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OPERATING

LEASE
Definiton of lease:
The accounting standard on leases is PAS 17.

Under PAS 17, paragraph 4, a lease is defined as an


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.

Otherwise stated, a lease is an agreement between one party


called the lessor and another party called the lessee whereby
the lessee is granted the right use the property owned by the
lessor for a specific period of time in consideration for certain
payment in the form of rent.

Accountants recognize two kinds of lease namely operating


lease and finance or capital lease.
Operating lease- Lessee
PAS 17, paragraph 33, provides that lease payments under an
operating lease shall be recognize as an expense on a straight
line basis over the lease term unless another systematic basis
is more representative of the time pattern of the users
benefit.

In other words, the periodic rental is simply recognized as rent


expense on the part of the lessee. The operating lease is also
called the rental approach.

A lease bonus paid by the lessee to the lessor in addition to


the periodic rental is treated as prepaid rent expense by
lessee to be amortized over the lease term.
Leasehold improvement made by the lessee shall
be depreciated over the life of the improvement or
lease term, whichever is shorter.

The residual value of the leasehold improvement is


ignored by the lessee in computing depreciation
because legally the leasehold improvement
becomes the property of the lessor upon the
expiration of the lease term.

Any security deposit refundable upon the lease


expiration is accounted for as an asset by the
lessee.
Operating lease- Lessor
PAS 17, paragraph 50, provides that lease income
from operating lease shall be recognized on a
straight line basis over the lease term, unless
another systematic basis is more representative of
the time pattern in which use benefit derived from
the leased asset is diminished.

Otherwise stated, the periodic rental received by


the lessor in an operating lease is simply recognized
as rent income.

A lessor shall present an asset subject to operating


lease in its statement of financial position according
to the nature of the asset.
The leased property remains as an asset of
the lessor and consequently, the lessor bears
all ownership or executor costs such as
depreciation of leased property, real property
taxes, insurance and maintenance.

However, the lessor may pass on to the lessee


the payment for taxes, insurance and
maintenance cost.

The depreciation policy for depreciable leased


asset shall be consistent with the lessors
normal depreciation for similar asset.
Initial direct costs are often incurred by the lessor and
include amounts such as commissions, legal fees and
internal costs that are incremental and directly attributable
to negotiating and arranging a lease.

Initial direct costs incurred by lessor in an operating lease


shall be added to the carrying amount of the leased asset
and recognized as an expense over the lease term on the
same basis as the lease income.

Any security refundable upon the lease expiration shall be


accounted for as liability by the lessor.

Any lease bonus received by the lessor from the lessee is


recognized as unearned rent income to the amortized over
the lease term.
Illustration-Lessee
1. On January 1, 2012, Easy Company
leased an equipment from another entity
for P300,000 annually for 3 years.
Rent expense 300,000
Cash 300,000
2. On January 1, 2012, Easy Company made
a security deposit of P300,000 refundable
upon the lease expiration.
Rent deposit 300,000
Cash 300,000
3. In addition to the annual rental, Easy
Company paid P60,000 to the lessor as
a lease bonus on January 1, 2012.
Prepaid rent 60,000
Cash 60,000
4. The lease bonus is amortized over 3
years or P20,000 annually.
Rent expense 20,000
Prepaid rent 20,000
Illustration-Lessor

