Transcript Leases

Week 6: Accounting for
Leases
Financial Accounting BFA201
Readings and references
• Deegan Chapters 10 and 11
• Ignore sections 11.6 – 11.9 (lessors)
• AASB 117 also review AASB Framework
and scan AASB 137
Learning Objectives
• Understand when to recognise a liability
• Explain the difference between finance and
operating leases
• Account for both finance and operating leases
• Understand the implications that lease
recognition will have for a reporting entity’s
financial statements
• Sale and leaseback transactions
• Apply the requirements of AASB 117
Independent Study Tasks
Tutorial questions (for workbooks)
Independent study questions
4
Liabilities: An Overview
•
AASB 137 defines a liability as
•
a present obligation of the entity arising from past
events, the settlement of which is expected to result in
an outflow from the entity of resources embodying
economic benefits
•
The above is equivalent to the definition provided in the
AASB Framework
•
Three components of the liability definition
1. There must be a future disposition of economic benefits
to other entities
2. There must be a present obligation
3. A past transaction or other event must have created the
obligation
Liabilities: An Overview
• As we can see from the definition, a central aspect of a
‘liability’ is the existence of a ‘present obligation’
• Present obligation
• a duty or responsibility to act in a certain way;
• might be legally enforceable, e.g. binding contracts or
statutory requirements; and
• might also arise from normal business practice, custom
and a desire to maintain good relations or act equitably,
e.g. repairing faulty goods outside of warranty periods.
Liabilities: An Overview
•
For a liability to be recognised and disclosed in the balance sheet (the
AASB Framework)
• it must be probable that a sacrifice of economic benefits will be
required; and
• the amount of the liability must be able to be reliably measured
•
Where the entity retains discretion to avoid making any future sacrifice
of economic benefits
• a liability does not exist and is not recognised
•
Some professional judgment might be required to determine if a liability
should be recognised
•
Para 12 – in a general sense all provisions are contingent liabilities
because they are uncertain in timing or amount. However in AASB137
contingent means waiting on a ‘future event’ – & liabilities that do not
meet the recognition criteria.
Liabilities: Contingent Liabilities
•
Contingent liabilities are
• obligations only payable contingent upon a future event; or
• present obligations not currently deemed to be probable or not
measurable with sufficient reliability
•
Examples include guarantees to cover another organisation’s debts or
potential obligations from legal actions
•
It would be inappropriate to recognise them on the statement of financial
position (balance sheet)
•
Disclosure of contingent liabilities is relegated to the notes to the
financial statements
•
Appendix B to AASB 137 provides a useful decision tree for determining
whether a transaction or event should be recognised as a provision and
therefore included within the statement of financial position, or disclosed
as a contingent liability within the notes to the financial statements. The
decision tree is reproduced on the following slide.
1. Introduction to Accounting for
Leases
Introduction to accounting for
leases
Accounting for leases is governed by AASB 117
Lease defined (AASB 117, par. 4):
• 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 of time
What is a Lease?
• Leasing is a form of renting or financing
• A company owns the asset and you pay for the use of
the asset over a set time
• Benefits:
– No large upfront cash payment, so matches cash
outlays more closely with the business operations
– Tax deductible if used for business purposes
– Easy to keep up-to-date with technology
• Check out
https://www.moneysmart.gov.au/borrowing-andcredit/other-types-of-credit/consumer-leases
12
http://www.flexirent.com.au/Reasons-to-
13
http://www.leaseplan.com.au/where-tostart/benefits
14
What is a Lease?
• Leases are agreements which, in exchange for rental
payments, convey to one party (the lessee) the right to
possess and to use an asset owned by another party (the
lessor) for a stated period.
• In general terms, the lessee acquires the right to use the
asset during the of the lease, while the lessor retains the
right to use or dispose of the asset at the end of the lease
term.
• The lessor continues to own the asset but does not have
possession of the right to use it during the term of the
lease.
Common terms of a Lease
• The period of the lease
• The amount and timing of lease payments
• Whether the lease is cancellable by either party
• What is to become of the asset at the end of the lease
• The asset’s residual value
• Whether the lessor or the lessee is responsible for
payment of maintenance and repairs, insurance, taxes
and other operating costs.
