Special Class note for

CMA Professional Level –II

201-Advanced Financial Accounting-I

CMA : Professional Level –II

201-Advanced Financial Accounting-I
Basics of leasing;
accounting by lessee;
Special Class-1 201.02 Accounting for leases accounting by lessor;
nd
(2 Session) (IAS-17) special accounting problems;
lease accounting;
sale and leaseback accounting.
IAS 17 Leases
Lease – 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.

Types of Lease:

1. Operating Lease - lease other than a

finance lease.

2. Finance Lease - a lease that transfers

substantially all the risks and rewards
incidental to ownership of an asset. Title
may or may not eventually be
transferred.

Accounting treatments of Operating Lease

Lessor Lessee
• Treats contract as an executory contract • Treats contract as an executory contract
• Retains leased asset on the statement of • Does not recognise leased asset on the
financial position statement of financial position
• Recognises lease income on a straight line basis • Recognises lease expense on a straight line
over the lease term. basis over the lease term.

Considerations to note
• A lessee may classify a property interest held under an operating lease as an investment property.
If this is done, then that interest is accounted for as if it were a finance lease
• Lessors and lessees recognise incentives granted to a lessee under an operating lease as a reduction in lease
rental income or expense over the lease term
• A lease of land and building should be treated as two separate leases, a lease of the land and a lease of the
building, and the two leases may be classified differently
• A series of linked transactions in the legal form of a lease is accounted for based on the substance of the
arrangement; the substance may be that the series of transactions is not a lease
• Special requirements apply to manufacturer or dealer lessors granting finance leases.
Accounting treatment of Finance Lease

Classification Accounting treatments

Finance lease (Meeting only one criterion leads
to financial lease classification) Lessor Lessee
1. The lease transfers ownership of the asset to • Derecognises the • Recognises a leased asset
the lessee by the end of the lease term tangible asset (and on the statement of
16
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

2. The lessee has a bargain purchase option and recognises resultant financial position at the
it is certain at the date of inception that the gain/loss) lower of the fair value of
option will be exercised • Lessor recognises a the leased asset and
3. The lease term is for the major part of the receivable equal to the present value of lease
economic life of the asset even if title is not net investment of the payments
transferred lease • Discount rate is the implicit
4. At the inception of the lease the present • Leased asset not rate in the lease
value of the minimum lease payments amounts recognised on the • Liability recognized
to substantially all of the fair value of the leased statement of financial • Lease payments made are
asset position apportioned between
5. The leased assets are of such a specialised • Recognises finance finance charges and
nature that only the lessee can use them income based on a reduction of liability
without major modifications pattern reflecting a • The finance charge
6. Gains or losses from the fluctuation in the constant periodic rate of allocation is allocated to a
fair value of the residual accrue to the lessee return on the lease. period to produce a
7. The lessee has the ability to continue the constant rate of interest
lease for a secondary period at a rent that is over the period.
substantially lower than market rent
8. If the lessee can cancel the lease, the lessor’s
associated losses are borne by the lessee.

Sale and leaseback transactions

Finance lease
Any excess of sale proceeds over carrying amount is recognised by the lessor over the lease term and not immediately.
Operating lease
• If the sale price is at fair value, any excess of sale proceeds over carrying amount is recognised by the lessor
immediately
• If the sale is below fair value, any profit or loss should be recognised immediately unless the loss is in respect of
future lease payments below market value in which case it is deferred
• If the sale price is above market value, the excess of fair value is amortised over the lease period.

Basics of leasing :
• The lease is a contractual agreement between the lessor and the lessee.
• The lease gives the lessee the right to use specific property.
• The lease specifies the duration of the lease and rental payments.
• The obligations for taxes, insurance, and maintenance may be assumed by the lessor or the lessee.

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.

