10 STEPS TO UNLOCKING AN UNDERSTANDING OF LEASE ACCOUNTING – PART 2
In 10 STEPS TO UNLOCKING AN UNDERSTANDING OF LEASE
ACCOUNTING – PART 1, we learned how to account for finance lease in the books
of the leasee at the commencement of the lease and during the period of the
lease. But in this second part i.e. 10 STEPS TO
UNLOCKING AN UNDERSTANDING OF
LEASE ACCOUNTING – PART 2, we shall consider finance lease from the perspective
of a leasor. Here, we shall learn how to account for a finance lease at both
the inception, and throughout the duration of the lease in the books of the
leasor.
Going forward also, we shall look at operating lease,
and how this can be accounted for in both the leasee’s and the leasor’s books.
Happy study all the way!
STEP
5: How is finance lease recorded and treated in the books of account of the
leasor at the commencement of lease period?
In the books of the leasor, the finance lease is recognized (i.e. recorded) at the commencement of the lease as LEASE RENT RECEIVABLE which
is an asset. The value of this asset (i.e. LEASE RENT RECEIVABLE) at the point
of recognition is the net investment in the lease by the leasor. Well, what is
the meaning of “net investment in the lease by the leasor”? And how would you
calculate it?
The ‘what’ and ‘how’ of the leasor’s net investment in
the lease are similar. Therefore, leasor’s net investment is defined and
calculated as the sum of all the minimum lease payments plus any unguaranteed
residual value of the leased asset discounted at an interest rate implicit in
the lease.
At this junction, it is needful to say that leasor can
be classified into 2 namely MANUFACTURER/DEALER LEASOR and FINANCIAL
INTERMEDIARY LEASOR.
A manufacturer/dealer leasor is a leasor that either
manufactures and sells the leased item or assets or buys and sells it in the
ordinary course of business. A manufacturer/dealer leasor is an organization
that manufactures for sale or buys for resale the asset which is the object of
a finance lease.
While a financial intermediary is just an organization that finances the direct purchase of the asset which it subsequently leases out. That is, a financial intermediary leasor acts as a middle man. For a financial intermediary the scenario is like this: A company needs an asset for its operation, but has no fund for its purchase; it then runs to a financial firm or financial house which purchases the asset and leases it out to the company.
While a financial intermediary is just an organization that finances the direct purchase of the asset which it subsequently leases out. That is, a financial intermediary leasor acts as a middle man. For a financial intermediary the scenario is like this: A company needs an asset for its operation, but has no fund for its purchase; it then runs to a financial firm or financial house which purchases the asset and leases it out to the company.
This categorization is necessary as this will help you
in determining the components of the net investment of the leasor in the lease. The components of the net investment vary with the type of leasor under consideration.
Therefore, for a manufacturer/dealer leasor:
NET INVESTMENT = (Present Value of the Minimum Lease
Payments + Present Value of the Unguaranteed Residual Value)
For a Financial Intermediary Leasor:
NET INVESTMENT = (Present Value of the Minimum Lease
Payments + Present Value of the Unguaranteed Residual Value – Initial Direct
Costs)
Note
here that the initial direct cost of a dealer or manufacturer should be
expensed in the profit or loss as they are incurred while that of a financial
intermediary should be used to reduce the net investment in the lease as
indicated above.
- For a Manufacturer/Dealer Leasor the entry in the books at the inception of the lease will be:
DR: LEASE RENT RECEIVABLES
CR: REVENUE
With
the manufacturer/dealer leasor’s net investment in the finance lease at the
inception of the lease
DR: COST OF GOOD SOLD
CR:
INVENTORY
With
the cost price of the asset leased at the inception of the lease
- For a Financial Intermediary Leasor the entry in the books, at the inception of the lease will be:
DR: LEASE RENT RECEIVABLES
CR: ASSET
PURHASED TO LEASE
With
the financial intermediary leasor’s net investment in the finance lease at the
inception of the lease
ILLUSTRATION 5a:
Ogun Plc gave out a machinery with a fair value of N 30,000 to Osun Ltd on January 1, 2006
under the following terms:
- The lease
period is 3 years with lease rent of
N20,000 payable on December 31 of each year. - The leasee has
the right of purchase of the machinery at the end of the lease period.
- The implicit interest
rate is 10%.
- The estimated
residual value of the machinery is
N3,000 with a guaranteed portion amounting toN1,000. - Initial legal
expenses of
N3,000 were incurred by the leasor in arranging the lease.
Required:
- Assuming Ogun
Plc is the manufacturer of the machinery, determine the leasor’s net
investment in the lease and show the journal entries.
- Record the
lease transaction in the books of Ogun plc, the leasor on January 1, 2006.
SOLUTION 5a:
- The net investment of the leasor (i.e. Ogun Plc) assumed to be a manufacturer of the machinery leased out is calculated as the aggregate of the minimum lease payments and unguaranteed residual value of the machinery discounted at 10% interest rate.
This is computed using the
formula below:
Or alternatively you can
calculate it using the present value table method as below:
The
journal entries are:
DR:
LEASE RENT RECEIVABLES N 51,239.67
CR: REVENUE N 51,239.67
With
Ogun Plc’s net investment in the finance lease at the inception of the lease.
- The ledger
entries of the lease transaction are given below:
ILLUSTRATION 5b:
Ogun Plc gave out a machinery with a fair value of N 30,000 to Osun Ltd on January 1, 2006
under the following terms:
- The lease
period is 3 years with lease rent of
N20,000 payable on December 31 of each year. - The leasee has
the right of purchase of the machinery at the end of the lease period.
