Accounting for leases

Lecture 11
FAR LEARNING OUTCOMES
FAR aims to train students as academic professionals in financial accounting and reporting.
At the end of this course, the students should be able to:
3. Describe and explain the accounting principles, including the principles for valuation and income
measurement allowed under IFRS.
• Describe and explain the principles for valuation and income measurement for leases allowed under IFRS.
– Kieso et al. (2018/2020): CH21 Accounting for leases
PROGRAM
Accounting for leases
1. Lease
– Differences between renting, leasing or buying a car
– Finance lease vs Operating lease
2. (Additional) exercises 11 on accounting for leases:
– Accounting for finance leases
– Accounting for operating leases
Financial calculations, journal entries & financial reporting
3. Multiple choice
CH21: Accounting for Leases Additional exercises 11

ACCOUNTING FOR LEASES: INTRODUCTION

Rent a car / Lease a car / Buy a car
o What are differences between renting, leasing and buying a car?
o When do you rent, lease or buy a car?

Rent or buy a car?

LEASE
• A lease is a
contractual
agreement
between a lessor
and a lessee that gives the lessee the right to use specific
property, owned by the lessor, for a specified period of
time. In return for this right, the lessee agrees to make rental payments over the lease term to the lessor.
• Lease contract (contractual agreement)
• Lessor
‒ Obligation to provide lessee the right-of-use asset for entire lease duration.
• Lessee
‒ Right-of-use asset: lessee's right to use an asset over the life of a lease
‒ Obligation to pay stipulated periodic fees (lease payments) to lessor during the lease term.
ADVANTAGES OF LEASING FOR LESSEES
o (Financial) flexibility
o Tax advantages
o Protection against obsolescence
o Depending on a firm-specific situation:
financing less costly
o 100% financing at fixed rates
o Off-balance-sheet financing
WHAT DO COMPANIES LEASE?
Company Description
Carrefour (FRA) “Stores not fully owned are rented under leasing agreements.
The Group also owns shopping centers, mainly anchored by its hypermarkets and supermarkets, that are rented
out.”
Ahold Delhaize Group (NLD/BEL) “Delhaize Group operates a significant number of its stores under finance lease arrangements. Various properties
leased are (partially or in full) subleased to third parties, where the Group is therefore acting as a lessor. Lease terms
(including reasonably certain renewal options) generally range from 1 to 36 years with renewal options ranging from
3 to 30 years.”
Diageo (GBR) “The company owns or leases land and buildings throughout the world. Diageo’s largest individual facility, in terms of
net book value of property, is St James’s Gate brewery in Dublin. Approximately 96% by value of the group’s
properties are owned and approximately 3% are held under leases running for 50 years
or longer.”
Marks and Spencer plc (GBR) “The Group leases various stores, offices, warehouses and equipment under non-cancellable lease agreements. The
leases have varying terms, escalation clauses and renewal rights.”
McDonald’s Corp. (USA) “The Company was the lessee at 15,235 restaurant locations through ground leases (the Company leases the land
and the Company or franchisee owns the building) and through improved leases (the Company leases land and
buildings).”
RELX (GBR/NLD) “The company leases various properties, principally offices and warehouses, which have varying terms and renewal
rights that are typical to the territory in which they are located.”
BACKGROUND INFORMATION: FLY IN AN AIRCRAFT THAT IS ON AN AIRLINE’S BALANCE SHEET?
“One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet,” Sir David Tweedie,
Former Chairman of the IASB, (2008).
http://www.ifrs.org/
IAS 17 Leases à IFRS 16 Leases

IFRS 16 LEASES
The objective of IFRS 16 is to report information that:
a) faithfully represents lease transactions and
b) provides a basis for users of financial statements to assess the amount, timing and uncertainty of cash flows
arising from leases.
For accounting purposes, IFRS 16 classifies all leases as either finance or operating leases:
Finance lease
To be classified as a finance lease, the lease must
be a non-cancellable agreement that meets one or
more of the criteria on the next slide.
Operating lease
All other leases are classified as operating leases.

