O RIENTATION Objective Scope Definition Classification of Leases Finance Lease Operating Lease Finance Leases and Operating Leases Calculations Sale and lease back Disclosures

OBJECTIVE The objective of this Standard is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to leases.

Where can this stand apply ? Where shall not be applied?

D EFINITION OF A L EASE

Finance leaseOperating lease A lease is 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

F INANCE LEASES V O PERATING LEASES A lease is a finance lease if it transfers substantially all the risks and rewards incident to ownership A lease is an operating lease if it does not transfer substantially all the risks and rewards incident to ownership Finance Lease Operating Lease Substance over Form

R ISKS AND REWARDS INCIDENT TO OWNERSHIP  Losses from idle capacity  Technological obsolescence  Changes in value due to changing economic conditions etc.  Expectation of service potential or profitable operation over the asset’s economic life  Gain from appreciation in value  Realisation of a residual value etc. RisksRewards

F INANCE LEASE OR O PERATING LEASE ? (4) Conclude on whether substantially all the risks and rewards have been transferred from the lessor to the lessee (1) Identify the business purpose behind the lease and its economic impact together with the economic issues at the end of the lease term (2) Determine the lease term (3) Determine the net present value (NPV) of the minimum lease payments Cancellation provisions Rights and obligations at end of lease Renewal options

F INANCE LEASE OR O PERATING LEASE ? Examples of situations which would normally lead to a lease being classified as a finance lease:  The lessor transfers ownership of the asset to the lessee at the end of the lease term  The lessee has the option to purchase the asset at a price, which is expected to be sufficiently lower than the fair value at the date the option becomes exercisable such that, at the inception of the lease, it is reasonably certain that the option will be exercised

F INANCE LEASE OR O PERATING LEASE ? Examples of situations which would normally lead to a lease being classified as a finance lease (cont’d):  The lease term is for the major part of the economic life of the asset even if title is not transferred  The leased assets are of a specialised nature such that only the lessee can use them without major modifications being made  The leased assets cannot be easily replaced  At the inception of the lease, the present value of the minimum lease payments (MLP) amounts to at least substantially all of the fair value of the leased asset

F INANCE LEASE OR O PERATING LEASE ? Other indicators which individually or in combination could also lead to a lease being classified as a finance lease:  If the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee  The lessee bears gains/losses from changes in the fair value of the residual  The lessee has the ability to continue the lease for a secondary period at a rate which is substantially lower than market rate

A CCOUNTING FOR F INANCE L EASE

F INANCE L EASE – A CCOUNTING BY L ESSEE Substance of the transaction should be considered.  At the beginning of the lease term, the lessee recognizes,  The leased asset and  The obligation to make lease payments as a liability  The asset and liability are measured at the lower of  The fair value of the asset  The present value of the minimum lease payments

F INANCE L EASE – A CCOUNTING BY L ESSEE CONT..  Lease payments are split between finance charge and the repayment of the outstanding liability.  The depreciation policy for assets held under finance leases should be consistent with that for owned assets.  If the lessee will obtain ownership of the asset at the end of the lease, depreciation is made over the useful life of the asset.  Otherwise the asset should be depreciated over the shorter of the lease term or the life of the asset.

D OUBLE ENTRIES IN THE BOOKS OF THE LESSEE – F INANCE L EASE  Recognize the asset Non-Current asset Dr LessorCr  Lease rental repayment Lessor Dr Cash/ Bank Cr  Annual Interest Interest Expense (P&L) Dr Lessor Cr

D OUBLE ENTRIES IN THE BOOKS OF THE LESSOR – F INANCE L EASE  Asset transferred Receivable Dr Non-current asset Cr  For the lease installment received Cash/Bank Dr Lessee Cr  For the interest Lessee Dr Interest income Cr

O PERATING L EASE

D EFINITION An operating lease is a lease other than finance lease Lease that does not transfer substantially all of the risks and rewards to the lessee. Lessor Right to use asset Lessee Asset

O PERATING L EASE – A CCOUNTING BY L ESSEE / L ESSOR Lessee Lessor Statement of financial position  Prepaid/accrued lease rental payable  Leased asset  Accrued/deferre d lease rental receivable Statement of comprehensive income  Lease rental expense  Depreciation expense  Lease rental income

A CCOUNTING BY L ESSEE An asset is not recognized Rental under operating lease are charged to the income statement on a straight line basis over the term of lease, unless another systematic and rational basis is more appropriate. Any difference between amount charged and amounts paid will be prepayments or accruals.

A CCOUNTING BY L ESSOR Lease income from operating leases shall be recognized in income on 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 diminished. The depreciation policy for depreciable leased assets shall be consistent with the lessor’s normal depreciation policy for similar assets and depreciation shall be calculated in accordance with LKAS 16.

