Accounting for Leases IFRS 16 and IAS 17

All companies need various types of assets to make products or render services to their
customers. Any company has two options to use an asset: buy or lease. In many cases
companies prefer to lease rather than to buy, as it does not require initial lump-sum large
payment. So accounting treatment for lease is often used and is a very important topic in the
accounting world.

It is IAS 17 Leases that standardizes the accounting treatment and disclosure of assets held
under lease.

IAS 17 Leases takes the concept of substance over form and applies it to the specific accounting
area of leases.

When applying this concept, it is often deemed necessary to account for the substance of a
transaction – ie its commercial reality, rather than its strict legal form. In other words, the legal
basis of a transaction can be used to hide the true nature of a transaction.

Why do we need to apply substance to a lease?

A lease agreement is a contract between two parties, the lessor and the lessee. The lessor is the
legal owner of the asset, the lessee obtains the right to use the asset in return for rental
payments.

Historically, assets that were used but not owned were not shown on the statement of financial
position and therefore any associated liability was also left out of the statement – this was
known as ‘off balance sheet’ finance and was a way that companies were able to keep their
liabilities low, thus distorting gearing and other key financial ratios. This form of accounting did
not faithfully represent the transaction.

So how does IAS 17 work?

IAS 17 states that there are two types of lease, a finance lease and an operating lease.
A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of
an asset to the lessee.

An operating lease is defined as being any lease other than a finance lease.

How to classify?

In order to gain classification of the type of lease you are dealing with, you must first look at the
information provided within the scenario and determine if the risks and rewards associated with
owning the asset are with the lessee or the lessor. If the risks and rewards lie with the lessee
then it is said to be a finance lease, if the lessee does not take on the risks and rewards, then the
lease is said to be an operating lease.
Finance lease indicators

The main reward is where the lessee has the right to use the asset for most of, or all of, its useful
economic life. The primary risks are where the lessee pays to insure, maintain and repair the
asset.

Other indicators that a lease is a finance lease include:

 At the inception of the lease the present value of the minimum lease payments*
amounts to substantially all of the fair value of the asset
 The lease agreement transfers ownership of the asset to the lessee by the end of the
lease
 The leased asset is of a specialized nature
 The lessee has the option to purchase the asset at a price expected to be substantially
lower than the fair value at the date the option becomes exercisable

FINANCE LEASE ACCOUNTING

Initial Recognition
The initial accounting is that the lessee should capitalize the finance leased asset and set up a lease
liability for the value of the asset recognised. The accounting for this will be:
Debit Non-current-assets
Credit Finance lease liability

This should be done by using the LOWER of (1) the fair value of the asset or (2) the present value
of the minimum lease payments.

Subsequent Measurement at each reporting date

Depreciation
After the initial capitalization of the leased asset, depreciation should be charged on the asset over the
SHORTER of the lease term or the useful economic life of the asset. The accounting entries for this will
be:
Debit Depreciation expense (profit or loss account)
Credit Accumulated depreciation (provision for depreciation account)

Lease rental/interest
A closer look at a lease agreement it should be relatively easy to see that there is a finance cost tied up
within the transaction. For example, a company could buy an asset with a useful economic life of four
years for $10,000 or lease it for four years paying a rental of $3,000 per annum.

If the leasing option is chosen, over a four-year period the company will have paid $12,000 in
total for use of the asset ($3,000 pa x 4 years) – ie the finance charge in this example totals
$2,000 (the difference between the total lease cost ($12,000) and the purchase price of the
asset ($10,000)).
 Land and buildings

As land has an indefinite economic life, the practice is to treat it as an operating lease unless
title was expected to pass at the end of the lease term. So a lease of land can be treated as a
finance lease if it meets the existing criteria, specifically if the risks and rewards of ownership
can be considered to have been transferred. This would be the case if the present value of the
minimum lease payments in respect of the land element amounts to ‘substantially all’ of the fair
value of the land. A lease of buildings will be treated as a finance lease if it satisfies the
requirements above

Example

A business has taken out a new lease on a factory building and surrounding land. The fair value
of the building is $5m and the fair value of the land is $3m. The lease is for 20 years, which is the
expected life of the factory, with annual payments in arrears of $500,000. The business has a
cost of capital of 8%. The annuity factor for $1 receivable every year for 20 years is 9.818.

