ACCOUNTING

FOR LEASES
 Muhammad Rizal Rifa’i
2000012016

Our Team
Zhaqiela Ainayah
2000012073
 THE LEASING ENVIRONMENT
✘ A lease is a contractual agreement between a lessor and a lessee.
This arrangement gives the lessee the right to use specific
property, owned by the lessor, for an agreed period of time.
✘ Any type of equipment can be leased, such as railcars,
helicopters, bulldozers, barges, CT scanners, computers, and so
on.

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 THE LEASOR THAT OWN PROPERTY
✘ Banks
Banks are the largest players
in the leasing business.
✘ Captive Leasing
Companies
Captive leasing companies are
subsidiaries whose primary
business is to perform leasing
operations for the parent
company.
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✘ Independents
Independent often does
developing innovative contracts
for lessees.
In addition, they are starting to
act as captive finance
companies for some companies
that do not have a leasing
subsidiary
Advantages of Leasing
The growth in leasing indicates that it often has some advantages, such as:
100% financing
fixed rates
Lease payments often
remain fixed, which
protects the lessee against
inl ation and increases in
the cost of money
Less costly
Financing
Some companies find
leasing cheaper than
other forms of
financing..
Protection against Flexibility
obsolescence
Leasing equipment reduces Innovative lessors can
risk of obsolescence to the tailor a lease
lessee, and in many cases agreement to the
passes the risk of residual lessee’s special needs.
value to the lessor
Off-balance-sheet
Tax advantages
Financing
For tax purposes, companies
can capitalize and depreciate Such off-balance-sheet financing is
the leased asset. critical to some companies.
 Conceptual Nature of a Lease
Don’t capitalize any Capitalize leases that are similar
leased assets to installment purchases
This view considers
capitalization inappropriate
Companies should report transactions in
because Lessee doesn’t own the
accordance with their economic
property.
substance.

Capitalize all long- Capitalize non-cancelable leases

term leases where the penalty for non-
Only the long-term right to use performance is substantial
the property in order to
capitalize. Only non-cancelable contractual rights and
obligations.
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 ACCOUNTING BY THE LESSEE
✘ The typical journal entries for Air France and ILFC, assuming leased and
capitalized equipment.
Journal Entries for Capitalized Lease

When Air France makes a lease payment, it records rental expense; ILFC
recognizes rental revenue

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 Capitalization Criteria
Transfer of Ownership Test
If the lease transfers ownership of the asset to
the lessee, it is a finance lease.
 Bargain-Purchase Option Test
A bargain-purchase option allows the lessee to
purchase the leased property for a price that is
significantly lower than the property’s
expected fair value at the date the option
becomes exercisable.
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Economic Life Test
Lessees and lessors should consider all
relevant factors when assessing whether
substantially all the risks and rewards of
ownership have been transferred in the lease.
 Recovery of Investment Tes
If the present value of the minimum lease
payments is reasonably close to the fair
value , lessee is effectively purchasing the
asset.
Minimum Lease Payments.
include the
Minimum rental following
payments
those that Lessee must make to Lessor under the lease
agreement

Guaranteed residual value

the estimated fair value of the leased property at the end of
the lease term

Penalty for failure to renew or extend the lease

the amount of Lesse must pay if the agreement speciies that it
must extend or renew the lease, and it fails to do.
Bargain-purchase option
an option given to Lesse to purchase the aset at the end of the
lease term at a price that is fixed sufi ciently below the
expected fair value 9
Kebutuhan Sistem Kerja Pengetahuan
1. Asset and Liability Recorded
 minimum lease payments the
present value of the (excluding
executory costs) or
 the fair value of the leased
asset at the inception of the
lease
3. Effective-Interest Method
 effective-interest method to
allocate each lease payment
between principal and interest
2. Depreciation Period
 or contains a bargain-purchase option.
 Air France depreciates the aircraft
consistent with its normal depreciation
policy for other aircraft, using the
economic life of the asset
4. Depreciation Concept
 the depreciation of the aircraft and the
discharge of the obligation are
independent accounting processes
during the term of the lease.
 FINANCE LEASE
METHOD (LESSE)
The terms and provisions of the lease agreement and other pertinent data are as follows:
 The term of the lease is five years. The lease agreement is non-cancelable, requiring equal rental
payments of $25,981.62 at the beginning of each year (annuity-due basis).
 The loader has a fair value at the inception of the lease of $100,000, an estimated economic life of five
years, and no residual value.
 Ivanhoe pays all of the executory costs directly to third parties except for the property taxes of $2,000
per year, which is included as part of its annual payments to CNH.
 The lease contains no renewal options. The loader reverts to CNH at the termination of the lease.
 Ivanhoe’s incremental borrowing rate is 11 percent per year.
 Ivanhoe depreciates similar equipment that it owns on a straight-line basis.
 CNH sets the annual rental to earn a rate of return on its investment of 10 percent per year; Ivanhoe
knows this fact.

