SOLUTION: Accounting for lease | My Assignment Tutor

1-1Welcome toFinancialAccounting andReportingWednesday 8.30am – 11.30amUBSS Sydney CBD CampusLevel 10 & 11 233 Castlereagh StreetSydney NSW20001-2Financial Accountingand ReportingAccounting for lease(chapter 11)(AASB 117)Assistant Professor Dr Nilima PaulLecture 41-3What is a lease? Lease defined (AASB 117, par. 4)An agreement whereby the lessor conveys to the lessee in return for apayment or series of payments the right to use an asset for an agreed periodof time. Typical terms in lease agreements:● Period of the lease● Amount and timing of the lease payments● Whether the lease is cancellable by either party● What is to become of the asset at the end of the lease term● The asset’s residual value● Responsibility for payment of maintenance, repair costs etc.1-4Difference between operating lease and Financelease Operating lease:● The risks and benefits of ownership of the leased asset remain withthe lessor● Typically short-term● Described as ‘off-balance sheet’ as they do not satisfy the definitionsand recognition criteria for assets and liabilities Finance lease:● Transfers substantially all of the risks and rewards of ownership of theleased asset to the lessee● Typically used as means of financing long-term use and purchase1-5Other types of leasing arrangements● Sale-and-leaseback agreement:►An asset’s owner sells it to a financial institution for an amountusually equal to its current market value and immediately leases itback● Leveraged lease►The majority of funds to purchase the asset is borrowed by thelessor►The lessor may comprise one or more banks or finance companieswhich provide the remaining funds to purchase the asset1-6Accounting for operating leases Rental (or expense) method:● A method of accounting for leases under which the lessee recognises assets andliabilities only from accruals or prepayments of lease rentals● Rent paid by the lessee during a reporting period► Is recorded as an expense● Rent received by the lessor during a reporting period► Is recorded as rent revenue in the lessor’s accounts The lessor would show:● Rent received during the accounting period as rent revenue (income)● ‘Accrued revenue’ as an asset; and● Any rent received in advance as a liability The leased asset remains the lessor’s property:● The lessor will depreciate the asset over its estimated useful life1-7Accounting for finance leases by the lessor Finance method:● The lessor has given up the rights to use the asset in exchange forthe right to receive rental payments● The asset is the present value of the rental payments and is shown as‘lease receivables’● Finance method is the mirror image of the lease capitalisation methodin the lessee’s accounts1-8Accounting for leases: incentives and effects Operating leases (off-balance sheet):● No lease assets or liabilities are recognised● All lease payments are recognised as expenses when incurred Finance leases (on-balance sheet):● Lease and asset recognised at inception of lease● Lease payments allocated between interest component (expense) andreduction in lease principal (lease liability)● Increased debt ratio and lower return on assets may impact onperceptions of operating performance Managers have incentives to favour operating leases1-9Classifying leases:AASB 117 Operating lease:● The risks and rewards of ownership remain substantially with thelessor Finance lease:● The risks and rewards of ownership are transferred substantially tothe lesseeRisks include:● The possibilities of losses from idle capacity or technologicalobsolescence and of variations in return because of changingeconomic conditionsRewards may be represented by:● The expectation of profitable operation over the asset’s life and gainfrom appreciation in valueAASB 117’s focus on risks and rewards is inconsistent with the Framework1-10Classifying leases:AASB 117 Classification of a lease depends on (AASB 117):● The substance of the transaction, not the form of the contract Indicators of a finance lease (AASB 117):● Lease transfers ownership of the asset to the lessee at the end of thelease term● The lessee has the option to purchase the asset at a bargain price● The lease term is for a major part of the asset’s life● At the start of the lease, the present value of the minimum leasepayments amounts to at least substantially all of the asset’s fair value● The leased assets are of such a specialised nature that only thelessee can use them1-11Accounting for operating leases by lessees andlessors:AASB 117• Lease payments of an operating lease must be:● Recognised as an expense on a straight-line basis over the leaseterm unless another systematic basis is more representative of thetime pattern of the user’s benefit• Lessor shows the leased property as a non-current asset and depreciatesit in the usual way• Various disclosure requirements for lessees and lessors1-12Accounting for finance leases by the lessee:AASB117 At the inception of the lease:● The lessee shall recognise a lease asset and lease liabilityThe assets and liabilities shall be initially recognised at:● Fair value of the leased propertyor, if lower,● The present value of the minimum lease payments Subsequent to initial recognition:● The minimum lease payments shall be apportioned between the finance charge andthe reduction of the outstanding liability● The finance charge shall be allocated to each period during the lease term so as toproduce a constant periodic rate of interest on the remaining balance of the liabilityIf there is reasonable certainty that the lessee will obtain ownership by the end of the leaseterm:● The asset’s useful life for depreciation purposes is its useful life as defined in AASB116If there is no reasonable certainty that the lessee will obtain ownership at the end of thelease term:● The asset’s useful life for depreciation purposes is the shorter of the lease term andits useful life1-13Sale-and-leaseback:AASB 117 Sale-and-leaseback transaction:● Where the owner of an asset sells it to a financial institution and immediately leasesit back from the new owner If the lease is classified as a finance lease:● Any excess of the proceeds received by the lessee over the asset’s carrying amountmust be deferred and amortised over the lease term● Any gain on sale is treated as a reduction in the lease payments If the lease is classified as an operating lease:● Where the fair value of the asset is less than carrying amount:► a loss must be recognised● Where sales price equals fair value:► There can be no loss as carrying amount must not exceed fair value► If selling price is greater than carrying amount:– the gain is to be recognised immediately1-14Sale-and-leaseback:AASB 117● Where sales price is greater than fair value:► the gain is to be deferred and amortised over the period theasset is expected to be used● Where sales price is less than fair value:► the gain or loss is to be recognised immediately, unless a loss isto be compensated for by future lease payments below marketprice