Solution

The lease payments will be split in line with the fair values of the land and the building.

$187,500 (500,000 × 3/8) will be treated as lease payment for the land and $312,500 will be treated
as payment on a finance lease for the building. The payment for the building will be treated as a
finance lease because it is for the expected useful life of the building. The present value of the
minimum lease payments in respect of the land amounts to $1.84m (187,500 × 9.818). This is not
‘substantially all’ of the fair value of the land, so the lease of land will be treated as an operating
lease.

Disclosure requirements for lessees

IAS 17 requires the following disclosures by lessees in respect of finance leases:

 The net carrying amount at the end of the reporting period for each class of leased asset
 Reconciliation between the total of minimum lease payments at the end of the reporting
period, and their present value. In addition, an entity should disclose the total of
minimum lease payments at the end of the reporting period, and their present value, for
each of the following periods:

– Not later than one year

– Later than one year and not later than five years

– Later than five years

Operating lease accounting

As the risks and rewards of ownership of an asset are not transferred in the case of an operating
lease, an asset is not recognised in the statement of financial position. Instead rentals under
operating leases are charged to the statement of profit or loss on a straight-line basis over the
term of the lease, any difference between amounts charged and amounts paid will be
prepayments or accruals.

Example
On 1 October 2009 Alpine Ltd entered into an agreement to lease a machine that had an
estimated life of 10 years. The lease period is for four years with annual rentals of $5,000
payable in advance from 1 October 2009. The machine is expected to have a nil residual value at
the end of its life. The machine had a fair value of $50,000 at the inception of the lease.

How should the lease be accounted for in the financial statements of Alpine for the year end 31
March 2010?

Solution

In the absence of any further information, this transaction would be classified as an operating
lease as Alpine does not get to use the asset for most of/all of the assets useful economic life
and therefore it can be argued that they do not enjoy all the rewards from this asset.

The accounting for this lease should therefore be relatively straightforward and is shown below:

Rental of $5,000 paid on 1 October:

Debit Lease expense (statement of profit or loss) 5,000

Credit Bank 5,000

This rental however spans the lease period 1 October 2009 to 30 September 2010 and therefore
$2,500 (the last six-month’ rental) has been prepaid at the year-end 31 March 2010.

Debit Prepayments 2,500

Credit Lease expense 2,500

Treatment of rent free period/cash back incentives in an operating for Lessees

Where the lessor offers the lessee a rent free period or cash back incentive, to the lessee, the
lessee should observe strict accrual accounting by charging lease rentals over the lease period
even if no rental was paid or rental was paid at an amount lower than the actual amount
supposed to be paid.

The relevant accounting entries are as follows:

Rent Free Period

 1. For the period in which no rent was payable:
Debit Lease rentals (profit or loss account)
Credit Lease payable (statement of financial position)

2. When the rental is paid

Debit Lease rental payable (for the amounts accrued in the previous periods)
Debit Rental expenses in profit or loss (for the amount relating to the current period)
Credit Bank/Cash (with the amount paid)

Example

MET Nigeria Limited entered into an agreement to rent premises for the expansion of its
accountancy programs for 8 years. The agreement provides that there will be rent payment for
the first three years, however rental payment from the fourth to the end of the lease period is
at $30,000 per year.

How will this lease be accounted for in the fourth year of the agreement?