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✘ The minimum lease payments are $119,908.10 ($23,981.62).
✘ Ivanhoe computes the amount capitalized as leased assets as the present value of
the minimum lease payments (excluding executory costs-property taxes of $2,000)
✘ Computation of Capitalized Lease Payments

✘ Ivanhoe records the finance lease on its books on January 1, 2015, as follows.
Leased Equipment 100,000
Lease Liability 100,000

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 Ivanhoe records the first lease payment on January 1, 2015, as follows.
Property Tax Expense 2,000.00
Lease Liability 23,981.62
Cash 25,981.62
 Each lease payment of $25,981.62 consists of three elements:
1. a reduction in the lease liability
2. a financing cost (interest expense)
3. executory costs (property taxes).
 The total financing cost (interest expense) over the term of the lease is $19,908.10
($119,908.10 - $100,000).

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Lease Amortization Schedule for Lessee-
Annuity-Due Basis

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✘ At the end of its fiscal year, December 31, 2015, Ivanhoe records
accrued interest as follows.
Interest Expense 7,601.84
Interest Payable 7,601.84
✘ Depreciation of the leased equipment over its five-year lease term,
applying Ivanhoe’s normal depreciation policy (straight-line
method), results in the following entry on December 31, 2015.
Depreciation Expense 20,000
Accumulated Depreciation—Leased Equipment 20,000
($100,000 4 5 years)

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✘ Ivanhoe records the lease payment of January 1, 2016, as follows.
Property Tax Expense 2,000.00
Interest Payable 7,601.84
Lease Liability 16,379.78
Cash 25,981.62
✘ If Ivanhoe purchases the equipment at termination of the lease, at a price of $5,000 and
the estimated life of the equipment changes from five to seven years, it makes the
following entry.
Equipment ($100,000 1 $5,000) 105,000
Accumulated Depreciation—Leased Equipment 100,000
Leased Equipment 100,000
Accumulated Depreciation—Equipment 100,000
Cash 5,000
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 Operating method (lesse)
✘ Under the operating method, rent expense (and the associated liability) accrues
day by day to the lessee as it uses the property
✘ For example, assume that the finance lease illustrated in the previous section did
not qualify as a finance lease. Ivanhoe therefore accounts for it as an operating
lease.The first-year charge to operations is now $25,981.62, the amount of the
rental payment. Ivanhoe records this payment on January 1, 2015, as follows.
Rent Expense ​25,981.62
Cash ​25,981.62
✘ Ivanhoe reports rent expense on the income statement.
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 Comparison of Finance Lease
with Operating Lease
✘ if accounting for the lease as an operating lease, the first-year charge
to operations is $25,981.62, the amount of the rental payment.
✘ Treating the transaction as a finance lease, however, results in a
firstyear charge of $29,601.84: depreciation of $20,000 (assuming
straight-line), interest expense of $7,601.84, and executory costs of
$2,000.

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Comparison of Charges to
Operations—Finance vs.
Operating Leases

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✘ This illustration shows that while the total charges to operations are the same
over the lease term whether accounting for the lease as a finance lease or as an
operating lease, under the finance lease treatment the charges are higher in the
earlier years and lower in the later years.