17
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for Lessee-user of
CMA Professional Level –II the asset who
201-Advanced Financial Accounting-I makes payments

Accounting by lessee:

Accounting by lessor:

Lessor- owner of
the asset who
receives payment

Special accounting problems:

Lease accounting:

FINANCE LEASE ACCOUNTING OPERATING LEASE

Initial accounting ACCOUNTING
The initial accounting is that the lessee should capitalise the finance leased asset and set
up a lease liability for the value of the asset recognised. The accounting for this will be: As the risks and rewards of
ownership of an asset are
Non-current assets ………………………………… Dr. not transferred in the case of
Finance lease liability ………………………. Cr. an operating lease, an asset
(This should be done by using the lower of the fair value of the asset or the present value is not recognised in the
of the minimum lease payments.) statement of financial
position.
Subsequent accounting
Depreciation Instead rentals under
Following the initial capitalisation of the leased asset, depreciation should be charged on operating leases are charged
the asset over the shorter of the lease term or the useful economic life of the asset. The to the income statement on
accounting for this will be: a straight-line basis over the
Depreciation expense…………………………….. Dr. term of the lease, any
Accumulated depreciation ……………… Cr. difference between amounts
charged and amounts paid
Lease rental/interest will be prepayments or
When you look at a lease agreement it should be relatively easy to see that there is a accruals.
finance cost tied up within the transaction.

18
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Sale and leaseback accounting:

The term sale-leaseback describes a transaction in which the owner of the property (seller-lessee) sells the
property to another and simultaneously leases it back from the new owner. The use of the property is generally
continued without interruption.

Problem No. 4 [ CMA Examination –Aug-2013: Q1(b). Marks: 5 + (3x5)=20]

(a). What are the advantages and disadvantages of leasing assets instead of owning them?
(b). Purabi Leasing Co. Ltd. signs an agreement on January 01, 2008, to lease equipment to Rana Enterprise. The following
information relates to this agreement:
1) The term of the non-cancelable lease is 8 years with no renewal option. The equipment has an
estimated economic life of 10 years.
2) The equipment will revert to the lessor at the end of the lease term, at which time the equipment is
expected to have a residual value of Tk 500,000 which is guaranteed by Ran Enterprise.
3) Rana Enterprise will bear the executory cost which include insurance cost of Tk. 15,000 and servicing
cost of Tk. 9,000 per year. The executory cost is to be paid with annual rental payment.
4) The agreement requires equal rental payment of Tk. 250,000 to Purabi leasing beginning on January 01,
2008.
5) Rana Enterprise can borrow at 12% to purchase this type of equipment while Purabi Leasing expects
10% returns on its investment. Purabi’s expected rate of return is known to Rana Enterprise.
6) Rana Enterprise uses the straight line depreciation method for all equipment.
(Present Value of Tk. 1 payable annually at beginning for 8 years at 10% interest rate is 5.86842 and at
th
12% is 5.56376. Present value of Tk. 1 payable at the end of 8 Assets year at 10% interest rate is
0.46651 and at 12% is 0.40388)

Required:
(i) Do you think that the lease is capital one? Explain.
(ii) Prepare an amortization schedule for Rana Enterprise.
(iii) Prepare all journal entries for Rana Enterprise for the years 2008 and 2009.
(iv) Prepare Balance Sheet as on December 31, 2008 for Rana Enterprise reflecting lease related items only.
Assume Rana Enterprise follows calendar year to prepare Financial Statements.
(v) Assume that instead of paying installment due on 01.01.2010 Rana Enterprise offered to purchase the
equipment for Tk. 13,40,000. What journal entry would Rana pass on 01.01.2010 ?

Solution of problem No. 4

Ans. 4(b)(i): Yes, the lease is capital lease as the lease term is 8 years which is 80% of the economic life of the equipment.

19
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Ans. 4(b)(ii): Rana Enterprise

Lease Amortization Schedule:
Year Description Amount Interest Principal Lease Obligation
(Tk.) (Tk.) (Tk.) (Tk.)
1 2 3 4 = (6 uper line x 10%) 5 = (3-4) 6
01.01.2008 Initial Balance - - - 17,00,360
01.01.2008 Payment 250,000 - 250,000 14,50,360
01.01.2009 Payment 250,000 145,036 104,964 13,45,396
01.01.2010 Payment 250,000 134,540 115,460 12,29,936
01.01.2011 Payment 250,000 122,994 127,006 11,02,929
01.01.2012 Payment 250,000 110,293 139,707 963,222
01.01.2013 Payment 250,000 96,322 153,678 809,544
01.01.2014 Payment 250,000 80,954 169,046 640,499
01.01.2015 Payment 250,000 64,050 185,950 454,549
01.01.2015 Payment 500,000 45,455 454,549 0

