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Section 20: Leases.
20.2.1 Extract from FRS 102 – Section 20.1-20.2.
20.2.2 OmniPro comment – Scope.
20.3 Determining whether an arrangement contains a lease.
20.3.1 Extract from FRS 102 – Section 20.3- 20.3A.
20.4 Classification of leases.
20.4.1 Extract from FRS 102 – Section 20.4- 20.7.
20.4.2.1 Risks and rewards of ownership.
20.4.2.2 Lease term defined and major part of an asset life – option to extend.
20.4.2.4 Indicators suggesting a finance lease exists.
20.4.2.4.1 Option to purchase at end of lease – put and call options / residual value guarantees.
20.4.2.4.2 Meaning of substantially in respect to present value of future payment
20.5 Change in lease classification.
20.5.1 Extract from FRS 102 – Section 20.8.
20.6 Initial recognition and subsequent measurement-financial statements of lessees: finance leases
20.6.1 Extract from FRS 102 – Section 20.9- 20.12.
20.6.2.2 Interest rate implicit in the lease.
20.6.2.3 Minimum lease payments including options to extend.
20.6.2.4 Depreciation of leased assets.
20.6.2.6 Lessee: Initial and subsequent measurement – finance lease.
20.7.1 Initial Recognition and subsequent measurement
20.7.1.1 Extract from FRS 102 – Section 20.15-20.15B.
20.7.1.2.2 Time when expense is recognised.
20.7.1.2.3 Costs directly incurred in negotiating/arranging lease.
20.7.1.2.4 Treatment of termination penalties.
20.7.1.2.5 Operating leases with payment linked to other variables.
20.8 Initial recognition and subsequent measurement -financial statements of lessors: finance leases
20.8.1 Extract from FRS 102 – Section 20.17-20.19.
20.9 Manufacturer or dealer lessors.
20.9.1 Extract from FRS 102 – Section 20.20-20.22.
20.10 Financial statements of lessors: operating leases.
20.10.1 Extract from FRS 102 – Section 20.24-20.25 and Section 20.27-20.29.
20.10.1.1 Recognition and measurement
20.10.1.2.2 Time when expense is recognised.
20.10.1.2.3 Costs directly incurred in negotiating/arranging lease.
20.10.1.2.4 Operating lease with payments linked to other variables.
20.10.1.2.5 Lease incentives – lesser
20.11 Sale and leaseback transactions.
20.11.1 Extract from FRS 102 – Section 20.32-20.34.
20.11.2.1 Sales and lease back defined.
20.11.2.2 Sales and lease back – finance lease.
20.11.2.3 Sales and lease back – operating lease.
20.12.1 Disclosures for operating leases – Lessors.
20.12.1.1 Extract from FRS 102 – Section 20.30.
20.12.1.2.1 Accounting policy note.
20.12.1.2.2 Extract from notes to the financial statements.
20.12.2 Disclosures – Operating leases for lessees.
20.12.2.1 Extract from FRS 102 – Section 20.
20.12.2.2.1 Accounting policy example.
20.12.2.2.2 Notes to the financial statements.
20.12.3 Sale and leaseback disclosures.
20.12.3.1 Extract from FRS 102 Section 20.35.
20.12.4 Disclosures – financial statements of lessees: finance leases.
20.12.4.1 Extract from FRS 102 – Section 20.13- 20.14.
20.12.4.2.1 Accounting policy disclosures.
20.12.4.2.2 Extract from notes to the financial statements.
20.12.5 Disclosures – financial statements of lessors: finance leases.
20.12.5.1 Extract from FRS 102 – Section 20.23.
20.12.5.2.1 Accounting policy disclosure.
20.12.5.2.2 Extract from notes to the financial statements
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20.8 Initial Recognition and Subsequent Measurement – Financial Statements of Lessors: Finance Leases
20.8.1 Extract from FRS 102 – Section 20.17-20.19
20.17 A lessor shall recognise assets held under a finance lease in its statement of financial position and present them as a receivable at an amount equal to the net investment in the lease. The net investment in a lease is the lessor’s gross investment in the lease discounted at the interest rate implicit in the lease. The gross investment in the lease is the aggregate of:
(a) the minimum lease payments receivable by the lessor under a finance lease;
AND
(b) any unguaranteed residual value accruing to the lessor.
20.18 For finance leases other than those involving manufacturer or dealer lessors, initial direct costs (costs that are incremental and directly attributable to negotiating and arranging a lease) are included in the initial measurement of the finance lease receivable and reduce the amount of income recognised over the lease term.
Subsequent measurement
20.19 The recognition of finance income shall be based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the finance lease. Lease payments relating to the period, excluding costs for services, are applied against the gross investment in the lease to reduce both the principal and the unearned finance income. If there is an indication that the estimated unguaranteed residual value used in computing the lessor’s gross investment in the lease has changed significantly, the income allocation over the lease term is revised, and any reduction in respect of amounts accrued is recognised immediately in profit or loss.