The Nature of Leases
Operating
• Rental
• Cancellable
• Risks and benefits are with lessor
Finance
• Lessee controls asset
• Risks and benefits are with lessee
• Are a means to purchase asset
Central Accounting Issue
• Should the leased assets and the associated
commitments relating to the lease arrangements
appear in the lessee’s balance sheet?
• But lessee does not have legal title
• Control is the issue
– control does not necessarily imply legal
ownership
Finance Versus Operating Lease
• Finance lease
• where substantially all the risks and rewards of
ownership pass to the lessee, the lessee
records the lease as an asset and
corresponding liability
• Operating lease
• where the risks and rewards are not transferred
to the lessee no lease liability or asset recorded
• lease payments effectively treated as rent
expense
Risks and rewards of ownership
Risks and rewards of ownership central to the application of
AASB 117:7
• If the lessee holds the risks and rewards of ownership,
the lessee’s risk exposure is basically what it would be if
the lessee acquired the asset by way of a purchase
transaction
• If the risks and benefits of ownership are transferred in
substance to the lessee, the lessee’s risk exposure in
relation to holding the asset is basically equivalent to
what it would have been if the lessee had acquired the
asset for cash or by way of a loan
Risks and Rewards of Ownership
• Risks of ownership include:
• Unsatisfactory performance of the asset,
obsolescence, idle capacity, decline in
residual value
• Benefits
• those obtainable from the use of the property
and gains in realisable value
Risks and rewards of ownership
• Not always a straightforward exercise to
determine whether the risks and rewards
incidental to ownership have passed
substantially to the lessee
• Often requires professional judgment
• Guidance offered in AASB 117 (pars 10–12) to
determine whether finance or operating lease
Finance Versus Operating Lease
•
AASB paras 10 and 11 give examples of situations that
individually or in combination could lead to an asset being
classified as a finance lease:
(a) the lease transfers ownership of the asset to the
lessee by the end of the lease term
(b) the lessee has the option to purchase the asset at a
price that is expected to be sufficiently lower than the
fair value at the date the option becomes exercisable
for it to be reasonably certain, at the inception of the
lease, that the option will be exercised
(c) The lease term is for the major part of the economic
life of the asset even if the title is not transferred
Finance Versus Operating Lease
(d)
At the inception of the lease, the present value of the minimum
lease payments amounts to at least substantially all of the fair
value of the leased asset
(e)
The leased assets are of such a specialised nature that only the
lessee can use them without major modifications
(f)
If the lessee can cancel the lease, the lessor’s losses associated
with the cancellation are borne by the lessee
(e)
gains or losses from the fluctuation in the fair value of the
residual accrue to the lessee (for example, in the form of a rent
rebate equalling most of the sale proceeds at the end of the
lease); and
(f)
the lessee has the ability to continue the lease for a secondary
period at a rent that is substantially lower than the market rent
Finance Versus Operating Lease
Note (AASB 117, par. 12):
•
The examples and indicators in paragraphs 10 and 11 are
not always conclusive
•
If it is clear from other features of the lease that the lease
does not transfer all risks and rewards incidental to
ownership, the lease is classified an operating lease
•
If the lease is cancellable at limited cost to lessee, the
lessee has limited risks and the lease is considered an
‘operating’ lease
•
Operating leases will not require disclosure within the
balance sheet, lease payments are typically treated as
rental expense.
Diagram to assist in classifying
leases
Yes
Is the lease non-cancellable?
No
Is ownership expected to be transferred at the
end of the lease term?
Yes
No
Is the lease term a MAJOR PART of the
economic life of the lease asset?
No
Is the present value of the minimum lease
payments SUBSTANTIALLY ALL of the fair
value of the leased asset?
No
Is the substance of the leasing arrangement and
any related arrangements such that
substantially all of the risks and rewards
incident to ownership are transferred to the
lessee?
