Leases : Lessor Accounting

Question 1

What are the 3 things we use to identify a lease?

Answer 1

1.) Right to control - Present if customer (potential lessee) has the right to
2.) Identified asset
3.) Period of time

Question 2

According to IFRS 16, what are the two different leases?

Answer 2

1.) Finance leases (for which a lease receivable is recognised as an asset in the statement of financial position
2.) Operating leases = which are accounted for as rental income in statement of profit or loss.

Question 2

Definition of a Finance Lease:

Answer 2

A lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset.

Question 3

Definition of Operating Lease:

Answer 3

A lease does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.

Question 4

According to IFRS 16 what are the 5 examples of situations that would would lead to lease being classified as finance lease:

Answer 4

STOMP
1.) S = underlying asset is of such SPECIALISED nature that only lessee can use it without major modifications
2.) T = lease TRANSFERS ownership of underlying asset to lessee by the end of lease term
3.) O = lessee has OPTION to purchase underlying asset at a price sufficiently lower than fair value at the exercise date that is reasonably certain at inception date that option will be exercised
4.) M = lease term is MAJOR part of underlying asset’s economic life
5.) P = PRESENT value of lease payments at inception date amounts to at least substantially all of fair value for underlying asset.

Question 5

What is the accounting entry for the Recognition and initial measurement for a finance lease?

Answer 5

Debit(receivable): Net investment in the lease
Credit (take out underlying asset) : Property,plant and equipment
Credit/Debit Profit or loss (balancing figure)

Question 6

How to calculate the Net investment in the lease (receivable)

Answer 6

• Present value of lease payments not received at the commencement date (does not include payments already received)
• Present value of any unguaranteed residual value accruing to the lessor
  =TOTAL

Question 7

What is the definition of unguaranteed residual value?

Answer 7

That portion of residual value of underlying asset, the realisation of which by a lessor is not assured or is guaranteed solely by a party related to the lessor.

Question 8

What is the discount rate to be applied to lease payments to calculate the net investment in lease?

Answer 8

The Interest Rate implicit in the lease. Referred to as ínternal rate of return (IRR)’.

Question 9

What do the Lease payments (measurement of net investment) include?

Answer 9

1.) Fixed lease payments
2.)Variable lease payments that depend on in an index(eg consumer price index) or rate(eg market rate)
3.)Any residual value guarantees provided to the lessor by lessee, party related to lessee or unrelated third party capable of discharging the obligations under the guarantee
4.) The exercise price of a purchase option if lessee is reasonably certain to exercise it
5.) Payments of penalties for terminating the lease, the lease term reflects the lessee exercising an option to terminate.

Question 10

Initial direct costs:

Answer 10

Initial direct costs incurred by lessor as a result of entering into lease are included in initial measurement of net investment in the lease.
Interest rate implicit in lease is defined in such a way that there is no need to add them separately.

Question 11

How do you measure the finance income as a result of a finance lease?

Answer 11

• Recognised over lease term based on pattern reflecting a constant periodic rate of return on lessor’s net investment in lease. Known as ‘interest rate implicit in the lease’ or ínternal rate of return’.

Question 12

What are the accounting entries for finance income?

Answer 12

INCREASE
Debit: Net investment in the lease (increase receivable)
Credit : Finance income
OR DECREASE
Debit : Cash
Credit : Net investment in the lease

Question 13

What is the Operating Lease’s Recognition and measurement?

Answer 13

Under an operating lease, the lessor retains the risks and rewards of ownership. Therefore on commencement of the lease, the lessor should continue to recognise the underlying asset.

Question 14

How are lease payments of Operating Leases recognised?

Answer 14

Are recognised as income on either a straight-line basis or another systematic basis.

Question 15

How are initial direct costs of an Operating Lease recognised?

Answer 15

Are added to the carrying amount of the underlying asset. Either IAS16 PPE or IAS38 Intangible Assets then applies to depreciation or amortisation of the underlying asset as appropriate.