Solution

The lease rentals for the duration of the lease is ($30,000 x 4 years) is $120,000 however the
lease is for eight years, therefore, annual lease rental expense shall be ($120,000/8 years)
$15,000. Based on this, the relevant entries in the books for each of the first three years
respectively shall be:

Debit Lease rental expenses $15,000

Credit Lease rental payable $15,000

In the fourth year in which the sum of $30,000 is paid, it should be noted that $45,000 should
have been accrued in the liability account. Given this scenario, the entries that will be passed
on the fourth year shall be as follows:

Debit Lease rental $15,000

Debit Lease rental payable $30,000
Credit Lease rental payable $15,000
Credit Bank/Cash $30,000

When there is cash back incentive

Where the lessor offers the lessee cash incentives such as discount, then the lessor should treat
the discount as a reduction to the rental payments in a systematic manner by amortizing the
incentive over the lease period irrespective of the fact the sum was received on initial
recognition of the transaction.
The following accounting entries are relevant to reflect this in the accounts:

On agreement with the lessor/receiving the cash from the lessor

Debit Bank/Receivable (with the amount received or receivable from the lessor)
Credit Deferred Income (with the unamortized amount received from the lessor)
At each reporting date
Debit Rental expenses (in profit or loss)
Debit deferred income (to reduce the unamortized amount received from lessor)
Credit Bank/Cash (with the amount paid as rental expenses)
Credit Rental expenses/other income (with the portion of the incentive recognised)

Example
Providus Bank Limited entered an agreement with A & A Leasing Limited for the rental of an
office premises to host its Server Room outside the bank’s facility for a period of ten years. The
useful life of the building to A & A Leasing Limited is 50 years. It was agreed that the annual
rental payment is $50,000 payable in arrears. However, A & A Leasing will refund Providus Bank
the sum of $5,000 which it incurred as expenses to clear rumbles at the premises before being
able to occupy the premises. The amount was to be refunded to Providus Bank at the end of the
lease period.

Show how this transaction will be accounted for in the books of Providus Bank for the first five
years.

Solution

Details/Years 1 2 3 4 5
Allocation of rental expenses $50,000.00 $50,000.00 $50,000.00 $50,000.00 $50,000.00
Rent Refund $(1,000.00) $(1,000.00) $(1,000.00) $(1,000.00) $(1,000.00)
Net rental expenses $49,000.00 $49,000.00 $49,000.00 $49,000.00 $49,000.00

The schedule above shows that the rental expenses for each year is $49,000. However, the
double entry relevant to each year is as follows:

Years 1 (only)
Debit Rental expenses $50,000
Credit Bank/Payable $55,000
Debit Rent receivable $5,000
Years 2 to 5
Debit rental expenses $50,000
 Credit Rental Expenses $1,000
Bank Rental Expenses $49,000

Accounting for sale and lease back arrangements in the books of the lessee

Sale and lease back gives rise to finance lease

If the transaction gives rise to a finance lease, the substance of the transaction is that no
disposal of the asset has taken place and therefore no gain or loss on disposal should be
recognised. The transaction is merely a means by which the lessor provides finance to the
lessee, with the asset as security. In such circumstances, any excess of the sales proceeds over
the carrying amount should not be immediately recognised as income in the financial
statements of the seller/lessee. Instead, it should be deferred and amortised over the lease
term.

In practice, the most straightforward treatment is to continue to recognise the asset at its
previous carrying amount and to account for the asset as if the sale and leaseback transaction
had not occurred. This reflects the reality that the sale and leaseback transaction has not
resulted in any change to the seller’s interest in the risks and rewards incidental to ownership.
Consequently, there is unlikely to be any change to the asset’s useful life or residual value so far
as the seller is concerned.

The proceeds from the ‘sale’ transaction are credited to a liability account representing the
initial net obligation under the finance lease. Subsequent accounting for the lease liability is as
described above.

Sale and lease back gives rise to operating lease

If the related leaseback is an operating lease, it is necessary to determine the fair value of the
asset and compare this with the contract sale price. Because the sale and lease transactions are
connected, the sale may be arranged at other than fair value, with the impact of any difference
being recognised in the rentals payable.