1. On January 1, 2012, Simple Company purchased a


machinery for P3,000,000 cash for the purpose of leasing
it. The machine is expected to have a 10-year life and no
residual value.
Machinery 3,000,000
Cash 3,000,000
2. On April 1, 2012, Simple Company leased the machine to
another entity for 3 years at a monthly rental of P50,000,
payable at the beginning of every month.
Cash (50,000x9) 450,000
Rent income 450,000
3. On April 1, 2012, Simple Company received a security
deposit of P600,000 to be refunded upon the lease
expiration.
Cash 600,000
Liability for rent deposit 600,000
4. In addition to the rental, Simple Company received
from the lessee a lease bonus of P120,000 on
January 1, 2012.
Cash 120,000
Unearned rent income 120,000
5. On April 1, 2012, Simple Company paid initial direct
costs of P300,000. Such costs are directly
attributable to negotiating and arranging the
operating lease.
Deferred initial direct costs 300,000
Cash 300,000
6. During the year, Simple Company paid repair and
maintenance of P 20,000.
Repair and maintenance 20,000
Cash 20,000
7. The lease bonus is amortized over 3 years or P40,000
annually.
Unearned rent income 30,000
Rent income (40,000x9/12) 30,000
8. The machinery is depreciated over 10 years or
P300,000 annually.
Depreciation 300,000
Accumulated depreciation 300,000

Note that the depreciation id from the date of acquisition,


January 1, 2012 and not from April 1, 2012, date of lease.
The reason is that the machinery is acquired for leasing
purposes and therefore available for its intended use,
meaning for rental from January 1, 2012. Idle property is
subject to depreciation as long as it is available for its
intended use.
9. The initial direct costs are recognized as
expense over the lease term.
Amortization of initial direct costs 75,000
Deferred initial direct costs 75,000
(300,000/3x9/12)

The balance of the deferred initial direct costs


shall be presented as an addition to the
carrying amount of machinery.
Unequal rental
payments
PAS 17, paragraph 33, provides that lease
payments under an operating lease shall be
recognized as an expense on a straight line
basis over the lease term unless another
systematic basis is representative of the time
pattern of the users benefits.

This simply means that where the operating


lease requires unequal cash payments, the total
cash payments for the lease term shall be
amortized uniformly on the straight line basis as
rent expense or rent income.
Illustration
Aye Company leased office space to Bee Company for a
three year period beginning January 1, 2012. Under the
terms of the operating lease, rent for the first year is P
1,000,000 and rent for the next two years, P1,250,000
annually. However, as an inducement to enter the lease,
Aye granted BEE the first six months of the lease rent-
free.

The total rental for the lease term is determined as


2012 (1,000,000x6/12)
follows: 500,000
2013 1,250,000
2014 1,250,000
Total rental for 3 years 3,000,000
Average annual rental 1,000,000
(3,000,000/3)
Books Aye Company- Lessor

2012 Cash 500,000


Rent Receivable 500,000
Rent income 1,000,000

2013 Cash 1,250,000


Rent income 1,000,000
Rent receivable 250,000

Rent income for 2012 and 2013 2,000,000


Rent collected(500,000+1,250,000) 1,750,000
Rent receivable 250,000
2014 Cash 1,250,000
Rent income 1,000,000
Rent receivable 250,000

Note that the rent receivable has zero


balance on December 31, 2014 and the
recorded rent income each year is P
1,000,000.
Books of Bee Company- Lessee

2012 Rent Expense 1,000,000


Cash 500,000
Rent Payable 500,000

2013 Rent expense 1,000,000


Rent Payable 250,000
Cash 1,250,000

2014 Rent expense 1,000,000


Rent Payable 250,000 Cash 1,250,000

Disclosures for operating lease- Lessee

1. The total of future minimum lease payments under


noncancelable operating leases for each of the following
period:

a. Not later than one year


b. Later than one year and not later than 5 years
c. Later than 5 years

2. The total of the future minimum lease payments expected to


be received under noncancelable subleases at the end of
the reporting period.

3. Lease and sublease payments recognized as expense in the


period, with separate amounts for minimum, lease payments,
contingent rents and sublease payments.

4. A general description of the lessees significant leasing


arrangements.
Disclosure for operating leases
Lessor
1. Future minimum lease payments under
noncancelable operating leases in the aggregate
and for each of the following periods:

a. Not later than one year


b. Later than one year and not later than 5 years
c. Later than 5 years

2. Contingent rents recognized as income in the


period.

3. A general description of the lessors leasing


arrangements
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