2. Chapter Outline
BKAF3063 – A1222
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.
3. Learning outcomes:
BKAF3063 – A1223
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
4. Definition of Lease
BKAF3063 – A1224
MFRS 117 (Para 4):
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 of time.
5. Advantages of Lease
BKAF3063 – A1225
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 on operating
lease.
6. 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
BKAF3063 – A1226
7. Classification of Lease …cont.
BKAF3063 – A122
7
Risks include the
possibilities of losses from
idle capacity or
technological obsolescence
and of variations in return
due to changing economic
conditions
Rewards may be represented
by the expectation of
profitable operation over the
asset’s economic life and of
gain from appreciation in
value or realization of a
residual value.
8. Ownership Transfer
BKAF3063 – A122
8
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.
9. Classification of Lease:
Para 10 - depends on the substance of the
transaction rather than the form of the contract.
BKAF3063 – A122
9
Operating Lease
NO
NO
NO
NO
NO
YES
YES
YES
YES
YES
Ownership transfers at the end of the lease?
Bargain Purchase Option?
Lease term is for majority of economic life?75% or
more
PV of MLP equals at least substantially all of FV of
the leased asset? 90% or more
Leased asset(s) specialised?
Finance Lease
Finance Lease
Finance Lease
Finance Lease
Finance Lease
10. 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:
BKAF3063 – A12210
Operating Lease
Finance Lease
NO
NO
NO
YES
YES
YES
Cancellation losses borne by lessee?
Changes in FV of residual borne by lessee?
Bargain lease renewal option?
11. Terms
BKAF3063 – A12211
☺ 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.
12. Terms… (cont)
BKAF3063 – A12212
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)
13. Terms …(cont.)
BKAF3063 – A12213
☺ 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.
14. Terms …(cont.)
BKAF3063 – A12214
☺ 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.
15. Classification of Lease…cont.
BKAF3063 – A12215
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 7–13.
☞ 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.
16. Classification of Lease
BKAF3063 – A12216
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.
17. Classification of Lease
Criteria Satisfied?
Y / N
Explanation
Transfer of
title
N Not transferred.
BPO Y BPO = RM20,000
Length of lease
term
Y useful life = 17 years;
Lease term = 15 years.
PV of MLP Y FV = RM460,000;
PV of MLP = RM450,000.
Specialised
assets
N Not specified.
BKAF3063 – A12217
Solution to illustration 1:
18. Finance and operating leases: Differences
(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
BKAF3063 – A12218
19. Let’s take a look at
Operating Lease in
the book of Lessee
BKAF3063 – A12219
20. Operating Lease:
Accounting by Lessee
BKAF3063 – A12220
Para 33 – 34:
☞ Lease payments - should be recognised as an expense in the
income statement on a straight-line basis over the lease
term.
☞ Lease payments – should 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).
21. Operating Lease:
Accounting by Lessee
BKAF3063 – A122
21
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 accounting
period of both parties ends on 31 December.
22. Operating Lease :
Accounting by Lessee
BKAF3063 – A12222
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?
23. Date Particulars Debit Credit
1/1/11
31/12/11
Dr. Prepaid rent
Cr. Cash
Dr. Rent expense
Cr. Prepaid rent
18,000
14,000
18,000
14,000
1/1/12
31/12/12
Dr. Prepaid rent
Cr. Cash
Dr. Rent expense
Cr. Prepaid rent
16,000
14,000
16,000
14,000
1/1/13
31/12/13
Dr. Prepaid rent
Cr. Cash
Dr. Rent expense
Cr. Prepaid rent
14,000
14,000
14,000
14,000
1/1/14
31/12/14
Dr. Prepaid rent
Cr. Cash
Dr. Rent expense
Cr. Prepaid rent
12,000
14,000
12,000
14,000
1/1/15
31/12/15
Dr. Prepaid rent
Cr. Cash
Dr. Rent expense
Cr. Prepaid rent
10,000
14,000
10,000
14,000
BKAF3063 – A122
23
24. Let’s take a look at
Operating Lease in
the book of Lessor
BKAF3063 – A12224
25. Operating Lease:
Accounting by Lessor
BKAF3063 – A122
25
Para 49 – 55:
☞ Title is not transferred, therefore lessor should present
assets in their balance sheet according to the nature of the
assets.
☞ Payments received from lessee are recorded as Rent
Revenue on a straight-line basis over the lease term.
☞ Costs including depreciation incurred in earning the lease
income are recognised as an expense.
☞ Initial direct costs incurred by lessor shall be added to the
carrying amount of the leased asset and recognised as an
expense over the lease term.