Minimum Lease Payment:

Rentals (250,000 x 5.86842) 14,67,105 14,50,360 x @10%
Guaranteed Residual Value (500,00 x 0.46651) 233,255 = 145,036
1,700,360

Ans. 4(b)(iii): Rana Enterprise

Journal Entry

Date Descriptions LF Debit Credit

(Tk.) (Tk.)
Leased Equipment 17,00,360 -
01.01.2008
Obligation Under Capital Lease - 17,00,360
Obligation Under Capital Lease 250,000 -
01.01.2008 Executory Cost 24,000 -
Bank A/C - 274,000
Interest Expenses 145,036 -
31.12.2008
Accrued Interest on Obligation under Capital Lease - 145,036
Amortization Expenses 150,045 -
31.12.2008 Accumulated Amortization on Leased Equipment - 150,045
[(17,00,360-500,000)/8 years ]
Obligation Under Capital Lease 104,964 -
01.01.2009 Accrued Interest on Obligation under Capital Lease 145,036 -
Executory Cost 24,000 -
Bank A/C - 274,000
31.12.2009 Interest Expenses 134,540 -
Accrued Interest on Obligation under Capital Lease - 134,540
31.12.2008 Amortization Expenses 150,045 -
Accumulated Amortization on Leased Equipment - 150,045

20
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Ans. 4(b)(iv): Rana Enterprise

Balance Sheet (proportion)
As on December 31, 2008

Assets:
Leased Equipment 17,00,360
Less: Accumulated Amortization 150,045 15,50,315
Liabilities:
Current Liabilities:
Obligation Under Capital Lease (Current Portion) 104,964
Accrued Interest on Obligation Under Capital Lease 145,036 250,000

Non Current Liabilities:

Obligation Under Capital Lease (Non Current Portion) 13,45,396

Ans. 4(b)(v): Rana Enterprise

Journal Entry
Date Descriptions LF Debit (Tk.) Credit (Tk.)
Accrued Interest on Obligation under Capital Lease 134,540 -
01.01.2010
Obligation Under Capital Lease 13,45,396 -
Accumulated Amortization on Leased Equipment 30,090 -
Equipment 15,30,334 -
Leased Equipment - 17,00,360
Bank A/C - 13,40,000

Problem No. 5 [ CMA Examination –December-2013: Q2. Marks: (4+8+8)=20]

21
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Solution of problem no. 5 [ CMA Examination –December-2013: Q2. Marks: (4+8+8)=20]

Ans. 5(a):

Ans. 5(b)(i):

22
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Ans. 5(b)(ii):

Ans. 5(b)(iii):

23
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Ans. 5(b)(iv):

Ans. 5(c):

24
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Problem No. 6 [ CMA Examination –April-2013: Q2. Marks: (4+5+6+5)=20]

(a) Write down the Licensing of financial institutions as per the Financial Institutions Act, 1993
(b) Lab Aid company and Prime Finance and Investment Ltd. sign a lease agreement On 1 January 2013 that calls for
Prime Finance to lease equipment to Lab Aid beginning January 2013. The terms and provisions of the lease agreement
and other information are as follows:
- The term of the lease is five years and the lease agreement is non cancellable, requiring equal rental payments
of 24,33,139.00 at the beginning of each year
- The equipment has a fair value at the inception of the lease is 1,00,00,000.00 . It has an estimated economic life
of 5 years without any residual value.
- Lessee company pays all of the executor costs directly to third parities except for the property taxes of
Tk 35,000.00 per annum, which is included in the annual payments to the lessor.
- The lease contains no renewal option and the equipment have to hand over to the lessor after the lease period.
- The lessee company incremental borrowing rate is 11% but the lessor company set the annual rental to earn a
rate of return on its investment @ 10% ,This fact is known to the lessee company.
- The lessee company charges depreciation on its similar types of equipments under straight line method.
Required:
(i) Calculate the present value of the leased equipment.
(ii) Journalize the transaction in the books of Accounts of Lab AID company for the year 2013 and 2014
assuming the company follows calendar year.
(iii) Prepare a lease amortization Table.

