LKAS 17

ORIENTATION

Objective  Scope  Definition Classification of Leases  Finance Lease  Operating Lease   Finance Leases and Operating Leases Calculations    Sale and lease back  Disclosures 

OBJECTIVE

The objective of this Standard

is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to leases.

Where can this stand apply?

Where shall not be applied?

DEFINITION OF A LEASE

Finance lease

Operating lease

A lease is 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

FINANCE LEASES V OPERATING LEASES

A lease is a finance lease if it transfers substantially all the risks and rewards incident to ownership

A lease is an operating lease if it does not transfer substantially all the risks and rewards incident to ownership

Finance Lease Operating Lease

Substance over Form

RISKS AND REWARDS INCIDENT TO OWNERSHIP

Losses from idle capacity

Technological obsolescence

Changes in value due to changing economic conditions etc.

Expectation of service potential or profitable operation over the asset’s economic life

Gain from appreciation in value

Realisation of a residual value etc.

Risks Rewards

FINANCE LEASE OR OPERATING LEASE? (4) Conclude on whether

substantially all the risks and rewards have been transferred from the lessor to the lessee

(1) Identify the business purpose behind the lease and its economic impact together with the economic issues at the end of the lease term

(2) Determine the lease term

(3) Determine the net present value (NPV) of the minimum lease payments

Cancellation provisions

Rights and obligations at end of lease

Renewal options

FINANCE LEASE OR OPERATING LEASE?

Examples of situations which would normally lead to a lease being classified as a finance lease: The lessor transfers ownership of the asset to the

lessee at the end of the lease term

The lessee has the option to purchase the asset at a price, which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised

FINANCE LEASE OR OPERATING LEASE?

Examples of situations which would normally lead to a lease being classified as a finance lease (cont’d): The lease term is for the major part of the economic

life of the asset even if title is not transferred The leased assets are of a specialised nature such

that only the lessee can use them without major modifications being made

The leased assets cannot be easily replaced At the inception of the lease, the present value of

the minimum lease payments (MLP) amounts to at least substantially all of the fair value of the leased asset

FINANCE LEASE OR OPERATING LEASE?

Other indicators which individually or in combination could also lead to a lease being classified as a finance lease: If the lessee can cancel the lease, the lessor’s

losses associated with the cancellation are borne by the lessee

The lessee bears gains/losses from changes in the fair value of the residual

The lessee has the ability to continue the lease for a secondary period at a rate which is substantially lower than market rate

ACCOUNTING FOR FINANCE LEASE

FINANCE LEASE – ACCOUNTING BY LESSEE

Substance of the transaction should be considered. At the beginning of the lease term, the lessee

recognizes, The leased asset and The obligation to make lease payments as

a liability The asset and liability are measured at the lower

of The fair value of the asset The present value of the minimum lease

payments

FINANCE LEASE – ACCOUNTING BY LESSEE CONT..

Lease payments are split between finance charge and the repayment of the outstanding liability.

The depreciation policy for assets held under finance leases should be consistent with that for owned assets. If the lessee will obtain ownership of the asset

at the end of the lease, depreciation is made over the useful life of the asset.

Otherwise the asset should be depreciated over the shorter of the lease term or the life of the asset.

DOUBLE ENTRIES IN THE BOOKS OF THE LESSEE – FINANCE LEASE

Recognize the assetNon-Current asset DrLessor Cr

Lease rental repaymentLessor DrCash/ Bank Cr

Annual InterestInterest Expense (P&L) DrLessor Cr

DOUBLE ENTRIES IN THE BOOKS OF THE LESSOR – FINANCE LEASE

Asset transferredReceivable DrNon-current asset Cr

For the lease installment receivedCash/Bank DrLessee Cr

For the interestLessee DrInterest income Cr

OPERATING LEASE

DEFINITION

An operating lease is a lease other than finance lease

Lease that does not transfer substantially all of the risks and rewards to the lessee.

LessorRight to use asset

Lessee

Asset

OPERATING LEASE – ACCOUNTING BY LESSEE / LESSOR

Lessee LessorStatement of financial position

Prepaid/accrued lease rental payable

Leased assetAccrued/deferred lease rental receivable

Statement of comprehensive income

Lease rental expense

Depreciation expense

Lease rental income

ACCOUNTING BY LESSEE

An asset is not recognized Rental under operating lease are charged to

the income statement on a straight line basis over the term of lease, unless another systematic and rational basis is more appropriate.

Any difference between amount charged and amounts paid will be prepayments or accruals.

ACCOUNTING BY LESSOR

Lease income from operating leases shall be recognized in income on straight line basis over the lease term, Unless another systematic basis is more representative of the time pattern in which use benefit derived from the leased asset diminished.

The depreciation policy for depreciable leased assets shall be consistent with the lessor’s normal depreciation policy for similar assets and depreciation shall be calculated in accordance with LKAS 16.

DOUBLE ENTRIES IN THE BOOKS OF THE LESSEE – OPERATING LEASE

Lease rental repayment

Rental expense DrCash or accrued lease rental payable Cr

DOUBLE ENTRIES IN THE BOOKS OF THE LESSOR – OPERATING LEASE

At the Beginning

Leased asset DrCash or creditor Cr

At the end of the year

Depreciation expense DrLeased asset Cr

Cash or accrued lease rental DrLease rental income Cr

26

OPERATING LEASE - EXAMPLE Example

On 1 January 2014, X signs a 5-year lease for equipment

The cost of the equipment was 30,000 Total lease payments are 20,000 (4,000/year) Unguaranteed residual value is 15,000 Economic life of equipment is 10 years

Questions What are the journal entries to be recorded at 1

January 2014 and 31 December 2014?