26. Operating Lease:
Accounting by Lessor
BKAF3063 – A12226
Refer 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
Depreciation expense recognized per year = RM450,000/20
= RM22,500
Journal entries?
27. Operating Lease :
Accounting by Lessor
Date Particulars Debit Credit
1/1/11
31/12/11
Dr. Cash
Cr. Unearned rent revenue
Dr. Unearned rent revenue
Cr. Rent revenue
Dr. Depreciation expense
Cr. Accumulated depreciation
18,000
14,000
22,500
18,000
14,000
22,500
1/1/12
31/12/12
Dr. Cash
Cr. Unearned rent revenue
Dr. Unearned rent revenue
Cr. Rent revenue
Dr. Depreciation expense
Cr. Accumulated depreciation
16,000
14,000
22,500
16,000
14,000
22,500
BKAF3063 – A122
27
28. Let’s take a look at
Finance Lease in
the book of Lessee
BKAF3063 – A12228
29. Finance Lease :
Accounting by Lessee
BKAF3063 – A122
29
Para 20 – 30:
☞ Should be recognized as assets and liabilities (as if the assets
being purchased) at amounts equal to the fair value of leased
asset or if lower, at the PV of MLP [Para 20].
☞ Cost of assets recorded in lessee’s book:
The lower of:
Fair value at inception date.
PV of MLP at inception date.
OR
Reason: the leased
asset should not be
recorded for more than
its fair value.
30. Finance Lease :
Accounting by Lessee
BKAF3063 – A12230
Dr. Leased asset xxx *
Cr. Lease Liability xxx *
☞ The discount rate (to be used in calculating PV of MLP): implicit in the
lease.
IF impracticable to determine, use lessee’s incremental
borrowing rate.
☞ MFRS 117 requires the lessee to record the obligation arising from
finance lease at then same amount as the leased asset ( para 22)
☞ Journal entries :
* The lower of fair value or PV of MLP
31. Finance Lease :
Accounting by Lessee
BKAF3063 – A12231
☞ Interest: MLP Lease Liabilities/FV of asset :
► Lease payment should be apportioned between the
finance charge and the reduction of the
outstanding liability.
► Finance charge – allocated to periods during the
lease term so as to produce a constant periodic rate
of interest on the remaining balance of the liability
for each period [ Para 27].
☞ Contingent rents: charged as expense as incurred.
32. Finance Lease :
Accounting by Lessee
BKAF3063 – A12232
☞ Depreciation (Para 27):
► Depreciation policy should be consistent with that for depreciable
assets which are owned by the lessee (in accordance with
MFRS116).
► Use economic useful life, if the lease:
i. transferred rights at the end of lease term;
OR
ii. contains BPO.
► Otherwise, use:
The lower of:
Lease term
Economic useful life
OR
33. Finance Lease :
Accounting by Lessee
BKAF3063 – A122
33
Illustration 3:
Assume that Pajakan Company (lessor) and Trojan Company (lessee) sign a
lease agreement dated 1 January 2012. The terms are as follows:
Term of lease is 5 years, it is non-cancellable, requiring equal rental
payments of RM20,000 at the end of each year.
1. The FV = RM75,816 at the inception date, estimated useful life of 5 years,
and no residual value.
2. The lease contains no renewal options, and the equipment reverts to
Pajakan Co. at the termination of the lease.
3. Discount rate agreed by both parties is 10%.
4. Trojan Co. depreciates on a straight line basis, similar equipment that it
owns.
34. Finance Lease :
Accounting by Lessee
BKAF3063 – A12234
Solution to Illustration 3:
Type of lease: Finance lease
MLP = 20,000 x 5 years = RM100,000
PV of MLP = 20,000 x PVOA(5, 10%)²
= 20,000 x 3.7908
= 75,816 FV = 75,816.