20.8.2 OmniPro comment
Section 20.17 to 20.19 of FRS 102 provides the rules to lessers in relation to finance leases. The accounting calculations for the lessor and the thought process is almost a mirror to what it is for a lessee. These were discussed at 20.4.2. The exception is in the determination and calculation of the minimum lease payments. For the lessor they must include the minimum lease payments to be received plus any residual value that has been guaranteed (whether by the lessee or someone related to them or a third party) in addition to the payments required to be made by the lessee.
Example 6: Finance lease accounting for the lessor
If we take example 3 at 20.6.2.6 and apply this from the perspective of the lessor this time as opposed to the lessee. Assume payments are made annually. Note if payments are made monthly then it would have to be completed on a monthly basis.
| Year | Opening Balance | Rent Received | Capital Element | Financial Income for Period 13.477% | Gross investment allocated at end of period | Gross earning allocated to future periods | Net investment at end of period |
| 1 | 50,000 | 12,000 | 38,000 | 5,121 | 53,000 | 9,879 | 43,121 |
| 2 | 43,121 | 12,000 | 31,121 | 4,194 | 41,000 | 5,685 | 35,315 |
| 3 | 35,315 | 12,000 | 23,315 | 3,142 | 29,000 | 2,542 | 26,458 |
| 4 | 26,458 | 12,000 | 14,458 | 1,948 | 17,000 | 594 | 16,406 |
| 5 | 16,406 |
12,000 _______ |
4,406 |
594 _______ |
5,000 | – | 5,000 |
| 60,000 | 15,000 |
The CU15,000 represents the interest income earned over the life of the lease (i.e. the CU60,000 in rentals received over the life of the lease plus the expected residual value for which the lessor is entitled to of CU5,000). At any period end the net receivable balance is the unearned finance income plus the residual value. The journals required on initial recognition are:
| CU | CU | |
| Dr Grossed Leased Asset | 50,000 | |
| Cr Creditors | 50,000 |
Being journal to reflect the initial purchase of the assets and the initial recognition of the lease assuming it occurs straight away
Then throughout the life the finance income will be journaled. For example the journal required at the end of year one would be:
| CU | CU | |
| Dr Gross leased asset | 5,121 | |
| Cr Gross earnings allocated to future periods | 5,121 |
Being journal to reflect finance income on invoices raised in period
| CU | CU | |
| Dr Gross Earnings Allocated to Future Periods on BS | 5,121 | |
| Cr Finance Income/Turnover | 5,121 |
Being journal to recognise the finance income as it is earned
The receipts into the bank are obviously set against the gross leased asset as they are received.
As can be seen from the above, a key estimation for lessors is the residual value of the asset. Therefore if this change in estimate occurs it is corrected prospectively. The difference between the carrying amount at the date of change in estimate and the recalculated balance using the original effective interest rate is credited or debited to finance income. In order to determine the required carrying value on the revised residual amount, the present value of future receivables needs to be calculated using the same effective rate.
Example 7: Finance lease accounting for the lessor – change in residual value
If we take example 3 at 20.6.2.6 and assume that the estimated residual value at the end of year 3 changes to CU4,500. See below the revised cash flows present valued using the original effective rate:
| Period Ending | Cashflows | Formula to get PV factor | Discount rate at 13.477% PV factor | Present Value of Cash Flow |
| 3 | 12,000 | 1 | 1 | 12,000 |
| 4 | 12,000 | 1/(1.13477)^1 | 0.8812 | 10,575 |
| 5 | 12,000 | 1/(1.13477)^2 | 0.7766 | 9,319 |
| End of Year 5 | 4,500 | 1/(1.13477)^3 | 0.6843 |
3,080 _____________ |
| Total PV | 34,973 |
We then recalculate the interest to be charged over the remaining years.
| Year | Opening Balance | Rent Received | Capital Element | Finance Income for Period 13.477% | Gross investment allocated at end of period | Gross earning allocated to future periods | Net investment at end of period |
| 3 | 34,973 | 12,000 | 22,973 | 3,096 | 37,973.29 | 11,904 | 26,069 |
| 4 | 26,069 | 12,000 | 14,069 | 1,896 | 25,973 | 10,008 | 15,966 |
| 5 | 15,966 | 12,000 | 3,966 | 534 | 13,973 | 9,473 | 4,500 |
The difference of CU342 between the carrying amount at the end of year 2 as calculated in example 6 of CU35,315 and the recalculated balance at the start of year 3 of CU34,973 is debited against finance income in the year.
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Examples
Example 1: Residual value guarantee.
Example 2: Changes in lease classification.
Example 3: Accounting for finance leases – initial recognition and subsequent measurement– Lessee
Example 4: Operating lease with inflationary increases.
Example 4A: Leases linked to general inflation indexes.
Example 6: Finance lease accounting for the lessor
Example 7: Finance lease accounting for the lessor – change in residual value.
Example 8: Operating lease with inflationary increases.
Example 10: Sale and Leaseback
Example 10A: Extract from an accounting policy note and the related disclosures – Operating Lease.
Example 13: Extract from an accounting policy note and related disclosures for financial statements of lessors: finance leases.
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