No
Operating lease
Yes
Yes
Yes
Finance lease
2. Some Important Definitions for
Accounting for Leases
Important Definitions
When classifying leases there are three main
conditions of the lease agreement to examine:
• cancellability of the lease
• extent of the asset’s economic life transferred to
the lessee
• present value of minimum lease payments
Inherent in these conditions are definitions of
certain terms
Important Definitions – Fair value
AASB 117 uses the new definition of ‘fair value’ under
AASB 13
The new definition under AASB 13:9
– Price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction
between market participants at measurement date
This is necessary for determining the amount to be included
for the leased asset in the balance sheet of the lessee
Important Definitions – Non
cancellability
A non-cancellable lease is a lease that is cancellable only:
(a)
upon occurrence of some remote contingency
(b)
with the permission of the lessor
(c)
If the lessee enters into a new lease for the same or an
equivalent asset with the same lessor; or
(d) upon payment by the lessee of such an additional amount
that at inception of the lease, continuation of the lease is
reasonably certain.
• Important because if the lessee was able to cancel the lease
at short notice with limited penalty the lessee would not be
considered to be holding the risks and rewards associated with
asset ownership—lease would be considered an operating lease
• If lease cancellable—regardless of remaining terms the lease
would be considered to be an operating lease
Important Definitions – Transfer of
ownership
• If lease transfers ownership of the asset to the
lessee at the end of the lease term it is
considered a finance lease (AASB 117:10a)
• If the lease is also non-cancellable, the lease
is really only another type of debt agreement
with title passing after last payment is made
Important Definitions – Bargain
purchase option
Considered in AASB 117:10b
•
A provision that allows a lessee to purchase a leased property for a
price expected to be far lower than the expected fair value of the
property at the date the option becomes exercisable
•
Difference between the option price and expected fair market value
must be large enough to make exercise of the option reasonably
assured— evaluation made at inception of lease
•
If exercise of option is likely (bargain) it is also likely that transfer of
ownership will occur—risks and rewards of ownership are assumed
to be transferred
•
Included in the calculation of minimum lease payments because the
exercise of a ‘bargain’ option is reasonably assured and it is
therefore probable that the amount will ultimately be paid by the
lessee
Important Definitions – Lease term
•
The non-cancellable period for which the
lessee has contracted to lease the asset,
together with any further terms for which the
lessee has the option to continue to lease the
asset with or without further payment, when at
the inception of the lease it is reasonably
certain that the lessee will exercise the option
Important Definitions – Economic
life
Either:
(a)The period over which an asset is expected
to be economically usable by one or more
users; or
(b) the number of production or similar units
expected to be obtained from the asset by
one or more users
Important Definitions – Economic
life
Why important? AASB 117:10(c)
• If the non-cancellable lease term is for the
major part of the economic life of the asset the
lease is generally considered a finance lease
Note:
‘Major part’ not defined but generally accepted
that if lease term is greater than or equal to
75% of the economic life of the leased asset
risks and rewards are effectively transferred to
the lessee (finance lease)
Important Definitions – Minimum
lease payments
AASB 117:4
The payments over the lease term that the lessee is or can
be required to make, excluding contingent rent, costs for
services and taxes paid by and reimbursed to the lessor
together with:
(a) For the lessee, any amounts guaranteed by the lessee
or by a party related to the lessee; or
(b) for a lessor, any residual value guaranteed to the lessor
by:
(i) the lessee
(ii) a party related to the lessee; or
(iii)a third party unrelated to the lessor that is financially
capable of discharging the obligations under the
guarantee
Important Definitions – Minimum
lease payments
Why important?
•
The present value of the minimum lease payments is used to
determine whether a lease is a finance or operating lease—AASB
117, par. 10(d):
• If at the inception of the lease the present value of the minimum
lease payments amounts to at lease substantially all of the fair
value of the asset—normally leads to lease classified as
‘finance’-type lease
•
If a finance lease the amount to be initially recognised in the
balance sheet for the asset and liability is (par. 20) the fair value
of the leased property or, if lower, the present value of the
minimum lease payments as determined at inception of
lease
Minimum lease payments
•
•
For a finance lease, the amount to be initially recognised in
the balance sheet for the asset and liability is the lower of:
a)
the fair value of the leased property or,
b)
the present value of the MLP … (para.20)
Any initial direct costs for the lessee such as legal fees and for
preparing documents are added to the value of the asset.