Journal entry on 1 Jan 2012
Dr. Leased asset 75,816
Cr. Lease Liability 75,816
(to recognise the asset leased)
35. Finance Lease :
Accounting by Lessee
Date Annual lease
payment
(A)
Interest (10%)
(B)
Principal
payment
(C)
Lease liability
(D)
1 Jan 12 - - - 75,816
31 Dec 12 20,000 7,582 12,418 63,398
31 Dec 13 20,000 6,340 13,660 49,738
31 Dec 14 20,000 4,974 15,026 34,712
31 Dec 15 20,000 3,471 16,529 18,183
31 Dec 16 20,000 1,818 18,182 0
(D) X 10% (A) - (B) Preceeding
- (C)
BKAF3063 – A12235
Lease amortization schedule: Effective interest method
36. Finance Lease :
Accounting by Lessee
Date Particulars Debit Credit
31/12/12 Dr. Lease liability
Interest expense
Cr. Cash
Dr. Depreciation expense
Cr. Accumulated depreciation
12,418
7,582
15,163
20,000
15,163
31/12/13 Dr. Lease liability
Interest expense
Cr. Cash
Dr. Depreciation expense
Cr. Accumulated depreciation
13,660
6,340
15,163
20,000
15,163
BKAF3063 – A12236
Journal entries:
37. Finance Lease :
Accounting by Lessee
Date Particulars Debit Credit
31/12/14 Dr. Lease liability
Interest expense
Cr. Cash
Dr. Depreciation expense
Cr. Accumulated depreciation
15,026
4,974
15,163
20,000
15,163
31/12/15 Dr. Lease liability
Interest expense
Cr. Cash
Dr. Depreciation expense
Cr. Accumulated depreciation
16,529
3,471
15,163
20,000
15,163
BKAF3063 – A12237
Journal entries:
38. Finance Lease :
Accounting by Lessee
Date Particulars Debit Credit
31/12/16 Dr. Lease liability
Interest expense
Cr. Cash
Dr. Depreciation expense
Cr. Accumulated depreciation
20,000
1,818
15,163
20,000
15,163
Dr. Accumulated depreciation
Cr. Leased assets
(to record the return of the assets)
75,816
75,816
BKAF3063 – A12238
Journal entries:
39. Let’s take a look
at Finance
Lease in the
book of Lessor
BKAF3063 – A12239
40. Finance Lease :
Accounting by Lessor
BKAF3063 – A122
40
Para 36 – 40:
☞ The receivable to be presented in the Balance
Sheet at an amount equal to the net investment in
the lease [Para 36], which is defined in para 4 as
“the gross investment in the lease less unearned
finance income”
☞ Initial direct cost – included in the initial
measurement of finance lease receivable and
reduce the amount of income recognised over the
lease term [para 38].
41. Finance Lease :
Accounting by Lessor
BKAF3063 – A12241
Refer to Illustration 3:
Gross investment = 20,000 x 5 years = RM100,000
Net investment = PV of gross investment
= 20,000 x PVOA(5, 10%)
= 20,000 x 3.7908
= 75,816
Unearned finance income = 100,000 – 75,816 = 24,184
Amortization schedule?
Journal entries?
42. Finance Lease :
Accounting by Lessor
Date Particulars Debit Credit
01/01/05 Dr. Lease receivable
Cr. Fixed assets
Unearned interest revenue
100,000
75,816
24,184
31/12/05 Dr. Cash
Cr. Lease receivable
Dr. Unearned interest revenue
Cr. Interest revenue
20,000
7,582
20,000
7,582
31/12/06 Dr. Cash
Cr. Lease receivable
Dr. Unearned interest revenue
Cr. Interest revenue
20,000
6,340
20,000
6,340
BKAF3063 – A12242
Journal entries:
43. Bargain Purchase Option
MLP will be increased by the exercise price
Useful life will be used as basis for depreciation charge.
Example:
On 1/1/2011, ABC Bhd entered into lease agreement with terms:
a) non-cancellable lease term of four years,
b) Lease rental of RM10,000 per year to be paid on 31 Dec,
commencing 31/12/2011.
c) ABC Bhd has an option to buy the equipment at the end of lease
term for RM1,000. On 1/1/2011, it was estimated tha the fair
value of the equipment would be RM5,000 after 4 years’ usage.
The FV of the equipment on 1/1/2011 was RM42,000 and have
estimated useful life of 5 years. The implicit rate was 5%.
44. Bargain Purchase Option
Solution - Lesse:
MLP = (10,000 x 4) + 1,000 = 41,000
PV of MLP = (10,000 x PV n=4,i=5%) + (1,000 x PVA n=4,i=5%)
= 36,282
1/1/11 : Dr. Leased Equipment 36,282
Cr. Lease Payable 36,282
Depreciation exp = 36,282 / 5 = RM7,256.40
31/12/14 - exercise of BPO:
Dr. Lease Payable 1,000
Cr. Cash 1,000
45. Bargain Purchase Option
Solution - Lessor:
Gross Investment = (10,000 x 4) + 1,000 = 41,000
PV of MLP = (10,000 x PV n=4,i=5%) + (1,000 x PVA n=4,i=5%)
= 36,282
1/1/11 : Dr. Leased Receivable 42,000
Cr. Equipment 36,282
Unearned interest revenue 5,718
31/12/14 - exercise of BPO:
Dr. Cash 1,000
Cr. Leased Receivable 1,000
46. Guaranteed Residual Value
MLP will be increased by GRV
GRV will be deducted from the depreciable amount
of leased asset.
