AC2101 S2 20132014 Seminar 4 Leases
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Transcript of AC2101 S2 20132014 Seminar 4 Leases
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AC2101Accounting Recognition
and Measurement
Semester 2, AY 2013/2014
Seminar 4
Lease Accounting I
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Recap from Seminar 3
Comprehensive income as a bridge between economic
& accounting income
Presentation issues pertaining to
recycling/reclassification
Financial capital maintenance (nominal dollars)
concept
Assets: definition & general recognition criteria
Leases: a brief introduction
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Seminar 4 Agenda
- FRS 17 Technicalities
- Classification of Leases
- Operating LeasesLessee/Lessor
- Finance LeasesLessee/Lessor
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Bargain purchase option (BPO)
Bargain renewal option (BRO)
Lease term (incl. reasonably certain renewal period)
Minimum lease payments (MLP)
Annual lease payments (ALP): ordinary annuity or
annuity due
Residual value (RV): guaranteed vs unguaranteed
(note that only GRV is included in MLP)
Some Technicalities in FRS 17
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BPO
Bargain Purchase Option (BPO)
Option for lessee to purchase the asset at aprice that is expected to be sufficiently lower
than fair value at the date the option becomesexercisable
Reasonably certain, at the inception of the lease,
that the option will be exercised by the lessee
FRS 17 para 4
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BRO
Bargain Renewal Option (BRO)
Option for lessee to renew the lease over
periods in which the lease rentals aresignificantly lower than the expected market rate
Reasonably certain, at the inception of the lease,
that the option will be exercised by the lessee
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Lease Term
Lease Term
Non-cancellable lease term +
Further lease term under BRO or
Further lease term to exercise BPO
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What is the lease term?
Initial lease period= 5 yrs
RO
Normal renewal period= 2 yrs
81 2 3 4 5
0% 0% 0%0%0%
1. 2 years
2. 3 years
3. 5 years
4. 7 years5. 8 years
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What is the lease term?
Initial lease period= 5 yrs
BRO
Bargain renewal period= 3 yrs
91 2 3 4 5
0% 0% 0%0%0%
1. 2 years
2. 3 years
3. 5 years
4. 7 years5. 8 years
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What is the lease term?
BPO
Initial lease period= 5 yrs
RO
Normal renewal period= 2 yrs
101 2 3 4 5
0% 0% 0%0%0%
1. 2 years
2. 3 years
3. 5 years
4. 7 years5. 8 years
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MLPs
Minimum lease payments (MLPs) are payments overthe lease term that the lessee is or can be required to make
together with amounts guaranteed (FRS 17 para 4), i.e.
usually
Sum of Annual Lease Payments (ALPs) + BPO or Guaranteed Residual Value (GRV)
To Lessee: rep. future obligations for payments by the lessee
under the lease contract.To Lessor: rep. future economic benefits to the lessor under the
lease contract.
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ALPs
Pause and Think:Assume you are in the business of leasing printers. Id like to lease a
pr inter that yo u just bou ght for $200 over a 2-year lease. At the end
of th e 2 years, the ownership o f the pr inter wi l l be transferred to m e.
The effective interest rate youd like to earn is 10%. How would you
determ ine the ALP?
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ALP@Y2ALP@Y1
$200 = ALP/(1+r) + ALP/(1+r)2
$200 = ALP[1/(1+r) + 1/(1+r)2]
ALP = $200/[1/(1+r) + 1/(1+r)2]
ALP = $200/PV of annuity factor= $200/1.73554
= $115.23
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ALPs
Annual lease payments (ALPs): essentially a pricing decision
made by LESSOR!!!