Important Definitions – Minimum
lease payments
Minimum lease payments
• Expressly exclude contingent rent
• Include guaranteed residual values
Important Definitions – Minimum
lease payments
(a) Guaranteed residual value defined for the lessee
•
That part of the residual value that is guaranteed by the
lessee or by a party related to the lessee
(b) Guaranteed residual value defined for the lessor:
•
That part of the residual value that is guaranteed by the
lessee or by a third party unrelated to the lessor that is
financially capable of discharging the obligations under the
guarantee
(c) Amount of a guaranteed residual value
•
The amount that the lessor has the right to require the
lessee or a related party to the lessee to pay at the end of
the lease term
•
Payment of this residual will often lead to the asset being
legally transferred to the lessee
Important Definitions – Minimum lease
payments
•
Do not include costs for services and taxes
(executory costs) that are paid to the lessor in
reimbursement
Unguaranteed residual
•
•
No certainty that this residual will be paid
Not included in minimum lease payments as there is
not sufficient certainty that the amount will be paid
Important Definitions – Minimum lease
payments
Minimum lease payments
Payments over the lease term
Guaranteed residual value
Bargain purchase option
Contingent rent
Reimbursement of costs paid to lessor
=
+
+
-
43
Minimum lease payments
Include
Do not
include
• Guaranteed residual
• Bargain purchase
option
• Unguranteed residual
• Executory costs (e.g.
Maintenance, rent,
insurance, taxes
• Contingent rents
44
3. Interest rate for determining
the present value of minimum
lease payments
Discount rate
Discount rate used in calculating present value:
The interest rate implicit in the lease is the interest
rate that makes the:
PV of MLP + unguaranteed residual = Fair value
(if this is practical to determine);
OR
if not, the lessee’s incremental borrowing rate
Interest rate for determining the present value of
minimum lease payments
Why interest in present value of minimum lease
payments?
AASB 117 (par. 20):
At commencement of lease term lessees are to recognise finance
leases as assets and liabilities in their balance sheets at amounts equal
to the fair value of the leased property or, if lower, the present value of
the minimum lease payments
Discount rate to be used in calculating present value:
– interest rate implicit in the lease (if this is practical to
determine); or
– if not, the lessee’s incremental borrowing rate to be
used
Interest rate for determining the
present value of minimum lease
payments
Interest rate implicit in the lease (AASB 117):
The discount rate that, at the commencement of
the lease term, causes the aggregate present
value of:
(a) the minimum lease payments; and
(b) the unguaranteed residual value to be equal
to the sum of:
(i) the fair value of the leased asset;
and
(ii) any initial direct costs of the lessor.
Lecture Example 1: Leases (Case a)
• An asset with a fair value of $170 is leased for 4 years. The
asset has no expected value at the end of the lease. An initial
payment of $50 is required then 3 further $50 payments at the
end of each year.
Year
Minimum lease payments
0
$50
1 to 3
$50 x 2.4018
Present
value
50
120
170
• The leased asset and liability will be recorded initally at
$170
Solution 1 a)
Yr 0
Yr 1
Yr 2
Yr 3
50 + 50 + 50 + 50 = 170
(1+k) (1+k)2 (1+k)3
This is the same as an annuity for 3 periods plus
$50 upfront.
50 + 50 x PVA3 = 170
120/50 = PVA3
PVA3 = 2.4 Look up annuity tables p. 1276 Deegan
to find interest rate is 12%.
50
Solution 1 a) cont.
The interest rate implicit in this lease is 12%:
Minimum lease payments
Present value
$50
50
$50 x 2.4018
120
170
Dr
Leased asset
Cr
170
Lease liability
170
To record the leased asset and lease liability (at PV of
minimum lease payments at inception)
51
Example: Leases (Case b)
• Exactly the same facts as Case a except the asset has an
expected value at the end of the lease of $9.
• The interest rate implicit in this lease is 15%
Year
0
1 to 3
3
Minimum lease payments
$50
Present
value
50
$50 x 2.2832
114
(Initial recognition)
164
Unguaranteed residual
$9 x 0.6575
6
170
Example: Leases (Case c)
• Exactly the same facts as Case 2 except the lessee pays $2
to the lessor for maintenance each year so only $48 relates to
the lease (not $50).