25
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Solution of problem no. 6 [ CMA Examination –April-2013: Q2. Marks: (4+5+6+5)=20]

Ans. 6(b)(i):

Ans. 6(b)(ii):

Ans. 6(b)(iii):

26
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Problem No. 7 [ CMA Examination –December-2012: Q3. Marks: (4+4+12)=20]

(a) Describe the lessee’s accounting for sale-leaseback transactions.
(b) What disclosures are to be made by lessee and lessor for ‘finance lease’ and ‘operating lease’ as per IAS-17?
(c) Bay Leasing Company signs an agreement on January 1, 2008, to lease equipment to KKK Company. The following
information relates to this agreement.
1. The term of the non-cancelable lease is 5 years with no renewal option. The equipment has an estimated
economic life of 5 years.
2. The fair value of the asset at January 1, 2008, is TK.80,000.
3. The asset will revert to the lessor at the end of the lease term, at which time the asset is expected to have
a residual value of Tk.7,000, none of which is guaranteed.
4. KKK Company assumes direct responsibility for all executor costs, which include Tk.900 to Rock Mountain
Insurance for Insurance.
5. The agreement requires equal annual rental payments of Tk.18,142.95 to the lessor, beginning on January 1,
2008.
6. The lessee’s incremental borrowing rate is 10%.
7. KKK Company uses the straight-line depreciation method for all equipment.
8. KKK Uses reversing entries when appropriate.
• Present value of an annuity due at 10% for 5 years is 4.16986.
Required:
(i) Prepare an amortization schedule that would be suitable for the lessee for the lease term.
(ii) Prepare all of the journal entries for the lessee for 2008 and 2009 to record the lease agreement, the lease payments,
and all expenses related to this lease. Assume the lessee’s annual accounting period ends on December 31.

Solution of problem no. 7 [ CMA Examination –December-2012: Q3. Marks: (4+4+12)=20]

Ans. 7(c)(i):
This is a finance lease to lessee and lessor since lease term covers major part of the economic life of the asset (Para 10(c)
of IAS-17).

Computation of present value of minimum lease payment:

PV of annual payment = Tk. 18,142.95 x 4.16986 (PV of an annuity due @10% for 5 years)
= Tk. 75,653.56

KKK Company
Lease Amortization Schedule:
Year / Annual Lease Interest @ 10 on Reduction of Lease Lease Liability
Date Description Payment (Tk.) Liability (Tk.) Liability (Tk.) (Tk.)
1 2 3 4 = (6 uper line x 10%) 5 = (3-4) 6
01.01.2008 Initial Balance - - - 75,653.56
01.01.2008 Payment 18,142.95 - 18,142.95 57,510.61
01.01.2009 Payment 18,142.95 5,751.06 12,391.89 45,118.72
01.01.2010 Payment 18,142.95 4,511.87 13,631.08 31,487.64
01.01.2011 Payment 18,142.95 3,148.76 14,994.19 16,493.45
01.01.2012 Payment 18,142.95 1,649.50 16,493.45 0

27
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Ans. 7(c)(ii):
KKK Company
Journal Entry

Date Descriptions LF Debit Credit

(Tk.) (Tk.)
Leased Equipment Account 75,653.56 -
01.01.2008
Lease Liability Account - 75,653.56
Lease Liability Account 18,142.95 -
01.01.2008
Cash Account - 18,142.95
31.12.2008 Insurance Expenses Account 900.00 -
Cash Account - 900.00
31.12.2008 Depreciation Expenses 15,130.71 -
Accumulated Depreciation ( Tk. 75,653.56 / 5 years) - 15,130.71
31.12.2008 Interest Expense 5,751.06 -
Interest Payable Account - 5,751.06
01.01.2009 Interest Payable Account 5,751.06 -
Interest Expense - 5,751.06
01.01.2009 Lease Liability Account 12,391.89 -
Interest Expense 5,751.06 -
Cash Account - 18,142.95
31.12.2009 Insurance Expenses Account 900.00 -
Cash Account - 900.00
31.12.2009 Depreciation Expenses 15,130.71 -
Accumulated Depreciation - 15,130.71
31.12.2009 Interest Expense 4,511.87 -
Interest Payable Account - 4,511.87