= Fair value of the Asset at the start of lease term PV of est. recovery value at end of lease term
PV of annuity factor
Lessors estimated recovery value at end of lease term
BPO
GRV
unGRV
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Residual Value
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Residual value may be
a.Guaranteed(GRV),
By lessee, party related to lessee, or unrelated third
party
From the lesseespoint of view, GRV would be the
value guaranteed by lessee or a party related to lessee
From the lessorspoint of view, GRV would be thevalue guaranteed by lessee or a party related to lessee
or a third party unrelated to the lessor
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Residual Value
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Residual value may be
b. Unguaranteed(unGRV),
Is that portion of the residual value of the leased asset,
the realisation of which by the lessor is not assured, or
is guaranteed solely by a party RELATED to the lessor
c. Shared (SRV) (Not in syllabus) Proceeds from disposal shared by lessee & lessor in specified
ratio
Recall from earl ier:
Minimum lease payments (MLPs) -
Sum of Annual Lease Payments (ALPs) +
BPO or Guaranteed Residual Value (GRV)
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For lessor (R)a. MLPR= (Annual lease payments) + [GRVRor BPO]
b. GRVR= RV guaranteed by
Lessee, a party related to lessee OR a party unrelated to
lessor
For lessee (E)
a. MLPE= (Annual lease payments) + [GRVEor BPO]
b. GRVE= RV guaranteed by Lessee or a party related to lessee
Some Technicalities in FRS 17
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PV of Minimum lease payment (MLP)
=MLP discounted at
For lessor: implicit rate
For lessee: implicit rate or lessees
incremental borrowing rate, if implicit rate is
not known
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PV of MLPs
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Classification of Leases
Classification criteria (FRS 17 para 10):
1. End of lease: lessee gets asset?
(transfer of ownership)
2. Bargain purchase option (BPO)?
3. Most of useful life: lessee uses asset?
(leaseterm75% of useful life rule)
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Classification of Leases
Classification criteria (FRS 17 para 10):
4. PV of minimum lease payments (MLPs):
close to assets fair value?
(recovery of investment 90% rule)
5. Asset: specialised nature, only lessee canuse it?
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Classification of Leases
If any one of the classification criteria is met,
it is a finance lease.
See flowchart in p. 269 of NCKL
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Other Indicators of Substantial Transferof Ownership Risks & Rewards
1. Lessors losses borne by lessee upon lessees
cancellation
2. Gains/Losses from fluctuation of residual fair
value accrues to lessee
3. BRO exists
If any oneof the indicators is present, it is a finance lease.
FRS 17:11
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Operating Lease
An operating lease will be accounted for as if it is a rental
transaction
Refer to write-up on operating leases in seminar
outline
Take note of JEs for lessee & lessor!
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Accounting Operating Lease (Rental)
Lessors books
Dr Cash
Cr Rental income
Dr Depr expense
Cr Accum Depr
Lessees books
Dr Rental expense
Cr Cash
No depreciation charge
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Seminar Question
- Question 1
- Application of FRS 17
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Summary of Note on Operating Lease in the Seminar
Outline
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Summary for Operating Lease
Lessor Lessee
Balance Sheet Asset under lease=> Accumulated
Depreciation
No asset
Income
Statement
Rental Income,
Depreciation
Rental expense
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Finance Lease
A finance lease will be accounted for as iflessee buys
over the asset with financing provided for by lessor
Refer to write-up on finance leases in seminar outline
Take note of JEs for lessee & lessor!
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Finance Lease - Lessee
Lessee Lease asset
Capitalise: at Fair Value or if lower, the PV (MLPs)
May include Initial Direct Costs (i.e. costs that are
directly attributable to negotiating and arranging alease. )
Depreciation
Useful life (if there is reasonable certainty that the
lessee will obtain ownership) or lease term (ifotherwise)
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See FRS 17 paras 27, 28 for more details.
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FRS 17 Finance Lease for Lessee
27. A finance lease gives rise to depreciation expense for
depreciable assets as well as finance expense for each
accounting period. The depreciation policy for depreciable
leased assets shall be consistent with that for depreciable
assets that are owned, and the depreciation recognised shall
be calculated in accordance with FRS 16 Property, Plant andEquipment and FRS 38 Intangible Assets. If there is no
reasonable certainty that the lessee will obtain ownership by
the end of the lease term, the asset shall be fully depreciated
over the shorterof the lease term and its useful life.