• The interest rate implicit in this lease is 12%
Year
0
1 to 3
3
Minimum lease payments
$48
Present
value
48
$48 x 2.4018
115
(initial recognition)
163
Unguaranteed residual
$9 x 0.7118
7
170
4. Lessee Accounting for Leases
Lessee accounting for finance leases
Overview
• Essentially the same as acquiring the asset by way of a
long- term loan
• Lessee records an asset (leased) and a lease liability
• Asset and liability recorded at the fair value of the leased
property or, where lower, at the present value of the
minimum lease payments
• Consideration to be given to present value of future cash
flows
Lessee accounting for finance leases
• Unguaranteed residual excluded from the amount
recognised for the lease asset and lease liability in
financial statements of lessee
• Rental payments to lessor include payment of principal
plus interest—to be apportioned by lessee
• Interest expense calculated by applying the interest rate
implicit in the lease to outstanding lease liability at
beginning of each lease period
• Balance of payment represents a reduction of principal of
lease liability
Lessee accounting for finance leases
Amortisation of leased assets
• Leased assets should be amortised using the
depreciation (amortisation) policies normally followed
by the lessee
• Period of amortisation—number of accounting periods
that are expected to benefit from the asset’s use
• Amortisation can be over useful life of asset, i.e. when
reasonable assurance that lessee will obtain
ownership at end of lease term (e.g. bargain purchase
option), otherwise amortisation over lease term
Lessee accounting for finance leases
Depreciation of leased assets
• Depreciate in accordance with AASB 116 and AASB
138
• If no reasonable certainty lessee will obtain ownership
at end of term, depreciation over the shorter of the
lease term and the useful life, otherwise the useful life
• Deduct guaranteed residual from initial value of
leased asset in the calculation of depreciation.
Lessee accounting for finance leases
Journal entries
• To record the leased asset and lease liability (at
PV of minimum lease payments):
Dr
Leased asset
Cr
Lease liability
• To record lease amortisation expense:
Dr
Lease amortisation expense
Cr
Accumulated amortisation
59
Lessee accounting for finance leases
• To record lease depreciation expense
Dr Lease depreciation expense
Cr Accumulated depreciation
• To record the lease payment, with the payment being
allocated between principal and interest:
Dr Lease liability
Dr Interest expense
Cr Cash
• To record payment of executory costs:
Dr Executory expenses
Cr Cash
Lecture Example 2
• Apple Ltd sells apple-picking machines for $263 948.
The machines have a useful life of 8 years.
• AJ Ltd decides to lease a machine from Apple Ltd for a
period of 7 years by way of a non-cancellable lease.
•
• The lease commenced on 1 July 2011.
• The lease payments, including reimbursement of Apple
Ltd’s executory costs of $5 000 per annum, are made at
the end of each year and amount to $55 000.
• There is an unguaranteed residual at the end of the
lease term of $40 000.
Lecture Example 2
According to the requirements of AASB 117:
1. Determine whether the lease is an operating lease or a
finance lease and list the reasons for your decision.
2. Confirm the interest rate implicit in the lease is 10%
and show your calculations.
3. Prepare the lease payment schedule for the life of the
lease.
4. Record entries in general form to record the lease
transactions at 1 July 2011 and at 30 June 2012 for AJ
Ltd (the lessee)
5. Show what would be reported in the statement of
financial position for AJ Ltd at 30 June 2012.
Lecture Example 2 Solution
1. Determining type of lease
• The lease is a finance lease because:
– It is non-cancellable
– The lease term is for a major part of the economic life of
the asset
– The present value of the minimum lease payments is
substantially all of the fair value of the leased asset (see b
below)
Lecture Example 2 Solution
a. Checking whether the minimum lease payments is
substantially all of the fair value of the leased asset:
• Minimum lease payments
$50 000 x 4.8684 = $243 420
• Fair value = $263 948
• Therefore $243 420/263 948 x 100 = 92%
Lecture Example 2 Solution
b. Confirming the implicit interest rate
• The implicit interest rate is that rate which causes the combined
present value of the minimum lease payments and the
unguaranteed residual to equal the fair value of the asset at the
inception of the lease.
• If a 10% discount rate is used, the PV of the two amounts over 7
years is:
Minimum lease payments
$50 000 x 4.8684 =
$243 420
Unguaranteed residual
$40 000 x 0.5132 =
20 528
$263 948
• As the discounted value equals the fair value of the asset at
inception of the leased, 10% must be the rate of interest implicit in
the lease.
c. Prepare the lease payment schedule for the life of the
lease.