At the end of lease term,
the lease liability will have a balance equal with GRV
If FV of leased asset < GRV , recognise loss (lessee)
47. Guaranteed Residual Value
Example:
On 1/1/2011, ABC Bhd entered into lease agreement with terms:
a) non-cancellable lease term of four years,
b) Lease rental of RM10,000 per year to be paid on 31 Dec,
commencing 31/12/2011.
c) ABC Bhd guaranteed to lessor that the leased asset would
have a residual value of RM5,000 at the end of lease term.
The FV of the equipment on 1/1/2011 was RM42,000 and have
estimated useful life of 5 years. The implicit rate was 5%. The
estimated residual value at the end of lease term was RM7,000.
48. Guaranteed Residual Value
Solution – Lessee:
MLP = (10,000 x 4) + 5,000 = 45,000
PV of MLP = (10,000 x PV n=4,i=5%) + (5,000 x PVA n=4,i=5%)
= 39,572
1/1/11 : Dr. Leased Equipment 39,572
Cr. Lease Payable 39,572
Depreciation exp = (39,572- 5,000) / 4 = RM8,643
31/12/14, if FV of leased asset is RM3,000,
Dr. Lease Payable 5,000
Accumulated depreciation 34,572
Cr. Leased Equipment 39,572
Dr. Loss on finance lease 2,000
Cr. Cash 2,000
49. Guaranteed Residual Value
Solution – Lessor:
GI = (10,000 x 4) + 7,000 = 47,000
PV of GI = (10,000 x PV n=4,i=5%) + (7,000 x PVA n=4,i=5%)
= 41,218
1/1/11 : Dr. Leased Receivable 47,000
Cr. Equipment 41,218
Unearned interest revenue 5,782
31/12/14, if FV of leased asset is RM3,000,
Dr. Equipment 3,000
Cash 2,000
Loss on finance lease 2,000
Cr. Leased Receivable 7,000
50. Sales and Leaseback
BKAF3063 – A122
50
☞ Transaction in which the owner of the asset (seller, lessee)
sells the asset to another and simultaneously leases it back
from the new owner.
?
In the book of Buyer/lessor:
- Same as lessor as discuss before.
In the book of seller/lessee:
- To recognize gain from sales of
asset: immediate or defer.
51. Sales and Leaseback
BKAF3063 – A12251
Para 59: for Finance lease
Should not be recognized immediately, instead, should
be deferred and amortized over the lease term.
Profit = Sales proceed – Carrying amount
52. Sales and Leaseback
BKAF3063 – A12252
Para 61: for Operating lease.
Should be recognized immediately.
Profit = Sales proceed – Carrying amount
(a) If Selling price = FV
53. Sales and Leaseback
BKAF3063 – A12253
Para 61: for Operating lease
Should be recognized immediately EXCEPT THAT if the
loss is compensated by future lease payments at below
market price, it should be deferred and amortized.
Profit = Sales proceed – Carrying amount
(b) If Selling price < FV
54. Sales and Leaseback
BKAF3063 – A122
54
Para 61: for Operating lease
deferred and amortized.
Profit = Sales proceed – FV
(c) If Selling price > FV (FV > carrying amount)
recognized immediately.
Profit = FV - Carrying amount
Profit = Sales proceed – Carrying amount
55. Sales and Leaseback
BKAF3063 – A12255
Illustration 5:
Chocolate Company sold an equipment to Chips Company and
lease back the asset. The carrying amount (book value) of the
asset is RM60,000. The asset has a fair value of RM70,000.
How to recognize profit/loss if the selling price:
1. RM70,000
2. RM55,000
3. RM50,000 (with lower lease payment)
4. RM90,000
56. Sales and Leaseback
BKAF3063 – A12256
Solution to Illustration 11:
1. SP < FV (SP > CA) =
Profit = 70,000 - 60,000 = 10,000
2. SP < FV (SP < CA)
Loss = 55,000 – 60,000 = 5,000 loss
3. SP < FV (SP < CA with lower lease payment)
Loss = 50,000 – 60,000 = 10,000 loss
recognize immediately
recognize immediately
defer & amortize
58. Disclosure Requirements
BKAF3063 – A12258
For Lessee:
Para 31: Finance lease.
Para 35: Operating lease.
For Lessor:
Para 47: Finance lease.
Para 56: Operating lease.
59. End of Chapter 2
(Part 1)
References:
MFRS 117 Lease
Ng Eng Juan 2010
Lazar & Huang 2012
Zaimah et al. 2009
BKAF3063 – A12259