Problem No. 8 [ CMA Examination – August-2012: Q1. Marks: {5+ (4+3+3+5)=20]

(a) “The substance rather than the legal form of the lease contract is indicative of the classification of lease as finance or
operating.” Do you agree? Why?
(b) SMX Leasing Company agrees to lease machinery to PMX Corporation on January 1, 2010. The following information
relates to the lease agreement.
1. The term of the lease is 7 years with no renewal option, and the machinery has an estimated economic
life of 9 years.
2. The cost of the machinery is Tk.420,000, and the fair value of the asset on January 1, 2010, is
Tk.560,000.
3. At the end of the lease term the asset reverts to the lessor. At the end to the lease term the asset is
expected to have a guaranteed residual value of Tk.80,000. PMX depreciates all of its equipment on a
straight-line basis.
4. The lease agreement requires equal annual rental payments, beginning on January 1, 2010.
5. The collectability of the lease payments is reasonably predictable, and there are no important
uncertainties surrounding the amounts of costs yet to be incurred by the lessor.
6. SMX desires a 10% rate of return on its investments. PMX’s incremental borrowing rate is 11%.
 Present value of Tk.1 at 10% for 7 years is 0.51316 and 11% for 7 years is 0.48166
 Present value of an annuity due at 10% for 7 years is 5.35526 and 11% for 7years is 5.23054.
Instructions:
(a) Discuss the nature of this lease for both the lessee and the lessor, according to IAS-17 Leases.
(b) Calculate the amount of the annual rental payment required.
(c) Compute the present value of the minimum lease payments.
(d) Prepare the journal entries PMX would make in 2010 and 2011 related to the lease arrangement.

28
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.
 Special Class note for
CMA Professional Level –II
201-Advanced Financial Accounting-I

Solution of problem no. 8 [ CMA Examination – August-2012: Q1. Marks: {5+ (4+3+3+5)=20]

Ans. 8(a):
This is a finance lease to lessee and lessor since lease term covers major part of the economic life of the asset (Para 10(c)
of IAS-17). As well as the lease payment is reasonably predictable, there are no important uncertainties surrounding the
costs yet to be incurred by the lessor (Para 8 of IAS-17).

Ans. 8(b): Calculation of annual rental payment:

= Tk.560,000- (Tk.80,000x 0.51316 *) / 5.35526 **
= Tk. 96,904.

*Present value of Tk. 1 @ 10% for 7 periods.

** Present value of an annuity due @ 10 % for 7 periods.

Ans. 8(c): Computation of present value of minimum lease payments:

PV of annual payments: Tk. 96,904x5.23054* = Tk. 506,860

PV of guaranteed residual value: Tk. 80,000x0.48166** = 38,533
Tk. 545,393

*Present value of an annuity due @ 11 % for 7 years.

**Present value of Tk. 1 @ 11% for 7 years.

Ans. 8(d):
PMX Corporation
Journal Entry
Date Descriptions LF Debit Credit
(Tk.) (Tk.)
Leased Machinery Account 545,393 -
01.01.2010
Lease Liability Account - 545,393
Lease Liability Account 96,904 -
01.01.2010
Cash Account - 96,904
Depreciation Expenses 66,485 -
31.12.2010 Accumulated Depreciation - 66,485
(Tk. 545,393 – Tk. 80,000 / 7 years)
31.12.2010 Interest Expense 49,334 -
Interest Payable Account - 49,334
01.01.2011 Lease Liability Account 47,570 -
Interest Payable 49,334 -
Cash Account - 96,904
31.12.2011 Depreciation Expenses 66,485 -
Accumulated Depreciation - 66,485
31.12.2011 Interest Expense 44,101 -
Interest Payable Account - 44,101
[ (Tk. 545,393 – Tk. 96,904 – Tk. 47,570) x @11% ]

Home work:
2. CMA Examination April-2012 : Question no. 3

29
Md.Monowar Hossain FCMA,FCPA,ACS,ACA Sunday, June 08, 2014
Audit Consultant (General Manager),
Rupali Bank Ltd.