Finance lease: non- cancellable agreement that meets at least one of the five tests.
Lease Classification Tests

LEASE: DIFFERENT TYPES OF LEASE

IFRS 16: Either finance or operating lease
Finance lease
Under the finance lease method:
•The lessee is required to recognize a Right-of-use asset representing its right to use the underlying leased asset and a
lease liability representing its obligation to make lease payments.
•the lease liability is computed as the present value of the lease payments.
•the lessee recognizes interest expense on the lease liability using the effective-interest method.
•the lessee records depreciation expense on the Right-of-use asset.
Operating lease
Under an operating lease:
•the asset remains on the lessor’s books.
•the asset is depreciated over its economic life by the lessor.
(like you are renting the car)

FINANCE LEASE VS OPERATING LEASE

EXERCISE I: AI - ACCOUNTING FOR FINANCE AND OPERATING LEASES

Assume that the leasing company Electric Car Lease (lessor) and AI company (AI) (lessee) sign a lease agreement dated 1 January
2021, that calls for Car Lease to lease an electric car to AI beginning 1 January 2021. Terms and provisions included in this lease
agreement are:
−The term of the lease is five years. The lease agreement is non-cancelable, requiring equal rental payments of
€21.539,58 at the end of each year (annuity-due basis).
−The car has a fair value at the commencement of the lease of €100.000,00, an estimated economic life of five years, and a
guaranteed residual value of €5.000.
−After 5 years, AI has the option to buy the car for €5.000. AI expects that it is probable that the expected value of the residual
value at the end of the lease will be greater than €5.000.
−AI depreciates its equipment on a straight-line basis.
−Car Lease sets the annual rental rate to earn a rate of return of 4 percent per year; AI is aware of this rate.
Questions
1At what amount should AI record the right-of-use asset on 1 January 2021?
2.Prepare AI’s amortization table for the finance lease.
3.Prepare the journal entries on the books of AI for the years 2021 and 2022.
4.Prepare the journal entry on the book of AI if AI, after 5 years, buys the right-of-use asset for €5.000.
5.Prepare the journal entries on the books of AI and Car Lease if the lease agreement would have been classified as an operating
lease.

PRESENT VALUE OF LEASE PAYMENTS

1.
Under the finance lease method the lessee is required to recognize a Right-of-use asset representing its right to use
the underlying leased asset and a lease liability representing its obligation to make lease payments.
The lease liability is computed as the present value of the lease payments as follows (amounts in €): 21.539,58/(1,04)
+ 21.539,58/(1,04)2 + 21.539,58/(1,04)3 + 21.539,58/(1,04)4 + 21.539,58/(1,04)5 + 5.000/(1,04)5
= 21.539,58 x 4,45182 + 5.000/(1,04)5 = 95.890,37 + 4.109,63= 100.000
LEASE AMORTIZATION SCHEDULE

LESSEE JOURNAL ENTRIES AT LEASE

INCEPTION

FINANCIAL STATEMENTS PRESENTATION

FINANCIAL STATEMENTS

PURCHASE OF ELECTRIC CAR AT TERMINATION

OF LEASE
ACCOUNTING FOR OPERATING LEASE –
JOURNAL ENTRIES
EXERCISE II: RJM- ACCOUNTING
FOR FINANCE AND OPERATING
LEASES
RJM company (lessee) signs a 5-
year, non-cancelable lease
agreement to lease a machine
from the leasing company
Finance (lessor). This lease
agreement starts on 1 January
2021. The lease agreement is
classified as a finance lease. The
terms and provisions of the lease
agreement and other relevant
data are as follows:
– The term of the lease is five
years. The non-cancelable lease
agreement requires equal rental
payments of € 79.139,18 to be made
at the end of each year (annuity-due
basis).
‒ The leased asset has a fair
value at the inception of the lease of €
300.000.
‒ The leased asset has an
estimated economic life of five years
and no residual value.
‒ The possession of the leased
assets reverts to the lessor on 31
December 2025.
‒ The lessee depreciates similar equipment that it owns on a straight-line basis.
‒ The lessor sets the annual rental to earn a rate of return on its investment of 10 percent per year; the lessee
knows this fact.
Financial calculations
1a. At what amount should RJM record the leased asset on the 1 st of January 2021.
Assume the same information except that that the lease payments have to be made at the beginning of the year
instead of at the end of the year.
1b. What annual lease payments does RJM have to make at the beginning of the year if RJM would record the leased
asset on 1 January 2021 for the same amount as under 1a.?
2a. Prepare RJM’s amortization table for the leased asset if the payments are made at the end of each year.
2b. Prepare RJM’s amortization table for the leased asset if the payments would have been made at the beginning of
each year.

