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Financial Accounting II

Prepared by: BCSV

CHAPTER 4: Leases
Lessor the owner of the leased property .
- nagpapaupa
Lessee the one who receives the right to
use the leased property.
- nangungupa
1. The LESSEE acquires ONLY the right
to the USE of the leased property.
2. The LESSOR retains the ownership
or title of the leased property.
3. Lease classification is made at the
INCEPTION of the lease.
CLASSIFICATION:
1. Operating lease
2. Finance lease
=========================

OPERATING LEASE

1. Lease income/expense should be


recognized on a straight-line basis
over the lease term (recognized
revenues/expenses annually should
be the same even periodic payments
are not the same.)
2. Initial direct costs (finders fee and
legal expenses) shall be capitalized
as a component of the carrying
amount of the leased asset and
recognized as an expense (part of
depreciation expense) over the
lease term on the same basis as
lease revenue.
3. Executory costs (property taxes,
repairs & maintenance, and
insurance) are expensed when
incurred.
4. In cases the lessor granted free rent,
rent expense/revenue are recorded
in the books of the lessee/lessor in
spite of zero rental payments.
Lessees viewpoint
1. Lease bonus
paid by the
lessee should

Lessors viewpoint
1. Lease bonus
paid by the
lessee should

be
recognized
as an
expense over
the lease
term.
2. Lease bonus
granted by
the lessor is
treated as a
deduction
from rent
expense over
the lease
term.
3. Contingent
rentals are
added to rent
expense in
the period in
which they
arise.

be
recognized
as a revenue
over the
lease term.
2. Lease bonus
granted by
the lessor is
treated as a
deduction
from rent
revenue over
the lease
term.
3. Contingent
rentals are
added to rent
revenue in
the period in
which they
arise.

=========================

FINANCE LEASE

[Lessees books]
- Initially recognize finance leases as
assets and liabilities at the LOWER
of [leased assets fair value vs.
present value of the minimum lease
payments]
If the lease contains:
1. BARGAIN PURCHASE OPTION, its
present value shall be included in
the leased assets cost.
2. GUARANTEED RESIDUAL VALUE, its
present value shall be included in
the leased assets cost.
3. In no case should: Capitalized cost >
fair value of the leased asset at the
INCEPTION of the lease.
For computation for the present value
factors:
1. Lessors implicit interest rate
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Financial Accounting II
Prepared by: BCSV

2. Lessees incremental borrowing


rate, if the above rate is not
determinable.
1. Executory costs are charged to
expense when incurred.
2. UNGUARANTEED RESIDUAL
VALUE, the lessee has no obligation
for the residual value at the end of
the lease term. It is not included in
the minimum lease payments.
If:
1. There is a reasonable certainty that
the lessee will obtain ownership by
the end of the lease term, the lessee
records depreciation on the leased
asset USING THE LESSEES NORMAL
DEPRECIATION POLICY BASED ON
THE ECONOMIC LIFE OF THE
ASSET. (Depreciable cost = Cost
salvage valueend of life)
2. There is no reasonable certainty
that the lessee will obtain
ownership by the end of the lease
term, the leased asset must be
depreciated over the SHORTER of
the [lease term vs. economic life of
the asset]. (Depreciable cost = Cost
guaranteed salvage value)
Minimum lease payments include:
(1) Total periodic payments over the
lease term.
(2) Bargain purchase option
(3) GUARANTEED residual value
Minimum lease payments DO NOT include:
(1) Contingent rentals
(2) Executory costs (property taxes,
repairs & maintenance, and
insurance)
[Lessors books]

Financial Lease Lessors viewpoint


Direct

Manufacturers/

Other
terms:
Lessor:
Asset for
lease
Revenue
earned

Financing
Lease
Simple
financing
lease
Financial
institutions
Not inventory
(still to be
bought)
Interest
revenue

Dealers lease
Sales-type lease
Dealer or
manufacturer
Inventory
(Finished
goods)
Gross profit &
interest
revenue

1. DIRECT FINANCING LEASE


- No gross profit from the lease
transaction.
- PV of the minimum lease payments
(MLP) = fair market value of the
leased asset = carrying amount of
the leased asset.
- Gross investment = finance lease
receivable (FLR), the
UNDISCOUNTED amount of the MLP
+ (if any of the following)
1. Guaranteed residual value
2. Unguaranteed residual value
3. Bargain purchase option
(NOTE: they cannot exist simultaneously)
- Net investment = Asset for Lease,
the DISCOUNTED (PV) amount of
MLP + (if any of the following)
1. Guaranteed residual value
2. Unguaranteed residual value
3. Bargain purchase option
(NOTE: they cannot exist simultaneously)
- Gross investment (FLR) Net
investment (A-for-L) = Unearned
Interest Revenue (UIR), is
amortized over the term of the lease
(Eff. Int. method).
- In cases when the title to the
property is not expected to be
transferred to the lessee, the assets
residual value (Guaranteed or
Unguaranteed) at the end of lease

Financial Accounting II
Prepared by: BCSV

term is included in the balance of


FLR account (or Gross investment).
To the lessor, it does NOT matter
whether the residual value is
guaranteed or unguaranteed.
Initial direct costs (IDL) incurred by
the LESSOR (always) is deducted
from UIR (added to the net
investment in the lease) and
amortized over the life of the lease.
Executory costs are charged to
expense when incurred.

BPO is treated same as GRV.

Source: Intermediate Accounting vol. 2 by


Robles & Empleo

2. MANUFACTURERS LEASE
- The lessor records the lease as a sale
of inventory on a deferred payment
contract.
- The lessor recognizes (in full) an
immediate profit (manufacturers
profit) at the commencement of the
lease.
- Sales price = FMV, the PV of MLP.
- Executory costs are charged to
expense when incurred.
- Cost of negotiating and arranging a
lease is charged to expense when
incurred (Addition to CGS [normal]
or charge to Selling expense).

MLP
BPO
GRV
URV
-

Gross:

PV of
Sales

XX
XX
XX
XX

X
X
X

PV of
CGS

(X)

CV of leased asset is recognized as


CGS.
Gross investment also includes the
unguaranteed residual value
however, the PV of URV reduces the
CGS.
If GRV, its PV increases the selling
price.
If URV, its PV reduces the CGS.
Whether GRV or URV, gross profit
will be the same.
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