✘ The following differences occur if using a finance lease instead of an

operating lease:
1. An increase in the amount of reported debt (both short-term and
long-term).
2. An increase in the amount of total assets (specii cally long-lived
assets).
3. A lower income early in the life of the lease and, therefore, lower
retained earnings.

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 ACCOUNTING BY THE LESSOR
Leasing’s advantages to the lessee, three important benefits are available to
the lessor:
 Interest revenue. Companies leasing attractive because it provides competitive
interest margins.
 Tax incentives. Companies that lease cannot use the tax benefitt of the asset,
but leasing allows them to transfer such tax benei ts to another party (the
lessor) in return for a lower rental rate on the leased asset.
 Residual value profits. Another advantage to the lessor is the return of the
property at the end of the lease term.

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 Classification of Leases by
the Lessor
✘ For accounting purposes, the lessor also classifies leases as operating or finance leases
✘ Finance leases may be further subdivided into direct-financing and sales-type leases.
✘ The distinction for the lessor between a direct-financing lease and a sales-type lease is the
presence or absence of a manufacturer’s or dealer’s profit (or loss). A salestype lease involves
a manufacturer's or dealer's profit, and a direct-financing lease.
✘ The profit (or loss) to the lessor is evidenced by the difference between the fair value of the
leased property at the inception of the lease and the lessor’s cost or carrying amount (book
value).

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 Direct-Financing Method (Lessor)
✘ Direct-financing leases are in substance the financing of an asset purchase by the lessee. In
this type of lease, the lessor records a lease receivable
✘ Minimum lease payments include:
1. Rental payments (excluding executory costs)
2. Bargain-purchase option (if any)
3. Guaranteed residual value (if any)
4. Penalty for failure to renew (if any).
✘ the lease meets the criteria for classification as a direct-financing lease for two reasons:
1. the lease term equals the equipment’s estimated economic life
2. the present value of the minimum lease payments equals the equipment's fair value.

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✘ The lease receivable is the present value of the minimum lease payments (excluding
executory costs which are property taxes of $2,000). CNH computes it as follows.

✘ CNH records the lease of the asset and the resulting receivable on
January 1, 2015 (the inception of the lease), as follows.
Lease Receivable ​100,000
Equipment ​100,000

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CNH replaces its investment (the leased front-end loader, a cost of $100,000) with a lease receivable. In a
manner similar to Ivanhoe's treatment of interest, CNH applies the effective-interest method and recognizes
interest revenue as a function of the lease receivable balance.

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✘ On January 1, 2015, CNH records receipt of the first year’s lease payment as follows.
Cash ​25,981.62
Lease Receivable​​ 23,981.62
Property Tax Expense/Property Taxes Payable​​ 2,000.00O

✘ December 31, 2015, CNH recognizes the interest revenue earned during the first year through
the following entry
Interest Receivable ​7,601.84
Interest Revenue ​ 7,601.84

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✘ At December 31, 2015, CNH reports the lease receivable in its statement of
financial position among current assets or non-current assets, or both.
✘ Theassets section as it relates to lease transactions at December 31, 2015.

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 The following entries record receipt of the second year's lease payment and recognition of the
interest earned.
January 1, 2016
Cash ​ ​25,981.62
Lease Receivable ​16,379.78
Interest Receivable ​7,601.84
Property Tax Expense/Property Taxes Payable ​2,000.00
December 31, 2016
Interest Receivable ​5,963.86
Interest Revenue ​5,963.86
 .If Ivanhoe buys the loader for $5,000 upon expiration of the lease, CNH recognizes disposition of
the equipment as follows.
Cash 5,000
Gain on Disposal of Equipment 5,000
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 Operating Method
(Lessor)
✘ the lessor records each rental receipt as rental revenue.
✘ It depreciates the leased asset in the normal manner, with the depreciation expense of the period matched
against the rental revenue.
✘ the lessor expenses maintenance costs and the cost of any other services performed under the provisions of
the lease that pertain to the current accounting period.