The appropriate accounting treatment is as follows:

•if the sale price is equal to the fair value, there has, in effect, been a normal sales transaction
and any profit or loss on sale should be recognised immediately;

•if the sale price is above the fair value:

•the difference between fair value and carrying amount may be recognised immediately; but

•the excess of proceeds over fair value should be deferred and amortised over the period for
which the asset is expected to be used. The excess of the sale price over the fair value will be
reflected in higher rental charges; and
•if the sale price is below the fair value, the difference between sale price and carrying amount
should be recognised immediately except that, if a loss arising is compensated by future rent at
below market price, it should be deferred and amortised in proportion to the rent payments
over the period for which the asset is expected to be used.

Thus, for operating leases, if the fair value at the time of the transaction is less than the carrying
amount of the asset, a loss equal to the amount of the difference between the carrying amount
and the fair value should be recognised immediately.

The following table summarizes the requirements of IAS 17 in various circumstances.

Circumstances Carrying amount equal to fair Carrying amount less than fair Carrying amount above fair value
value value
Sale price established at fair value
 Profit  n/a  recognise profit  n/a
 Loss  n/a immediately  recognise loss
 n/a immediately
Sale price below fair value
 Profit  n/a  recognise profit  n/a
 Loss not compensated by  recognise loss immediately  recognise loss
lease payments below immediately  recognise loss immediately
market price  defer and amortise loss immediately  loss recognised
 Loss compensated by  defer and amortise loss immediately for the
lease payments below difference between
market price carrying amount and fair
value (i.e. the asset is
written down to fair
value)
Sale price above fair value
 Profit  defer and amortise profit  profit may be recognised  loss recognised
immediately for the immediately for the
difference between difference between
carrying amount and fair carrying amount and fair
value, defer and amortise value (i.e. the asset is
 Loss  n/a any remaining profit written down to fair
 n/a value), defer and
amortise any remaining
profit
 loss recognised
immediately for the
difference between
carrying amount and fair
value (i.e. the asset is
written down to fair
value)
The example below illustrates these rules for sale and leaseback transactions that are classified as
operating leases:

Sale price below fair value:

$'000
Carrying amount (book value) 100
Fair value 110
Sale price 125
Profit to be recognised 10
Profit to be deferred 15

Sale price below fair value: Item A Item B

$'000 $'000
Carrying amount (book value) 100 100
Fair value 125 110
Sale price 110 95
Profit to be recognised 10 -
Apparent loss to be deferred if compensated by below market rentals - (5)

Disclosure requirements in the books of the lessee for operating leases

For operating leases the disclosures are as follows.

The total of future minimum lease payments under non-cancellable operating leases for each of
the

following periods:

– Not later than one year

– Later than one year and not later than five years

– Later than five years

New Standard IFRS 16 Lease

IAS 17 Lease is currently being replaced by IFRS 16 Leases which is developed by International
Accounting Standards Board.

The most obvious and impactful difference is how operating leases will be brought onto the
balance sheet. Under IAS 17, a lessee is not obligated to report assets and liabilities from
operating leases on their balance sheet and they are instead referred to in the footnotes. This
has typically provided financial statement users an inaccurate account of a company’s
outstanding expenses, forcing them to estimate the off balance sheet obligations, which often
results in overestimations. Similarly, it is difficult to compare businesses that lease assets with
those that buy them as a clear indication of the operating leases are left out of the equation.
IFRS 16 changes this by requiring a lessee to recognise arising right of use (ROU) assets and lease
liabilities on their balance sheet. Undoubtedly one of the biggest changes to leases accounting,
the consequences of recognising operating leases will see a large difference in various financial
metrics.

Difference between IAS 17 and IFRS 16

IAS 17 vs IFRS 16 IFRS 16 is developed by International Accounting

IAS 17 is developed by International Accounting Standards Board.
Standards Committee.
Recognition of Lease
Finance leases are recognized as assets and
All leases are recognized as assets.
operating leases are recognized as expenses.
Focus
The focus is on who bears the risks and the The focus is on who has the right to use the
rewards of the lease asset.

Why the difference?

Improved comparability and transparency on financial position of a reporting entity. Financial

statement users can clearly see the effect of operating leases and have a useful basis for
comparability with other companies. Currently, under IAS 17, it is difficult to compare
companies who lease with those who buy.

