FACR – ICMAP ML2 (S-21) Lessor

LESSOR ACCOUNTING UNDER IFRS 16

IFRS 16 tells about to classify lease w.r.t. lessor into finance and operating lease. Therefore, the very first
issue into lessor accounting is to classify it into operating and finance lease.

Finance Lease: Significant risks and rewards transferred to lessee.

Operating Lease: Other than Finance Lease.

CONDITIONS FOR FINANCE LEASE: (ANY)

a) Ownership is transferred to lessee at end of the lease term
b) Option to purchase asset at below fair value at end of lease and reasonably certain option will be
exercised. (bargain purchase option)
c) Lease term represents the major part of assets economic life (usually >75% in practice).
d) PV of minimum lease payments represents substantially all of the asset’s fair value (usually 90% in
practice)
e) Leased asset is specialized / customized in nature.

OPERATING LEASE:
Under operating lease, income receipts are recognised as income through profit or loss on a straight-line
basis. The asset is continued to be recognized in the books of lessor. Depreciation on the asset continues
over its useful life.

FINANCE LEASE:
This is a long-term leasing arrangement. For example, bank leases a plane to an airline for 40 years. The
control of the asset passes to the lessee during the term of the lease. Therefore, this is a form of lending
arrangement.

Accounting:
a) Derecognize asset and record a receivable (@ net investment in the lease).
b) Record finance lease receipts as a reduction in the receivable.
c) Record interest income on the receivable.

• Gross investment in the lease = MLP receivable plus any unguaranteed residual value.
• Net investment in the lease = Gross investment in the lease discounted at the implicit rate of interest.

Note: The unguaranteed portion of residual value comes from third party.

Opening Balance + Interest Income – Lease Rentals Collected = Closing Balance

Prepared by: M. Umar Munir (Gold Medalist), FCMA, MS Finance

FACR – ICMAP ML2 (S-21) Lessor

NOTE:
• At the time of payment, lease receivable is split between finance income and recovery.
• Lease receivable is to be allocated between current and non-current into SFP.

At inception of lease (initial measurement)

Debit Lease receivable at NIL
Credit Asset at book value
Balance Gain / loss on disposal.

Subsequent measurement entries:

Debit Cash
Credit Lease Receivable (with the number of periodic rentals)

Debit Lease receivable

Credit Finance income (P/L)

LESSOR ACCOUNTING
Cherry leases out an item of property, plant and equipment under a 5-year finance lease. The lease
commenced on 1 January 2015 and the rate implicit in the lease is 4%. The annual lease rentals of 5,000
are paid at the start of the lease period. Cherry estimates that the unguaranteed residual value of the
PPE is Rs.400. The asset has a carrying value of 24,000.

Required:
1. Calculate Cherry’s net investment in the lease. [Answer: NIL Rs.23,478]
2. Record the lease transaction at initial recognition. [Answer: Loss on disposal Rs.522]
3. Prepare lease amortization schedule.

Prepared by: M. Umar Munir (Gold Medalist), FCMA, MS Finance