✘ To illustrate the operating method, assume that the direct-financing lease illustrated in the previous section
does not qualify as a finance lease. Therefore, CNH accounts for it as an operating lease. It records the
cash rental receipt as follows.
Cash 25,981.62
Rent Revenue 25,981.62

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 CNH records depreciation as follows (assuming a straight-line method, a cost basis of $100,000,
and a five-year life).

Depreciation Expense ​ 20,000

Accumulated Depreciation—Equipment ​ 20,000

• If CNH pays property taxes, insurance, maintenance, and other operating costs during the year, it
records them as expenses chargeable against the gross rental revenues.
• If CNH owns plant assets that it uses in addition to those leased to others, the company separately
classifies the leased equipment and accompanying accumulated depreciation as Equipment Leased
to Others or Investment in Leased Property.

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 SPECIAL ACCOUNTING PROBLEMS

✘ Residual value
✘ Sales-type leases (lessor)
✘ Bargain-purcase option
✘ Initial Direct Cost
✘ Current vs non-current classification
✘ Disclosure
 Residual Values
Lease Payments
A guaranteed residual value-by definition-has more assurance of realization than does an unguaranteed
residual value. As a result, the lessor may adjust lease payments because of the increased certainty of recovery.
Assume the same data as in the CNH/Ivanhoe illustrations except that CNH estimates a residual value of
$5,000 at the end of the five-year lease term. In addition, CNH assumes a 10 percent return on investment
(ROI), whether the residual value is guaranteed or unguaranteed. CNH would compute the amount of the lease
payments as follows.

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Lessee Accounting for Residual Value
The accounting consequence is that the minimum lease payments, the basis for
capitalization, include the guaranteed residual value but exclude the unguaranteed
residual value.

Guaranteed Residual Value (Lessee Accounting). The guaranteed residual value is

an additional lease payment that the lessee will pay in property or cash, or both, at the
end of the lease term.
Using the rental payments as computed by the lessor, the minimum lease payments
are $121,185.45 ([$23,237.09 x 5] + $5,000).
The capitalized present value of the
minimum lease payments (excluding
executory costs) for Ivanhoe.

Ivanhoe prepares a schedule of interest

expense and amortization of the
$100,000 lease liability.
That schedule, is based on a $5,000
final guaranteed residual value payment
at the end of five years.

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Unguaranteed Residual Value (Lessee Accounting). From the lessee’s viewpoint, an unguaranteed
residual value is the same as no residual value in terms of its effect upon the lessee’s method of computing
the minimum lease payments and the capitalization of the leased asset and the lease liability.

Assume the same facts as those above except that the $5,000 residual value is unguaranteed instead of guaranteed. The
amount of the annual lease payments would be the same—$23,237.09. Whether the residual value is guaranteed or
unguaranteed, CNH will recover the same amount through lease rentals—that is, $96,895.40. The minimum lease payments
are $116,185.45 ($23,237.09 x 5).
Ivanhoe's schedule of interest expense and amortization of the lease liability of $96,895.40, assuming an
unguaranteed residual value of $5,000 at the end of five years.

Ivanhoe records the leased asset and liability, depreciation, interest, property tax, and lease payments on the basis of an
unguaranteed residual value. The format of these finance lease entries is the same as illustrated earlier. Note that Ivanhoe
records the leased asset at $96,895.40 and depreciates it over five years. Assuming that the company uses the straight-line
method, the depreciation expense each year is $19,379.08 ($96,895.40 : 5 years).
At the end of the lease term, before Ivanhoe transfers the asset to CNH, the lease asset and liability accounts
have the following balances.

Assuming that Ivanhoe has fully depreciated the leased asset and has fully amortized the lease liability, no entry is required at
the end of the lease term except to remove the asset from the books.
Lessee Entries Involving Residual Values. In comparative form, Ivanhoe’s entries for both a guaranteed
and an unguaranteed residual value.
Lessor Accounting for Residual Value
The lessor works on the assumption that it will realize the residual value at the end of the lease term whether
guaranteed or unguaranteed.
To illustrate, we again use the CNH/Ivanhoe data and assume classification of the lease as a direct-financing
lease. With a residual value (either guaranteed or unguaranteed) of $5,000, CNH determines the payments as
follows.
The amortization schedule is
the same for guaranteed or
unguaranteed residual value.

