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Topic 1 Accounting For Leases

This document discusses accounting for leases according to MFRS 117. It begins by defining what a lease is and differentiating between operating and finance leases. The key criteria for classifying a lease as a finance lease versus an operating lease are described, including if substantially all risks and rewards are transferred. Accounting is then explained for both lessees and lessors depending on the lease classification. For operating leases, the lessee recognizes rent expense and the lessor recognizes rent revenue over the lease term. For finance leases, the lessee capitalizes the leased asset as property, plant, and equipment and the corresponding liability.

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Atira Shamsul Bahari

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100% found this document useful (1 vote)

328 views59 pages

Topic 1 Accounting For Leases

Uploaded by

Atira Shamsul Bahari

We take content rights seriously. If you suspect this is your content, claim it here.

Available Formats

Download as PPT, PDF, TXT or read online on Scribd

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Topic 1

Accounting for
Leases
(MFRS 117)

Chapter Outline

Nature and classification of leases.

Accounting by lessee:

operating lease

finance lease

Accounting by lessor:

operating lease

direct financing lease

Sales and leaseback transactions.

Disclosure requirement.

Learning outcomes:
Define what is lease & differentiate

between operating & finance lease

Record the leases transactions in the
book of lessor and lessee
Define and record sales and leaseback
transantions

Definition of Lease
MFRS
MFRS 117
117 (Para
(Para 4):
4):
An
An agreement
agreement whereby
whereby the
the lessor
lessor conveys
conveys to
to
the
the lessee
lessee in
in return
return for
for aa payment
payment or
or series
series of
of
payments
payments the
the right
right to
to use
use an
an asset
asset for
for an
an
agreed
agreed period
period of
of time.
time.

Advantages of Lease
1) 100% financing at fixed rates without

requiring any down payment, lease

payments often remain fixed.
2) Protection against obsolescence reduce

risk of obsolescence.
3) Flexibility less restrictive provision than

other debt agreements.

4) Less costly financing.
5) Off-Balance-Sheet financing specifically
5

on operating lease.

Classification of Lease
Finance Lease

if it transfers
substantially all the risks
and rewards incidental to
ownership.
DMart

Operating

Lease

if it does not transfer

substantially all the risks
and rewards incidental to
ownership.

Classification of Lease
cont.
Rewards may be
represented by the
expectation of profitable
operation over the assets
economic life and of gain
from appreciation in value
or realization of a residual
value.

Risks include the

possibilities of losses from
idle capacity or
technological obsolescence
and of variations in return
due to changing economic
conditions

Ownership Transfer

Legal form:
- Title remains with the lessor for all
types of lease.
Accounting view:
Substance over form
A lease that transfers substantially all of
the benefits and risks incidental to the
ownership of property should be accounted
for as acquisition of an asset and the
incurrence of an obligation by the lessee.
practically how the asset treated/used
vs. legally who own the asset
Conclusion:
The ownership rights differs according to
type of the lease.

Classification of Lease:
Para 10 - depends on the substance of the
transaction rather than the form of the contract.

Ownership transfers at the end of the lease?

YES

Finance Lease

YES

Finance Lease

Bargain Purchase Option?

Lease term is for majority of economic life?75% or

YES

Finance Lease

PV of MLP equals at least substantially all of FV of

the leased asset? 90% or more
NO

Leased asset(s) specialised?

Operating Lease

YES

Finance Lease
Finance Lease

Classification of Lease (Cont.):

Para 11: Indicators of situations which individually or
in combination could also lead to a lease being
classified as a finance lease are:
Cancellation losses borne by lessee?

YES

Changes in FV of residual borne by lessee?

YES

Bargain lease renewal option?

YES

Operating Lease

Finance Lease

Terms
Lease Term
- Non-cancellable period for which lessee has contracted to lease.
- Commencement of lease term = when recognition takes place.
Inception date
- the earlier of the date of the lease agreement and the date of
commitment by the parties to the principle provision of the lease.
- Inception of the lease = when leases are classified.
Bargain purchase option (BPO)
- option to purchase the asset at a price lower than fair value at the date
of the option become exercisable.