Potential impacts:

 Financial report impact – As operating leases will be capitalized, there will be a shift in
financial metrics for businesses that have a particularly large number of this type of
lease.
Asset turnover, equity and operating expenses will likely see a decrease. Conversely,
liabilities, reported debt, recorded assets, EBIT and EBITDA will all see an increase.
 Covenants and shareholder relationships – With a change in financial metrics, ratios and
liabilities, companies will need to take extra care with their disclosures to explain the
shift figures. This could lead to a possible breach of financial based agreements and
contracts, both internally (performance KPIs and metric based compensation
payments/bonuses) and externally (bank covenants, stakeholder relationships, investor
relationships).

Accountant involvement

Accounting departments will be greatly impacted by the new standard, especially in the first
year of reporting. The way they interact with leasing within the company is likely to change as
they need to know more information about operating leases and how their inclusion affects the
financial reporting when accounting for leases under IFRS 16.

IAS 17 – The accounting treatment of operating leases is less complex than the treatment of
finance leases and the volume of operating leases is predominantly higher than that of finance
leases. So, currently, accounting departments have a lower volume of the challenging
calculations to make.

IFRS 16 – Under the new standard, however, as all leases will be treated under the same
accounting treatment, accounting departments will have a higher volume of complex
amortization calculations to perform.

IFRS 16 IN FOCUS

This section enables the reader to understand the following:

 The objectives of IFRS 16,

 The definition of lease in IFRS 16,
 The meaning of Right of Use Asset and the Right of Control (ROC),
 Items exempted from capitalization as ROU assets,
 The accounting treatment of ROU assets in the books of the lessee,
 The treatment of sale and leaseback transactions in the books of the lessee in IFRS 16,
and
 The accounting treatment of leases in the books of the lessor in IFRS 16.

The objectives of IFRS 16

IFRS 16 was issued by the IASB in May 2016, to remedy the non-recognition of liabilities for assets held
under operating leases.

Definition of Lease in IFRS 16

A contract or part of a contract that conveys the right to use an asset, the underlying asset, for a period
of time in exchange for consideration

An underlying asset is an asset that is the subject of a lease, for which the right to use that asset has been
provided by a lessor to a lessee.

A Right of Use asset is an asset that represents a lessee’s right to use an underlying asset for the lease
term.

A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset
for a period of time in exchange for consideration. Right to Control the use of an asset is dependent on:
 Direction over how and for what purpose the asset is used is a right that the lessee has
 Economic benefits from use of the identified asset will flow to the lessee

A lessee does not control the use of an identified asset if the lessor can substitute the underlying asset
for another asset during the lease term and would benefit economically from doing so.
Highlights of IFRS 16

For lessees, IFRS 16 removes the distinction between finance and operating leases which was a feature
of IAS 17. All qualifying items must be capitalized and depreciated as Right of Use (ROU) Assets.

Recognition Exemptions

A lessee may elect to account for lease payments as an expense on a straight line basis over the lease
term for the following two types of leases:

1. Short Term leases: where the lease term is 12 months or less. This election is made by class of
underlying asset (i.e. election to be applied to all assets in a particular class)

2. Low Value Leases: Where the underlying asset (i.e. leased asset) has a low value when new. This
election can be made on a lease by lease basis. Examples of a low value asset computer systems,
telephones and so on.

Accounting Treatment where a Contract contains a lease in the books of the

lessee

Initial recognition

1.Measure the right of use asset at cost. Cost comprises:

 Amount of the initial measurement of the lease liability,
 Any lease payments made before the commencement date less any lease incentives
received,
 Any initial direct costs incurred by the lessee,
 Any costs which the lessee will incur for dismantling and removing the underlying
asset or restoring the site at the end of the lease term in line with IAS 37.
2. Measure the lease liability at the present value of future lease payments, including any
expected payments at the end of the lease
Subsequent Measurement
3. The right of use asset should be depreciated from the commencement date to the earlier of
the end of the useful life of the underlying asset and the end of the lease term……(Dr SOPL
– Depreciation Expense, Cr Right of Use Asset (SOFP). If the lease transfers ownership of the
underlying asset at the end of the lease term, or if the cost reflects a purchase option , which
the lessee is expected to exercise, then the right of use asset should be depreciated over the
useful life of the underlying asset. If the right of use asset is an investment property or
belongs to a class of assets to which the revaluation model applies, then apply the revaluation
model as per IAS 40 and IAS 16
4. The carrying amount of the lease liability is increased by interest charges on the outstanding
liability (Dr SOPL - Finance Cost, Cr SOFP - ) and reduced by the lease payments made. (Cr
SOFP – Bank, Dr SOFP – Lease Liability). Then split the closing lease liability between current
and non-current liabilities.

The following journal entries are relevant for the above issues:
Details DR CR Remarks
Right of Use asset at cost* xxxxx
Lease liability (PV of future CFs)** xx
Provisions for dismantling costs x
Cash/Bank/payable x
To recognise the asset and the
underlying liability at inception
Depreciation expenses X
Provision for depreciation on ROA X
To recognise periodic depreciation
charge on the ROA and increase
accumulated depreciation.
Finance costs X
Lease liability X
To recognise the finance charge on
outstanding liability and increase the
liability (amortised cost per IFRS 9)
Lease liability X
Bank/cash X
To reduce the lease liability by the
payment of contractual sum.

Presentation in the Financial Statements

 Right of Use Assets should be presented on a separate line under Non-Current Assets in the
Statement of Financial Position
 Lease Liabilities to be presented separately in Liabilities. The liabilities should be split between
current and non-current liabilities.

Deposits Paid
Where the lessee has paid a deposit to the lessor before the lease commences, the deposit is used to
reduce the amount of the lease liability i.e. reduce the amount of lease finance advanced – deposits
are deemed to be all capital. The relevant journal for a deposit is to debit Lease Liability and Credit
Bank/Cash. In a situation where the initial payment is different in amount to the annual rentals, this
is generally taken to be an indicator of a deposit paid.

Sale and leaseback transactions

A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset.
The accounting treatment of a sale and lease back transaction by the lessee in IFRS 16 depends on
whether the sale meets the requirements of a sales transaction per IFRS 15 as follows:

If the sale satisfies the IFRS 15 requirement to be accounted for as a sale

The lessee measures the Right of Use Asset and the profit to be recognised in SOPL arising from the
leaseback at the proportion of the previous carrying amount of the asset that relates to the right of
use retained.

This is calculated as:

 ( A x B/C) and (P x B/C)

Where:
A =Carrying amount of asset
B = Present Value of Lease Payments
C = Fair Value of Asset sold
P = Profit to be recognised in SOPL

 The lessee only recognises the amount of any gain/loss on the sale that relates to the rights
transferred to the buyer. Such gains/losses are taken directly to the profit or loss.

 Where the sale proceeds exceed fair value, the excess is recognised as additional financing
provided by the lessor (liability in the form of deferred income).
The relevant journals to be passed for a Sale and Leaseback Transaction where a Lease is created are:

Details DR CR Remarks
Bank/Cash xxx
Right of Use Asset xxx
Asset sold xxx
Lease liability xx
Profit recognised on disposal x
These are to recognise the sale of an asset and the
purchase of same asset on credit including profit
made on the sale.

Subsequently the lease shall be accounted for as normal involving Depreciation of Right of Use asset ,
Interest, Capital Repaid, Split of Lease Liability between Current Liabilities and Non-Current Liabilities
and so on at each reporting date.

If the sale does not satisfy the IFRS 15 requirement to be accounted for as a sale

The seller continues to recognise the transferred asset and the transfer proceeds are treated as a
financial liability, as per IFRS 9. The transaction is more in the nature of a loan using the “sold asset”
as collateral.
Thus readers should keep their selves abreast of the circumstances giving rise to a contract of sale as
contained in IFRS 15 (Revenue from Contract with Customers).
LESSOR ACCOUNTING

Note that lessor accounting is largely unchanged under IFRS 16 from the previous leasing standard, IAS
17.
As a result, for lessor accounting, IFRS 16 retains the IAS 17 distinction between finance leases and
operating leases.