27

OPERATING LEASE - SOLUTION (LESSEE)

No entry at 1 January 2014

At 31 December 2014:

Dr Rental expense 4,000

Cr Cash or accrued lease rental payable 4,000

28

OPERATING LEASE - SOLUTION (LESSOR)

At 1 January 2014:

Dr Leased asset 30,000

Cr Cash or creditor 30,000

At 31 December 2014:

Dr Depreciation expense 3,000

Cr Leased asset 3,000

Dr Cash or accrued lease rental 4,000

Cr Lease rental income 4,000

EXERCISE

Samson PLC has purchased a machine on 01st of April 2014 under the terms of lease for 5 million for the period of 5 years at the rate of 12%. First payment coming at the end of the first year. The lease agreement specifies that Samson PLC gets to keep the machine at the end of the lease.

QuestionIndicate the amortization schedule & calculate the appropriate amounts to be included in the financial statements of the lessee for the year ended 31st March 2015.

AMORTISATION SCHEDULE

YearOpening Balance Installment Interest Capital

Closing Balance

0 -

-

-

-

5,000,000.

00

1

5,000,000.0

0

1,387,115.00

600,000.00

787,115.00

4,212,885.

00

2

4,212,885.0

0

1,387,115.00

505,546.20

881,568.80

3,331,316.

20

3

3,331,316.2

0

1,387,115.00

399,757.94

987,357.06

2,343,959.

14

4

2,343,959.1

4

1,387,115.00

281,275.10

1,105,839.9

0

1,238,119.

24

5

1,238,119.2

4

1,387,115.00

148,574.31

1,238,119.2

4 -

6,935,575.00

1,935,153.55

5,000,000.0

0

LEASE SCHEDULEGross Lease liability

Opening balance as at 01st April 2014 - Add : Lease obtained during the year 6,935,575Less : Settlements during the period -1,387,115Balance as at 31st March 2015 5,548,460

Interests in Suspense

Opening balance as at 01st April 2014 - Add : Interest in suspense charge during the year 1,935,154Less : Charged to Income Statement -600,000Balance as at 31st March 2015 1,335,154

LEASE OBLIGATION AS AT 31ST MARCH 2015 4,212,885

BALANCE SHEET CLASSIFICATION

CURRENT PORTION

Gross Lease liability 1,387,115INTERESTS IN SUSPENSE -505,546LEASE OBLIGATION ( Net Lease liability ) 881,569

LONG TERM PORTION Gross Lease liability 4,161,345INTERESTS IN SUSPENSE -829,607LEASE OBLIGATION ( Net Lease Liability ) 3,331, 316

TOTAL LEASE OBLIGATION AS AT 31ST MARCH 2015 4,212,885

SALE AND LEASEBACK

TRANSACTIONS

DEFINITION

Sale and leaseback transaction is an arrangement in which one party sells a property to a buyer and the buyer immediately leases the property back to the seller.

Advantages of sale and leaseback Releases cash tied up in assets already

owned Cheaper than borrowing money All the risks & rewards of the asset are

transferred to the buyer The lessee can still use the asset No extra time required for re-training on

new equipment

Disadvantages of sale and leaseback Loss control over the asset In the long term it is more expensive

Accounting Treatment for Sales & Leaseback Transactions

Sale & Leaseback Under Finance Lease

If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over the carrying amount shall not be immediately recognized as income by a seller-lessee. Instead, it shall be deferred and amortized over the lease term.

Sale & Leaseback Under Operating Lease

Any profit or loss arising is accounted for as followsIf the transaction is;

Recognize immediately

At fair valueBelow fair valueFuture lease

rentals at market rate

Recognize immediately

Future lease rentals below market rate

Deferred & amortized over the lease period Above fair

valueExcess over fair value should be deferred & amortized over the lease period

DISCLOSURES

KEY DISCLOSURES – FINANCE LEASES (LESSEES) Requirements of SLFRS 7 Net carrying amount at the end of the reporting

period A reconciliation between the total of future

minimum lease payments Contingent rents recognized as an expense in the

period General description of the lessee’s material

leasing arrangements Requirements for disclosure in accordance with

LKAS 16, LKAS 36, LKAS 38, LKAS 40 and LKAS 41 apply to lessees for assets leased under finance leases

KEY DISCLOSURES – OPERATING LEASES (LESSEES) Total of future minimum lease payments

Lease and sublease payments recognized as an expense in the period

General description of the lessee’s significant leasing arrangements

KEY DISCLOSURES – FINANCE LEASES (LESSORS)

Requirements in SLFRS 7

Reconciliation between the gross investment in the lease at the end of the reporting period

Unearned finance income

Unguaranteed residual values accruing to the benefit of the lessor

KEY DISCLOSURES – FINANCE LEASES (LESSORS) Accumulated allowance for uncollectible

minimum lease payments receivable

Contingent rents recognized as income in the period

General description of the lessor’s material leasing arrangements.

KEY DISCLOSURES – OPERATING LEASES (LESSORS) Requirements of SLFRS 7 Future minimum lease payments under

non-cancellable operating leases Total contingent rents recognized as

income in the period General description of the lessor’s leasing

arrangements disclosure requirements in LKAS 16, LKAS

36, LKAS 38, LKAS 40 and LKAS 41 apply to lessors for assets provided under operating leases

SUMMARY

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