Terms (cont)
Minimum Lease Payment (MLP)

Payments over the lease term that the lessee is or

can be required to make excluding contingent rent,
cost for services, and taxes, to be paid and
reimbursed to the lessor; together with
(+) Guaranteed residual value:
a) lessee: any amounts guaranteed by the
lessee or related party; or
b) lessor: any residual value guaranteed by
lessee or party related to lessee, or third party.
(+) BPO (bargain purchase option)

Terms (cont.)
Guaranteed Residual Value
-

Lessee: part of the RV guaranteed by the lessee or by a

party related to the lessee (being the max amounts payable
at the end of lease term)

Lessor: part of RV guaranteed by the lessee or by a third

party unrelated to the lessor who is capable to pay the
guaranteed amounts.
Initial direct cost
- incremental cost that are directly attributable to
negotiating and
arranging a lease, except for such costs incurred by
manufacturer or
dealer lessors.
- Example: legal fees, lease agreement commission etc.

Terms (cont.)
Gross Investment
a) the MLP receivable by the lessor under a finance lease, and
b) any unguaranteed residual value accruing to the lessor.
Net Investment
- the gross investment in the lease discounted at the interest rate
implicit in the lease.

Classification of Lease
cont.
Para 15A 18:
When a lease includes both land and buildings elements, an entity

assesses the classification of each element as a finance or an

operating lease separately in accordance with paragraphs 713.
Land
usually operating due to indefinite useful life.
if title passed finance lease.
MLP allocated in the proportion to the relative FV of both
elements.
if cannot reliably allocated: entire lease is considered finance lease,
unless it is clear that both are operating.
15

Classification
Classification of
of Lease
Lease
Illustration 1:
Pajakan Co. (Lessor) and Trojan Co. (Lessee)
entered into leasing agreement on 1 January 2012.
The term of lease is 15 years. The lease agreement
is non-cancellable and has minimum lease
payments with a present value of RM450,000. The
lease involves the use of machinery that has a 17
years estimated useful life and is valued at
RM460,000. The lease stated that Trojan has an
option to purchase the asset for RM20,000 at the
end of leased period.
16

Classification
Classification of
of Lease
Lease
Solution to illustration 1= Finance Lease
Criteria

Satisfied?
Y/N

Explanation

Transfer of
title

Not transferred.

BPO

BPO = RM20,000

Length of lease
term

useful life = 17 years;

Lease term = 15 years.

PV of MLP

FV = RM460,000;
PV of MLP = RM450,000.

Specialised
assets

Not specified.

Finance vs. operating lease

(Lessee)
Finance Lease

Operating Lease

Recognition of PPE and

liabilities on the book

Recognition of rental
expenses/revenue as
incurred/earned

PPE subject to impairment

and test

Not applicable

Lets take a look at

Operating Lease in
the book of Lessee

Operating Lease:
Accounting by Lessee
Para 33 34:
Lease payments should:
i. be recognised as an expense in the income statement
on a straight-line basis over the lease term.
ii. exclude costs for services such as insurance and
maintenance.
No records on the assets or liability related to the value of
the assets (off balance sheet).

Operating Lease:
Accounting by Lessee
Illustration 2:
Pajakan Company (lessor) leased an equipment costing
RM450,000 to Trojan Company. The economic useful life
of the asset is 20 years. The lease is classified as
operating lease with the lease term of 5 years starting
from 1/1/2011. Payments are made in advance as
follows:
1/1/11
RM18,000
1/1/12
RM16,000
1/1/13
RM14,000
1/1/14
RM12,000
1/1/15
RM10,000
Asset is used evenly throughout the lease term. The
21
accounting period of both parties ends on 31 December.

Operating Lease :
Accounting by Lessee
Solution to Illustration 2:
Total payment for the lease period:
= RM18,000 +RM16,000 + RM14,000 + RM12,000 + RM10,000
= RM70,000
Expenses recognized per year = RM70,000/5
= RM14,000
Journal entries?

BKAF3063 A132

Date

Particulars

Debit

1/1/11