Date ofpayment
Lease payment
Interest expense
Principal
repayment
1/07/11
Balance of
liability
243420
30/06/12
50000
24342
25658
217762
30/06/13
50000
21776
28224
189538
30/06/14
50000
18954
31046
158492
30/06/15
50000
15849
34151
124341
30/06/16
50000
12434
37566
86775
30/06/17
50000
8678
41322
45453
30/06/18
50000
4545
45453
0
c. Example of calculations
30/06/12
243 420 x 0.10 = 24 342 (interest)
50 000 – 24 342 = 25 658 (principal repay)
243 420 – 25 658 = 217 762 (balance)
30/06/13
217 762 x 0.10 = 21 776 (interest)
50 000 – 21 776 = 28 224 (principal repay)
217 762 – 28 224 = 189 538 (balance)
d. Journal Entries
1/07/11 Leased machinery
243420
Lease liability
To record lease asset and lease liability at lower of PVof MLP & fair value
30/06/12 Lease liability
Interest expense
Cash at bank
To record lease payment
25658
24342
30/06/12 Lease depreciation expense
Accumulated depreciation (leased asset)
Depreciate over useful life 243420/7
34774
30/06/12 Executory expenses
Cash at bank
Payment of executory costs not considered to be
part of minimum lease payments
243420
50000
34774
5000
5000
68
e. Statement of financial position extract
AJ Ltd
Extract from the Statement of Financial Position
As at 30 June 2012
ASSETS
Leased asset
less accumulated depreciation
CURRENT LIABILITIES
Lease liability (current portion)
NON CURRENT LIABILITIES
Lease liability
243420
34774
208646
28224
189538
217762
69
Leases - land & buildings
Land:
• indefinite life
• risks & benefits cannot be transferred unless
ownership transferred at end
• Unless transfer is likely, a lease of land will be
treated as an operating lease.
Land and buildings:
• May need to split the MLP between the land and
buildings in proportion to their relative fair values
• land - operating lease;
• building - finance lease (if criteria are met)
70
Operating leases
An operating lease is not a finance lease (para 4)
• NOT in the balance sheet – recognised as expense on
straight-line basis over term (para 33)
Indicators of an operating lease:
• Can cancel at short notice with limited penalty
• if ownership transfers at the end of the lease for a
variable payment equal to its then fair value
• if there are contingent rents (eg. if lease payments are
variable and depend partly on sales or how much the
asset is used).
71
Accounting for Operating leases
In each of these cases the lessee does not bear all the
risks and rewards of ownership.
Lease payments are treated like rent expense:
Dr
Rental expense
Cr
Cash
(May need to use accruals or prepayments for
lease payments)
72
Lessee accounting for operating leases
AASB 117 (par. 33):
Lease payments under an operating lease are to be recognised as an
expense on a straight-line basis over the lease term, unless another
systematic basis is more representative of the time pattern of the
user’s benefits
•
Journal entry:
Dr
Rental expense
Cr
Cash
Lecture Example 3
• On 1 June 2012 AJ Ltd enters a 5-year lease
agreement with Ground Ltd for land. The lease is
non-cancellable. The land has a value of $1
million and the annual lease payments are
$30,000 per year in arrears.
• Prepare the journal entries for AJ Ltd to account
for the lease.
74
Solution 3
Must determine whether operating or finance lease. As
land has indefinite life, period of lease is too short to be
finance lease.
Dr
Rental expense – land
Cr
Cash
$30,000
$30,000
To record operating lease payments for land
75
Sale and leaseback transactions
• Owner (seller/lessee) sells asset to another party and
simultaneously leases it back from the purchaser/lessor
(the legal owner )(para. 58)
• Seller does not lose control of the asset - Finance Lease:
Profit or loss on the sale is deferred in the balance sheet of
the seller/lessee and is amortised over the term of the
lease (para.59)
• Operating lease: any profit or loss can be recognised at
the point of sale as long as the exchange is at the fair value
of the asset (para.61)
76
Lessee accounting for sale and
leaseback transactions
Finance lease
• Where substantially all risks and rewards incidental to
ownership remain with lessee—represents refinancing
of an asset
• Any profit or loss on sale deferred in the balance
sheet and amortised to the profit and loss over the
term of the lease (AASB 117, par. 59)
• Asset considered not to have been ‘sold’ to lessor,
therefore inappropriate to recognise profit or loss
(AASB 117, par. 60)
Lessee accounting for sale and leaseback
transactions
Journal entries
• To record the sale of an asset (any profit on
sale is deferred and recognised throughout
lease term):
Dr Cash
Dr Accumulated depreciation
Cr Asset
Cr Deferred gain
Lessee accounting for sale and leaseback
transactions
Journal entries (cont.)