Financial Accounting
Assume for the following questions that the payments are made at the end of each year.
3.What is amount of depreciation and interest expenses that RJM should record for the years ended 31 December
2021 and 31 December 2022?
4.Prepare the journal entries on the books of RJM for the years 2021 and 2022.
5.Prepare the journal entries on the books of Finance for the years 2021 and 2022.
6.For reasons of comparability, prepare the journal entries on the books of RJM and Finance for the years 2021 and
2022 if the lease agreement would have been classified as an operating lease.
Suppose that RJM also has executory costs, i.e., costs of using the asset such as maintenance, taxes, and insurance.
These executory costs are € 2.000 per year.
7. Prepare the additional journal entries on the books of RJM for the years 2021 and 2022.
Suppose that the leased asset has a fair value at the inception of the lease of €300.000, an estimated economic life of
five years and a guaranteed residual value of €20.000, i.e., the lessee (RJM) guarantees the lessor (Finance) that the
asset will be worth no less than €20.000. In addition, assume that RJM does not have executory costs.
8. Prepare RJM’s amortization table for the leased asset.

EXERCISE II ON ACCOUNTING FOR LEASES

1a.
At what amount should RJM record the right-of-use asset on 1 January 2021.
Calculation of capitalized amount (amounts in €):
= 79.139,18 /(1,1) + 79.139,18 /(1,1)2 + 79.139,18 /(1,1)3 + 79.139,18 /(1,1)4 + 79.139,18 /(1,1)5
= 79.139,18 * (1 – (1/1,1)5)/0,1
= 79.139,18 * 3,79079 = 300.000
FINANCIAL STATEMENTS PRESENTATION

EXERCISE II ON ACCOUNTING FOR LEASES

1b.
What annual lease payments does RJM have to make at the beginning of the year if RJM would record the right-of-
use asset on 1 January 2021 for the same amount as under 1a.?
Calculation of annual lease payments (Annuity) (in €):
300.000 = Ann. + Ann. /(1,1) + Ann. /(1,1)2 + Ann. /(1,1)3 + Ann. /(1,1)4
= Ann. * (1 – (1/1,1)5)/0,1 * 1,1
= Ann. * 3,79079 * 1,1
= Ann. * 4,16987
 Ann. = annual lease payment = €71.944,69

EXERCISE II ON ACCOUNTING FOR LEASES

Questions 3-5 (Financial accounting)
For the following questions, assume that the payments are made at the end of each year.
3. What is amount of depreciation and interest expenses that RJM (lessee) should record for the years ended 31
December 2021 and 31 December 2022?
4. Prepare the journal entries on the books of RJM (lessee) for the years 2021 and 2022.
5. Prepare the journal entries on the books of Finance (lessor) for the years 2021 and 2022.

Financial
statements
presentation

EXERCISE ON
ACCOUNTING FOR
LEASES
Questions 3-5 (Financial accounting)
For the following questions, assume that the payments are made at the end of each year.
3. What is amount of depreciation and interest expenses that RJM (lessee) should record
for the years ended 31 December 2021 and 31 December 2022?
4. Prepare the journal entries on the books of RJM for the years 2021 and 2022.
5. Prepare the journal entries on the books of Finance (lessor) for the years 2021 and 2022.
EXERCISE ON ACCOUNTING FOR LEASES
Question 6 - Finance vs. Operating lease
6. For reasons of comparability, prepare the journal entries on the books of RJM (lessee) and Finance (lessor) for the
years 2021 and 2022 if the lease agreement would have been classified as an operating lease.

EXERCISE II ON ACCOUNTING FOR LEASES

Question 7 - Lessee: Executory Costs
Suppose that RJM also has executory costs, i.e., costs of using the asset such as
maintenance, taxes, and insurance. These executory costs are €2.000 per year and
included in the lease payment.
Prepare the additional journal entries on the books of RJM for the years 2021 and
2022.

Residual value guarantees

Provision that guarantees the lessor that the right-of-use asset will have a certain value at the end of the lease
Protection against two business risks:
‒ possibility that the lessee does not take proper care of the asset.
‒ unforeseen technological or marketplace changes that erode asset value.
Question 8
Suppose that the right-of-use asset has a fair value at the inception of the lease of
€300.000, an estimated economic life of five years and a guaranteed residual value of
€20.000. That is, the lessee (RJM) has to guarantee that the asset will be worth no less than €20.000.
Assume that RJM does not have executory costs.
‒ Prepare RJM’s amortization table for the right-of-use asset.
8. Lease with guaranteed residual value
Calculation of annual lease payments (Annuity) (in €):
300.000,00 = Ann. /(1,1) + Ann. /(1,1)2 + Ann. /(1,1)3 + Ann. /(1,1)4 + Ann. /(1,1)5 + 20.000 /(1,1)5
300.000,00 = Ann. * 3,79079 + 12.418,40
287.581,60 = Ann. * 3,79079 -Ann. = annual lease payment = €75.863,23