- The implicit interest
rate is 10%.
- The estimated
residual value of the machinery is
N3,000 with a guaranteed portion amounting toN1,000. - Initial legal
expenses of
N3,000 were incurred by the leasor in arranging the lease.
Required:
- Assuming Ogun
Plc is a financial intermediary, determine the leasor’s net
investment in the lease and show the journal entries.
- Record the
lease transaction in the books of Ogun plc, the leasor on January 1, 2006.
SOLUTION 5b:
- The net
investment of the leasor (i.e. Ogun Plc) assumed to be a financial firm is
calculated as the aggregate of the minimum lease payments and unguaranteed
residual value of the machinery discounted at 10% interest rate less
initial direct cost (i.e. Legal expenses).
This is computed using the formula below:
Or alternatively you can
calculate it using the present value table method as below:
The
journal entries are:
DR:
LEASE RENT RECEIVABLES N 48,239.67
CR: REVENUE N
48,239.67
With
Ogun Plc’s net investment in the finance lease at the inception of the lease.
- The ledger
entries of the lease transaction are given below:
STEP
6: How is finance lease recorded and treated in the books of account of the
leasor during the lease period?
During the period of the finance lease, the leasor will
be receiving lease rental payments from the leasee. At this point the lease
rent payment received should be divided into FINANCE INCOME and PAYMENT TO
REDUCE THE LEASE PAYMENTS RECEIVABLE.
Please note that the entries in the books of account
will be the same for both a Manufacturer/Dealer Leasor and a Financial Firm Leasor
during and throughout the lease period. This is given below:
DR: CASH
CR: LEASE
RENT RECEIVABLES
CR: FINANCE INCOME
With
the lease rent payment received by the leasor from a
finance lease during the period of the lease.
ILLUSTRATION 6:
Using the information in illustration 5a,
- Calculate the
finance income for each of the three years.
- Calculate the
payment in respect of the lease rent receivable.
- Show the ledger
entries for all the three years.
SOLUTION 6:
- The finance
income is calculated using the amortization table below:
- Below are the
ledger entries
STEP
7: How is operating lease recorded and treated in the books of account of the
leasee?
With operating lease, recognize the deposit and the lease
rentals paid in the books of the leasee.
The lease payment expense should be allocated on a straight line basis
over the period covered by the lease.
The value to recognize each year as lease payment
expense in the statement of Profit or Loss should be calculated as the sum of
all the lease payments allocated over the lease period.
(sum of
Lease Payments + initial Deposit – Rebate/Discount)
Lease Payment Expense =
------------------------------------------------------------------------
Lease Period (In Years)
The journal entries will be as follows:
DR:
LEASE PAYMENT ACCOUNT
CR: BANK/CASH ACCOUNT
With
the amount of the lease payment paid
DR:
PROFIT OR LOSS ACCOUNT
CR: LEASE PAYMENT ACCOUNT
With
the lease payment expense charged to the profit or loss account at year end
ILLUSTRATION 7:
Given that Gambia Plc leased a machine for a period of 5
years with an annual rentals of N50,000
after the payment of an initial deposit of N
40,000. Gambia Plc, under the terms of the lease is exempted from the payment
of lease rent in the 4th year of the lease.
a. Calculate
the lease payment to be allocated to each year as an expense.
b. Show
the ledger entries for each of the year.
c. Show
the Profit or Loss extract for each year.
d. Show
the extract of the Statement of Financial Position for each year.
SOLUTION 7:
a. Lease
Payment to be recognized as an expense each year is calculated as:
Initial Deposit + (4 X
Annual Lease Payment)
Lease
Period (In Years)
5
= N 48,000.00
b.
c.
d.
STEP
8: How is operating lease recorded and treated in the books of account of the
leasor?
Operating lease in the Leasor’s books should be treated
as follows:
1. The
leased asset should be treated according to its nature and the provisions of
IAS 16.
2. Record
lease rental from operating lease as LEASE INCOME on a straight line basis over
the term or period of the lease. That is, allocate the total lease payments
from the lease evenly over the period of the lease.
3. The
initial direct costs such as legal cost, negotiation cost, commission etc
should be added to the cost of the leased asset.
4. The
initial cost added to the cost of the leased asset should be expensed (i.e.
charged to the profit or loss account) over the period of the lease on the same
basis as the Lease Income.
5. Contingent
rents received should be recorded as income in the period it occurs.
6. The
leased asset should also be depreciated, and depreciation should be charged
annually according to the organization’s depreciation policy.
ILLUSTRATION 8:
On January 1, 2002, Opeki Ltd leased out, for a period
of 3 years, a luxury bus purchased on the same date at a cost of N120,000.
The leasee was to make an annual lease payment of N30,000 after the payment
of an initial deposit of N15,000. In finalizing the lease arrangement a
legal cost of N6,000 was incurred by Opeki Ltd. The estimated economic life
of the bus is 3 years.
a. Calculate
the lease income to be allocated to each year.
b. Calculate
the annual depreciation charge using straight line basis.
SOLUTION 5:
a. Lease payment to be recorded as income for each year is calculated as:
3
EQUALS
N35,000.00
b. The
depreciation charge will be made up of 2 components: the purchase cost and the
initial direct cost.
Depreciation on the purchase cost
= 3 Years
= N40,000
Amortization of the initial
cost = N6,000/3 Years
= N 2,000
Comments
Post a Comment