OPERATING LEASE
Lessees now must treat all leases as finance lease unless it is only 1 year or shorter and
determined to be low value items.
The lessor shall recognize lease or rental income using the straight-line method over the lease
term.
If the rentals are uneven (increasing or decreasing) or there is a period where rentals are not
paid. The total amount of rentals is computed and divided equally over the lease term.
Contingent rentals are recognized as additional income by the lessor using the accrual method.
Lease bonuses or prepayments (additional lumpsum amount received at the inception or start
of the lease) should be deferred and amortized as additional rental income over the lease term.
Initial direct cost is capitalized as cost of the leased asset and amortized as expense over the
lease term.
The depreciation on the asset and other expenses related to the ownership of the asset like
insurance and taxes shall be recognized as an expense by the lessor.
SALE AND LEASEBACK
The lessee shall automatically recognize a lease liability and capitalize the “right of use asset”
account for the asset sold and leased back.
There is no problem if the selling price is at fair value. If the selling price is above fair value, the
difference shall be treated as a lease incentive or additional financing and shall be deducted
from the lease liability and other components in computing for the right of use asset. If the
selling price is below fair value, the difference shall be treated as a lease prepayment and
therefore added in computing for the cost of the right of use asset.
SP>FV = additional financing (not included in the right of use asset)
SP<FC = lease prepayment (included)
Fair Value of the asset:
a. Right retained (PV of the lease payment plus lease prepayment)
b. Right transferred
Cost of Right of use asset to be recognized:
= (Carrying Amount X Percentage of right retained) + Initial Direct Cost
TOTAL gain on “right of use asset”
=FV of the Asset – CA of the Asset
Gain on right of use asset to be recognized
=TOTAL GAIN X Percentage of right transferred
FINANCE LEASE
1. LESSEE
The lessee shall always treat the lease as a finance lease unless low value or short-term (it is a
finance lease by default)
Right of use asset:
PV of lease payments (initial lease liability)
Lease Bonus
Initial Direct Cost
Cost of dismantling, removing and restoring (where the entity has a present obligation)
MINUS any lease incentives
Lease Payment:
Fixed Lease Payment
Variable Lease Payment
Purchase Option (must certain to be exercised)
Guaranteed Residual Value
Any termination penalties
If the lease payments are in advance use the PV of an annuity due if the it’s at the end of the
period use the PV of an ordinary annuity. Meanwhile the PV of 1 is used for the purchase option
and residual value guarantee.
The discount (difference of total payments and PV) is amortized using the effective interest
method and recognized as interest expense. While the difference of the interest and payment
shall be a reduction of the lease liability.
*What rate to be used?
1. rate of return of the lessor, if the lessee knows
2. Otherwise, use the incremental borrowing rate of the lessee
The amount to be recognized as a reduction of the lease liability within 12 months shall be
classified as a current liability.
The right of use asset shall be depreciated using the useful life if there is a transfer of ownership
or reasonable certain purchase option. If not, the useful life or lease term whichever is shorter is
used.
EXECUTORY COST is an outright expense
2. LESSOR
Can be accounted as Operating lease or finance lease. It is under finance lease if ANY of the
following is met:
a. Transfer of title
b. Purchase option (certain)* If the exercise price is < the FV of the asset at the end of the
lease term
c. Lease term is @ least 75% of the useful life
d. The PV of lease payment is @ least 90% of the FV of the asset
Finance Lease
a. Sales type lease
b. Direct financing lease
SALES TYPE LEASE DIRECT FINANCING LEASE
Gross Investment
=Gross rentals(lease payment)+Residual SAME
Value (whether G/UG)
Net Investment Net Investment
=Present Value of Gross Investment =cost of the asset + any initial direct cost
by the lessor
Total Financial Revenue SAME
=Gross Investment – Net Investment
Sales N/A
=Net Investment/Fair Value (lower)
Cost of Sales N/A
=Cost of the asset plus any initial direct
cost
Gross Profit N/A
= Sales-COS
Initial Direct Cost Initial Direct Cost
*Expensed (Cost of Sale) *Capitalized as cost of the asset (Net
Investment)