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If it is a finance lease and the leasedassets title DOES NOT pass to lessee bythe end of the lease.
Lessee should depreciate leased
asset over?
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Usually the lease term
1 2 3 4
0% 0%0%0%
1. Leased assets useful life
2. Lease term
3. Shorter of useful life and lease term
4. Longer of useful life and lease term
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FRS 17 Finance Lease for Lessee
28. The depreciable amount of a leased asset is allocated to each
accounting period during the period of expected use on a
systematic basis consistent with the depreciation policy the
lessee adopts for depreciable assets that are owned. If there
is reasonable certainty that the lessee will obtain ownership
by the end of the lease term, the period of expected use isthe useful lifeof the asset; otherwisethe asset is depreciated
over the shorterof the lease term and its useful life.
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If it is a finance lease and the leasedassets title passes to lessee by the endof the lease.
Lessee should depreciate leased
asset over?
341 2 3 4
0% 0%0%0%
1. Leased assets useful life
2. Lease term
3. Shorter of useful life and lease term
4. Longer of useful life and lease term
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Finance Lease - Lessee
Lessee Lease payable
Also at Fair Value or if lower, PV (MLPs)
Interest expense
Usually using effective interest rate method (i.e.,amortization schedule)
Discount rate = lessors implicit interest rate if
known, otherwise, lessees incremental borrowing
rate
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See FRS 17 paras 20, 25 for more details.
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Accounting for Finance Lease
Lessors books Lessees books
At the start of the lease:
Dr Leased asset X
Cr Lease payable (X1)
Cr Cash/Payable (X2)
X= X1+X2
X1 = Lower[FV or PV(MLPs)]
X2 = Lessees initial direct costs*
During the lease:
Dr Lease payableDr Interest expense
Cr Cash (= ALP)
Dr Depreciation expense
Cr Accumulated Depreciation36*IDC = costs that are directly attributableto negotiating and arranging a lease.
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Finance Lease LessorMore Technicalities
Lessorrecords a LEASE RECEIVABLE@GrossInvestment (G)
Gross investment in the lease or G=
MLPs + unGRV
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Contractual benefits
during the leaseterm, includingBPO or GRV
Benefits afterlease term(risky)
Note that the MLPs and unGRV are UNdiscountedvalues.
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Finance Lease LessorMore Technicalities
Present Value of the Gross Investment (G) discounted at
the lessors implicit interest rate is the Net Investment
(N),
i.e. PV (G) = N
Hence, GN = GPV(G) = Unearned Interest
Income (I)
In other words, I = GPV(G)
Interest income- Usually amortised using effective interest rate
method.
No depreciation!
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Finance Lease - Lessor
Lessor Lease receivable
- Gross investmentin the lease (G)
Unearned interest income(I)
- Difference between G and PV(G)
Net investmentin the lease (N)
- G less I
- Equal to PV(G)- In armslength trans., equal to assetsFV
- Note Statement of Financial Position presentation
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Accounting for Finance Lease (Asset sale)
Lessorsbooks Lesseesbooks
At the start of the lease:
Dr Leased asset X
Cr Lease payable (X1)
Cr Cash/Payable (X2)
X= X1+X2X1 = Lower[FV or PV(MLPs)]
X2 = Lessees initial direct costs*
During the lease:
Dr Lease payableDr Interest expense
Cr Cash (= ALP)
Dr Depreciation expense
Cr Accumulated Depreciation40
*IDC = costs that are directly attributable
to negotiating and arranging a lease.
At the start of the lease:
Dr Lease receivable (=G)
Cr Asset (=N)
Cr Unearned interest income
During the lease:
Dr Cash (= ALP)
Cr Lease receivable
Dr Unearned interest income
Cr Interest income
No depreciation charge
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Seminar Question
- Question 2
- Application of FRS 17