• To record finance lease:
Dr
Leased asset
Cr Lease liability
• To recognise periodic lease repayment:
Dr
Interest expense
Dr
Lease liability
Cr Cash
Lessee accounting for sale and
leaseback transactions
Journal entries (cont.)
• To record amortisation of leased asset:
Dr
Amortisation of leased asset
Cr Accumulated lease amortisation
• Recognition of deferred gain (on straight-line basis):
Dr
Deferred gain
Cr Profit on sale of leased asset
Lecture Example 4
• In an attempt to alleviate
its liquidity problems,
Banff Ltd entered into an
agreement on 1 July
2007 to sell its
processing plant to
Lethbridge Ltd for $3.5m
(which is the fair value of
the plant). At the date of
sale, the plant had a
carrying amount of
$2.75m. Lethbridge Ltd
immediately leased the
processing plant back to
Banff Ltd. The terms of
the lease agreement
were:
Lease term
6 years
Economic life of plant
8 years
Annual rental payment, in
arrears (commencing
30/6/08)
$700 000
Residual value of plant at end
of lease term (fully
guaranteed)
$500 000
Interest rate implicit in lease
10%
81
Example 4
The lease is non-cancellable. The annual rental
payment included $35,000 to reimburse the lessor
for maintenance costs. Ownership will transfer to
Banff Ltd at the end of the lease.
Required
a) Classify the lease
b) Record the sale and leaseback transaction in
the books of Banff Ltd on 1 July 2007, as well as
the entries required on 30 June 2008.
82
Solution 4 a)
•
•
•
•
•
Finance lease?
Non-cancellable
Ownership is expected to be transferred at the end of
term
Lease term is a major part of the economic life
PV of MLP is substantially all of the fair value. It is
calculated as follows:
PV of
MLP
= $665 000 x 4.3553
+ $500 000 x 0.5645
= $2 896 275
+ $282 250
= $3 178 525
PV/FV
= $3 178 525/$3 500 000
= 90.8%
83
Solution 4 b)
Date of payment Lease payment Interest expense
1/07/2007
30/06/2008
665000
317853
30/06/2009
665000
283138
30/06/2010
665000
244952
30/06/2011
665000
202947
30/06/2012
665000
156741
30/06/2013
1165000
105915
Principal
repayment
347148
381862
420048
462053
508259
1059085
Balance of
liability
3178525
2831378
2449515
2029467
1567413
1059155
70
84
Solution 4 b) cont.
1/07/2007Cash at bank
Accumulated depreciation
Plant
Deferred gain
To record the sale of the plant.
30/06/2008Leased asset
Lease liability
To record the finance lease
30/06/2008Interest expense
Lease liability
Executory costs
Cash at bank
To record lease payment
3,500,000
2,750,000
750,000
3,178,525
3,178,525
317,853
347,148
35,000
700,001
Depreciation expense: leased machine
Accumulated depreciation: leased machine
Depreciation over useful life (3178525 – 500000)/8
334,816
Deferred gain
Profit on sale of leased asset
Amortisation of the deferred gain on a straight line basis
750000/6
125,000
334,816
125,000
The nature of the accounting problem created
by leases: incentives and effects
• Operating leases (off-balance sheet):
– No lease assets or liabilities are recognised
• Finance leases (on-balance sheet):
– ↑NCA…Entity’s return on assets ratio is reduced
– ↑NCL…debt/equity ratio adversely affected
– Performance measures will be reduced
eg. Depreciation & interest charges (lower profits)
• Incentives for managers to favour operating leases
• IASB agenda - http://go.ifrs.org/leases (with FASB) may
lead to treating operating leases similarly to financial
leases
86
Disclosure requirements lessees
Finance lease para 31
Operating lease para 35
Disclose amounts owing:
i. Not later than 1 yr
ii. Between 1 and 5 yrs
iii. Later than 5 yrs
87
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