Using the amounts computed

above, CNH would make the
entries.
 Sales-Type Leases (Lessor)
The primary difference between a direct-
financing lease and a sales-type lease is the
manufacturer’s or dealer’s gross profit (or
loss).

In a sales-type lease, the lessor records the

sales price of the asset, the cost of goods
sold and related inventory reduction, and
the lease receivable.

Therefore, the lessor recognizes sales and cost of goods sold only for the portion of the asset for which
realization is assured. However, the gross profit amount on the sale of the asset is the same whether a
guaranteed or unguaranteed residual value is involved.
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To illustrate a sales-type lease with a guaranteed residual value and with an unguaranteed
residual value. The estimated residual value is $5,000 (the present value of which is $3,104.60),
and the leased equipment has an $85,000 cost to the dealer (CNH). Assume that the fair value of
the residual value is $3,000 at the end of the lease term.

In making this computation, we deduct the present value of the unguaranteed residual value from
sales revenue and cost of goods sold.
CNH makes the entries to record this transaction on January 1, 2015, and the receipt of the
residual value at the end of the lease term.
 Bargain-Purchase Option (Lessee)
A bargain-purchase option allows the lessee to purchase the leased property for a future price that
is substantially lower than the property’s expected future fair value.
If a bargain-purchase option exists, the lessee must increase the present value of the minimum
lease payments by the present value of the option price.
With a guaranteed residual value, the lessee must pay the residual value at the end of the lease.
Similarly, a purchase option that is a bargain will almost certainly be paid by the lessee.
The only difference between the accounting treatment for a bargain-purchase option and a
guaranteed residual value of identical amounts and circumstances is in the computation of the
annual depreciation.
 Initial Direct Costs (Lessor)
The accounting for initial direct costs depends on the type of lease:
✘ For operating leases, the lessor should defer initial direct costs and
allocate them over the lease term in proportion to the recognition of
rental revenue.
✘ For sales-type leases, the lessor expenses the initial direct costs in the
period in which it recognizes the profit on the sale.
✘ For a direct-financing lease, the lessor adds initial direct costs to the net
investment in the lease and amortizes them over the life of the lease as a
yield adjustment.
 Current versus Non-Current
A common method of measuring the current liability portion in ordinary
annuity leases is the change-in-the-present-value method.
To illustrate the change-in-the-present-value method, assume an ordinary-
annuity situation with the same facts as the CNH/Ivanhoe case, excluding
the $2,000 of executory costs. Because Ivanhoe pays the rents at the end
of the period instead of at the beginning, CNH sets the five rents at
$26,379.73, to have an effective-interest rate of 10 percent.
The current portion of the lease liability/receivable under the change-in-the-present-value method as of
December 31, 2015, would be $18,017.70 ($83,620.27 - $65,602.57). As of December 31, 2016, the
current portion would be $19,819.47 ($65,602.57 - $45,783.10). At December 31, 2015, CNH classifies
$65,602.57 of the receivable as non-current.
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 Disclosing Lease Data
These disclosure requirements provide investors with the following information :
For lessors:
✘ A general description of material leasing
arrangements.
✘ A reconciliation between the total of future minimum
lease payments at the end of the reporting period and
their present value.
✘ The total of future minimum lease payments at the end
of the reporting period, and their present value for
periods (1) not later than one year, (2) later than one
year and not later than five years, and (3) later than
five years.
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For lessors:
✘ A general description of material leasing arrangements
✘ A reconciliation between the gross investment in the lease at the
end of the reporting period, and the present value of minimum
lease payments receivable at the end of the reporting period.
✘ Unearned finance income.
✘ The gross investment in the lease and the present value of
minimum lease payments receivable at the end of the reporting
period for periods (1) not later than one year, (2) later than one
year and not later than five years, and (3) later than five years.
Resourch: Kieso, Donald E and Weygandt, Jerry J. Intermediate
Accounting. IFRS Edition. New York: John Wiley & Sons.

THANKS!
Any question?

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