D OUBLE ENTRIES IN THE BOOKS OF THE LESSEE – O PERATING L EASE  Lease rental repayment Rental expense Dr Cash or accrued lease rental payable Cr

D OUBLE ENTRIES IN THE BOOKS OF THE LESSOR – O PERATING L EASE  At the Beginning Leased asset Dr Cash or creditor Cr  At the end of the year Depreciation expense Dr Leased asset Cr Cash or accrued lease rental Dr Lease rental income Cr

26 O PERATING LEASE - E XAMPLE Example On 1 January 2014, X signs a 5-year lease for equipment The cost of the equipment was 30,000 Total lease payments are 20,000 (4,000/year) Unguaranteed residual value is 15,000 Economic life of equipment is 10 years Questions What are the journal entries to be recorded at 1 January 2014 and 31 December 2014?

27 O PERATING LEASE - S OLUTION ( LESSEE ) No entry at 1 January 2014 At 31 December 2014: Dr Rental expense4,000 Cr Cash or accrued lease rental payable4,000

28 O PERATING LEASE - S OLUTION ( LESSOR ) At 1 January 2014: Dr Leased asset 30,000 Cr Cash or creditor30,000 At 31 December 2014: Dr Depreciation expense3,000 Cr Leased asset3,000 Dr Cash or accrued lease rental 4,000 Cr Lease rental income4,000 At 1 January 2014: Dr Leased asset 30,000 Cr Cash or creditor30,000 At 31 December 2014: Dr Depreciation expense3,000 Cr Leased asset3,000 Dr Cash or accrued lease rental 4,000 Cr Lease rental income4,000

EXERCISE

Samson PLC has purchased a machine on 01 st of April 2014 under the terms of lease for 5 million for the period of 5 years at the rate of 12%. First payment coming at the end of the first year. The lease agreement specifies that Samson PLC gets to keep the machine at the end of the lease. Question Indicate the amortization schedule & calculate the appropriate amounts to be included in the financial statements of the lessee for the year ended 31 st March 2015.

AMORTISATION SCHEDULE Year Opening BalanceInstallmentInterestCapital Closing Balance ,000, ,387, , , ,212, ,387, , , ,331, ,387, , , ,343, ,387, , ,105, ,238, ,387, , ,238, ,935, ,935, ,000,000.00

LEASE SCHEDULE

BALANCE SHEET CLASSIFICATION

SALE AND LEASEBACK TRANSACTIONS

D EFINITION Sale and leaseback transaction is an arrangement in which one party sells a property to a buyer and the buyer immediately leases the property back to the seller.

Advantages of sale and leaseback  Releases cash tied up in assets already owned  Cheaper than borrowing money  All the risks & rewards of the asset are transferred to the buyer  The lessee can still use the asset  No extra time required for re-training on new equipment Disadvantages of sale and leaseback  Loss control over the asset  In the long term it is more expensive

Accounting Treatment for Sales & Leaseback Transactions  Sale & Leaseback Under Finance Lease If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over the carrying amount shall not be immediately recognized as income by a seller-lessee. Instead, it shall be deferred and amortized over the lease term.

 Sale & Leaseback Under Operating Lease Any profit or loss arising is accounted for as follows If the transaction is; Recognize immediately At fair value Below fair value Future lease rentals at market rate Recognize immediately Future lease rentals below market rate Deferred & amortized over the lease period Above fair value Excess over fair value should be deferred & amortized over the lease period

D ISCLOSURES

K EY D ISCLOSURES – F INANCE LEASES ( LESSEES )  Requirements of SLFRS 7  Net carrying amount at the end of the reporting period  A reconciliation between the total of future minimum lease payments  Contingent rents recognized as an expense in the period  General description of the lessee’s material leasing arrangements  Requirements for disclosure in accordance with LKAS 16, LKAS 36, LKAS 38, LKAS 40 and LKAS 41 apply to lessees for assets leased under finance leases

K EY D ISCLOSURES – O PERATING LEASES ( LESSEES )  Total of future minimum lease payments  Lease and sublease payments recognized as an expense in the period  General description of the lessee’s significant leasing arrangements

K EY D ISCLOSURES – F INANCE LEASES (L ESSORS )  Requirements in SLFRS 7  Reconciliation between the gross investment in the lease at the end of the reporting period  Unearned finance income  Unguaranteed residual values accruing to the benefit of the lessor

K EY D ISCLOSURES – F INANCE LEASES (L ESSORS )  Accumulated allowance for uncollectible minimum lease payments receivable  Contingent rents recognized as income in the period  General description of the lessor’s material leasing arrangements.

K EY D ISCLOSURES – O PERATING LEASES (L ESSORS )  Requirements of SLFRS 7  Future minimum lease payments under non- cancellable operating leases  Total contingent rents recognized as income in the period  General description of the lessor’s leasing arrangements  disclosure requirements in LKAS 16, LKAS 36, LKAS 38, LKAS 40 and LKAS 41 apply to lessors for assets provided under operating leases

SUMMARY

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