAMPLE Example
On 1 January 2014, X signs a 5-year lease for equipment
The cost of the equipment was 30,000 Total lease payments are 20,000 (4,000/year) Unguaranteed residual value is 15,000 Economic life of equipment is 10 years
Questions What are the journal entries to be recorded at 1
January 2014 and 31 December 2014?
27
OPERATING LEASE - SOLUTION (LESSEE)
No entry at 1 January 2014
At 31 December 2014:
Dr Rental expense 4,000
Cr Cash or accrued lease rental payable 4,000
28
OPERATING LEASE - SOLUTION (LESSOR)
At 1 January 2014:
Dr Leased asset 30,000
Cr Cash or creditor 30,000
At 31 December 2014:
Dr Depreciation expense 3,000
Cr Leased asset 3,000
Dr Cash or accrued lease rental 4,000
Cr Lease rental income 4,000
EXERCISE
Samson PLC has purchased a machine on 01st of April 2014 under the terms of lease for 5 million for the period of 5 years at the rate of 12%. First payment coming at the end of the first year. The lease agreement specifies that Samson PLC gets to keep the machine at the end of the lease.
QuestionIndicate the amortization schedule & calculate the appropriate amounts to be included in the financial statements of the lessee for the year ended 31st March 2015.
AMORTISATION SCHEDULE
YearOpening Balance Installment Interest Capital
Closing Balance
0 -
-
-
-
5,000,000.
00
1
5,000,000.0
0
1,387,115.00
600,000.00
787,115.00
4,212,885.
00
2
4,212,885.0
0
1,387,115.00
505,546.20
881,568.80
3,331,316.
20
3
3,331,316.2
0
1,387,115.00
399,757.94
987,357.06
2,343,959.
14
4
2,343,959.1
4
1,387,115.00
281,275.10
1,105,839.9
0
1,238,119.
24
5
1,238,119.2
4
1,387,115.00
148,574.31
1,238,119.2
4 -
6,935,575.00
1,935,153.55
5,000,000.0
0
LEASE SCHEDULEGross Lease liability
Opening balance as at 01st April 2014 - Add : Lease obtained during the year 6,935,575Less : Settlements during the period -1,387,115Balance as at 31st March 2015 5,548,460
Interests in Suspense
Opening balance as at 01st April 2014 - Add : Interest in suspense charge during the year 1,935,154Less : Charged to Income Statement -600,000Balance as at 31st March 2015 1,335,154
LEASE OBLIGATION AS AT 31ST MARCH 2015 4,212,885
BALANCE SHEET CLASSIFICATION
CURRENT PORTION
Gross Lease liability 1,387,115INTERESTS IN SUSPENSE -505,546LEASE OBLIGATION ( Net Lease liability ) 881,569
LONG TERM PORTION Gross Lease liability 4,161,345INTERESTS IN SUSPENSE -829,607LEASE OBLIGATION ( Net Lease Liability ) 3,331, 316
TOTAL LEASE OBLIGATION AS AT 31ST MARCH 2015 4,212,885
SALE AND LEASEBACK
TRANSACTIONS
DEFINITION
Sale and leaseback transaction is an arrangement in which one party sells a property to a buyer and the buyer immediately leases the property back to the seller.
Advantages of sale and leaseback Releases cash tied up in assets already
owned Cheaper than borrowing money All the risks & rewards of the asset are
transferred to the buyer The lessee can still use the asset No extra time required for re-training on
new equipment
Disadvantages of sale and leaseback Loss control over the asset In the long term it is more expensive
Accounting Treatment for Sales & Leaseback Transactions
Sale & Leaseback Under Finance Lease
If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over the carrying amount shall not be immediately recognized as income by a seller-lessee. Instead, it shall be deferred and amortized over the lease term.
Sale & Leaseback Under Operating Lease
Any profit or loss arising is accounted for as followsIf the transaction is;
Recognize immediately
At fair valueBelow fair valueFuture lease
rentals at market rate
Recognize immediately
Future lease rentals below market rate
Deferred & amortized over the lease period Above fair
valueExcess over fair value should be deferred & amortized over the lease period
DISCLOSURES
KEY DISCLOSURES – FINANCE LEASES (LESSEES) Requirements of SLFRS 7 Net carrying amount at the end of the reporting
period A reconciliation between the total of future
minimum lease payments Contingent rents recognized as an expense in the
period General description of the lessee’s material
leasing arrangements Requirements for disclosure in accordance with
LKAS 16, LKAS 36, LKAS 38, LKAS 40 and LKAS 41 apply to lessees for assets leased under finance leases
KEY DISCLOSURES – OPERATING LEASES (LESSEES) Total of future minimum lease payments
Lease and sublease payments recognized as an expense in the period
General description of the lessee’s significant leasing arrangements
KEY DISCLOSURES – FINANCE LEASES (LESSORS)
Requirements in SLFRS 7
Reconciliation between the gross investment in the lease at the end of the reporting period
Unearned finance income
Unguaranteed residual values accruing to the benefit of the lessor
KEY DISCLOSURES – FINANCE LEASES (LESSORS) Accumulated allowance for uncollectible
minimum lease payments receivable
Contingent rents recognized as income in the period
General description of the lessor’s material leasing arrangements.
KEY DISCLOSURES – OPERATING LEASES (LESSORS) Requirements of SLFRS 7 Future minimum lease payments under
non-cancellable operating leases Total contingent rents recognized as
income in the period General description of the lessor’s leasing
arrangements disclosure requirements in LKAS 16, LKAS
36, LKAS 38, LKAS 40 and LKAS 41 apply to lessors for assets provided under operating leases
SUMMARY
THANK YOU!