Finance Lease: In substance, the risks and rewards are transferred to the lessee
Operating Lease: In substance, the risks and rewards remain with the lessor.

Finance Lease - Accounting Treatment in the Books of the Lessor

In the SOFP, derecognise the asset as the substance of the transaction is equivalent to a sale.
Recognise net investment in a lease equivalent to the Present Value of Minimum Lease
Payments (PVMLP) plus unguaranteed residual value (if any). The foregoing is the Lease
Receivable (remember IFRS 9 Simplified Method of Expected Credit Loss Model for Impairment
Testing).

In the Statement of Profit or Loss, recognise constant finance income. Do not charge
depreciation expense on the leased asset.

Dealer Lessor Accounting

Where the lessor is also a dealer of the item given to a lessee under a finance lease, in the first year of
the lease transaction, the lessor should also recognise the profit on sale of the item separately apart from
the interest income to be recognised in the same period. In essence, the lessor may be entitled to two
streams of income in the first year.
Relevant journal entries for a lessor where the lease is a finance lease are:

Details DR CR Remarks
Lease Receivables xxx
Leased Assets xxx To recognise lease receivables and derecognise the
leased asset
Receivables/Bank xx
Finance Income xx To recognise finance income from the leased asset
Receivables/Bank x
Profit on sale of inventory x To recognise profit on the sale where the lessor is also a
dealer.
Impairment loss x
Lease Receivables x To recognise any impairment loss from the amount due
from lease debtors.
Operating Lease – Accounting Treatment in the Books of the Lessor
In the SOFP, the lessor retains the asset and depreciates over its useful life because the substance of the
transaction does not constitute a sale.

In the SOPL, the lessor recognises rental income on a straight line basis unless there is any other more rational way
of doing that over the lease term. Depreciation expenses are charged to profit or loss while the accumulated
depreciation account is credited.
Relevant journal entries are as follows:

Details DR CR Remarks
Depreciation expense xx
Provision for depreciation a/c xx To recognise depreciation charge (P/L) and accumulated
depreciation (SOFP)
Bank/Receivables x
Rental Income x To recognise rental income (P/L) and the cash received or
receivables (SOFP)
Impairment loss x
Lease Receivables x To recognise any impairment loss (P/L) from the
amount due from lease debtors (SOFP).
Tutorial questions on Lease Accounting
Question 1

Branch acquired an item of plant and equipment on a lease on 1 January 2018. The terms of the
agreement were as follows:

Deposit $1,150 (non-refundable)

Installments $4,000 per annum for 7 years
PV of lease rentals $20,000

The underlying asset has a useful life of 4 years and the interest rate implicit in the lease is 11%.
Required:
Prepare extracts from the SOPL and SOFP for the year ending 31 December 2018.

Question 2
A lease rental of $20 million was paid on 1 April 2015. It is the first of 5 annual payments in advance for
the rental of an item of equipment that has a cash purchase price of $80 million. The auditors have
calculated the implicit rate in the lease as 12% per annum. The right of use is to be depreciated on a
straight line basis over the life of the lease.

Required:
(a) Show the effect on the SOPL and Statement of Financial Position for 31 March 2016
(b) Calculate the interest charge for the remaining years of the lease

Question 3
Capital Co entered into a sale and leaseback on 1 April 2017. It sold a lathe with a carrying amount of
$300,000 for $400,000 (i.e. its fair value) and leased it back over a five year period, equivalent to its
remaining useful life. The transaction constitutes a sale in accordance with IFRS 15.

The lease provided for a five annual payments in arrears of $90,000. The rate of interest implicit in the
lease is 5%. The present value of the lease payments is $389,652.

What are the amounts to be recognised in the financial statements at 31 March 2018 in respect of this
transaction?

Question 4

Young Shall Grow (YSG) Limited wishes to expand their transport fleet and purchased three heavy Lorries with a list
price of $18,000 each. YSG Ltd has negotiated lease finance to fund this expansion, and the company has entered
into a lease agreement with Gregory Garages Co on 1 January 2017. The agreement states that YSG Limited will pay
a deposit of $9,000 on 1 January 2017, and two annual installments of $24,000 on 31 December 2017, 2018 and a
final installment of $20,391 on 31 December 2019. Interest is to be calculated at 25% on the balance outstanding on
1 January each year and paid on 31 December each year. The depreciation policy of YSG Limited is to write off the
vehicles over a four year period using the straight line method and assuming a scrap value of $1,333 for each
vehicle at the end of its useful life.

The cost of the vehicles to Gregory Garages is $14,400 each.

Required:

(a) Account for the above transactions in the books of YSG Limited showing the entries in the statement of profit or
loss and statement of financial position for the years ended 31 December, 2017, 2018 and 2019. This is the only
lease transaction undertaken by this company.

(b) Account for the above transactions in the books of Gregory Garages Co, showing the entries in the lease trading
account for the years 2017, 2018 and 2019. This is the only lease transaction undertaken by this company.
Calculations should be made to the nearest $.

Question 5

The following list of account balances relates to Winger at 31 March 2018:

Debit Credit
$'000 $'000
Sales revenue (note a) 358,450
Cost of sales 185,050
Distribution costs 28,700
Administration expenses 15,000
Lease rentals (note b) 20,000
Dividend paid 12,000
Property at cost (note c) 200,000
Loan note interest paid 2,000
Plant and equipment cost 154,800
Depreciation 1 April 2017 – plant and equipment 34,800
Development expenditure (note d) 30,000
Profit on disposal of non-current assets (note c) 45,000
Trade accounts receivable 55,000
Inventories: 31 March 2018 28,240
Cash and bank 10,660
Trade accounts payable 29,400
Taxation: over provision in year to 31 March 2017 2,200
Equity shares of 25c each 150,000
8% loan note (issued in 2009) 50,000

Retained earnings 1 April 2017 - 71,600

741,450 741,450

The following notes are relevant:

(a) Included in sales revenue is $27 million, which relates to sales made to customers under sale or return
agreements. The expiry date for the return of these goods is 30 April 2018. Winger has charged a mark-up
of 20% on cost for these sales,
(b) A lease rental of $20 million was paid on 1 April 2017. It is the first of five annual payments in advance for
the rental of an item of equipment that has a cash purchase price of $80 million. The auditors have advised
that this is a finance lease and have calculated the implicit interest rate in the lease as 12% per annum.
Leased assets should be depreciated on a straight-line basis over the life of the lease.
(c) On 1 April 2017, Winger acquired a new property at a cost of $200 million. For the purpose of
 Calculating depreciation only, the asset has been separated into the following elements.

Separate asset Cost Life

$'000
Land 50,000 freehold
Heating system 20,000 10 years
Lifts 30,000 15 years
Building 100,000 50 years

The depreciation of the elements of the property should be calculated on a straight-line basis. The new
property replaced an existing one that was sold on the same date for $95 million. It had cost $50 million
and had a carrying value of $80 million at the date of sale. The profit on this property has been calculated
on the original cost. It had not been depreciated on the basis that the depreciation charge would not be
material. Plant and machinery is depreciated at 20% on the reducing balance basis.

(d) The figure for development expenditure in the list of account balances represents the amounts deferred in
previous years in respect of the development of a new product. Unfortunately, during the current year, the
government has introduced legislation which effectively bans this type of product. As a consequence of
this the project has been abandoned. The directors of Winger are of the opinion that writing off the
development expenditure, as opposed to its previous deferment, represents a change of accounting policy
and therefore wish to treat the write off as a prior period adjustment
(e) A provision for income tax for the year to 31 March 2018 of $15 million is required.

Required

(a) Prepare the statement of profit or loss of Winger for the year to 31 March 2018.
(b) Prepare a statement of financial position as at 31 March 2018 in accordance with International
Financial Reporting Standards as far as the information permits.