Lessor Accounting

Operating Lease
IFRS 16, paragraph 61, provides that a lessor shall classify leases as either operating lease
or finance lease.

Operating lease is a lease that does not transfer substantially all the risks and rewards
incidental to ownership of an underlying asset.

Finance lease is a lease that transfers substantially all the risks and rewards incidental to
ownership of an underlying asset.

Include the possibilities of losses from idle capacity

RISKS or technological obsolescence and of variations in
return because of changing economic conditions. Operating
or
Finance?
May be represented by the expectation of profitable
REWARDS operation over the asset’s economic life and of gain
from appreciation in value or realization of a residual Substance over form
value
When is a lease classified as finance lease?

Under IFRS 16, paragraph 63, among others, any of the following situations would
normally lead to a lease being classified as a finance lease by the lessor:

o The lease transfers ownership of the underlying asset to the lessee at the end of the
lease term.
o The lessee has an 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.
o The lease term is for the major part of the economic life of the underlying asset even if
title is not transferred.
o The present value of the lease payments amounts to substantially all of the fair value of
the underlying asset at the inception of the lease.
Other indicators of finance lease

o The underlying asset is of such specialized nature that only the lessee can use it without
major modifications;
o If the lessee can cancel the lease, the lessor’s losses associated with the cancellation are
borne by the lessee (transfer of risk);
o Gains or losses from the fluctuation in the fair value of the residual accrue to the lessee
(transfer of risks and rewards);
o The lessee has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent (transfer of reward).
 Commencement
Inception Date Date
Earlier of:
Inception Date
a. Date of the
VS Lease Date on which
Commencement agreement a lessor makes
Date b. Date of an underlying
commitment by asset available
the paries to by a lessee.
principal
provision.

20XX Presentation title 5

OPERATING LEASE

RECOGNITION OF LEASE PAYMENTS AS INCOME

Straight Line Another Systematic

Basis Basis

more representative of the pattern in which

benefit from the use of the underlying asset
is diminished
OPERATING LEASE

RECOGNITION OF LEASE PAYMENTS AS INCOME

Straight Line Another Systematic

Basis Basis

more representative of the pattern in which

benefit from the use of the underlying asset
is diminished

PRESENTATION OF THE UNDERLYING ASSET

Real property taxes
Executory costs are borne by the lessor, Insurance
unless passed on the lessee. Maintenance cost
Depreciation
 INITIAL DIRECT COSTS INCURRED Added to the carrying
amount of the underlying
asset & recognized as
expense over the lease term
on the same basis as the
TREATMENT lease income
OF
Accounted for as liability
SOME ITEMS SECURITY DEPOSIT RECEIVED
by the lessor

LEASE BONUS RECEIVED Recognized as unearned

rent income to be amortized
over the lease term
UNEQUAL
RENTAL Where the operating lease
PAYMENTS requires unequal cash payments,
the total cash payments for the
lease term shall be amortized
uniformly on the straight line
basis as rent income over the
lease term.
 To record the purchase :
Equipment 1.6M
Lessor company purchased a truck on January 1,2020 for the Cash 1.6M
purpose of leasing it. The following are the information related to To record thee incurrenc of commission
the truck. Deferred initial Cost 120,000
Purchase price 1,600,000 Cash 120,000
Estimated to have a useful life 5 years To record rental for the year:
Residual value 100,000 Cash 600,000
Depreciation Method Straight-line Unearned Rent income 600,000

On April 1,2020, Lessor entered into a lease contract for the lease To record rental for the year:
of the tractor for a term of two years up to March 31,2022. The Unearned Rent income 450,000
following relates to the lease Rent income 450,000
Monthly Lease Fee 50,000 To record depreciation of machinery:
Lessee prepaids one year fee 600,000 Depreciation 300,000
Accum. Depn. 300,000
Lessor paid 120,000 commissi0n associated with negotiating the To record depreciation of machinery:
lease, 15,000 minor repair and 10,000 transportation of the truck Amort. Of IDC 45,000
to the lessee during the current year. Deferred initial Cost 45,000
To record other expenses:
Repairs Expense 15,000
Transportation Expense 10,000
Cash 25,000
Lessor Accounting
Finance Lease : Direct Finance Lease
Lessor Accounting
Sales Type Lease
Direct Finance
Lease

 Is type of lease arrangement where a company (the lessor)

provides financing to another party (the lessee) for the acquisition
of a specific asset.
 lessor is neither the manufacturer nor dealer of the asset being
lease
 Income of the lessor: Interest Income only
Sales type lease
Lessor is the MANUFACTURER OR DEALER

Uses leasing as a marketing technique

Often provides choice of either buying or leasing

Income of the Lessor: Interest Income & Profit

Accounted for LIKE Direct Finance Lease , except the

manufacturer or dealer lessor recognizes the following at the
commencement date:
a. SALES REVENUE
b. COST OF SALE
c. GROSS PROFIT

Initial Direct Cost are recognized immediately as an EXPENSE

 DIRECT FINANCE LEASE SALES TYPE LEASE
GROSS ① Lease Payment SAME
INVESTMENT ② Residual Value whether
guaranteed or
unguaranteed *
Net Investment ① Cost of Asset ① PV of Lease Payment
Direct Finance ② Initial Direct Cost ② PV of RV whether guaranteed or
unguaranteed
Lease vs Sales Unearned Gross Investment less Net SAME
Type Lease Interest Income
Sales
Investment
N/A **Whichever is lower bet. Net
Investment and FV of Asset
Cost of Sale N/A ① Cost of the Asset ***
① Initial Direct Cost
Gross Profit N/A Sales less Cost of Sales
*included as long as asset will revert back to the lessor
**PV of any unguaranteed residual value is deducted
***less present value of unguaranteed residual value
ILLUSTRATION: Lessor Company is in the business of leasing new hi-tech
DIRECT FINANCE equipment. As lessor, it expects a 12% return on the net
investment. All leases are classified as direct finance lease. At the
LEASE end of the lease terms the equipment will revert to the Lessor
Company. On January 1,2020 an equipment is leased to another
entity with the following information.
Cost of Equipment 5,000,000
Residual value – unguaranteed 600,000
Annual rental payable in advance 900,000
Initial Direct Cost 250,000
Useful life and lease term 8 years

Requirements:
a. Gross investment in the lease?
b. Net investment in the lease ?
c. Total interest income over the lease term?
d. Interest income for the current year?
Lessor Company is in the business of leasing new hi-tech Gross rentals (900,000 x 8) 7,200,000
equipment. As lessor, it expects a 12% return on the net Residual value guarantee 600,000
investment. All leases are classified as direct finance lease. At the Lease receivable – Gross investment 7,800,000
end of the lease terms the equipment will revert to the Lessor
Company. On January 1,2020 an equipment is leased to another Cost of Equipment 5,000,000
entity with the following information. Initial Direct Cost 250,000
Cost of Equipment 5,000,000 Net investment 5,250,000
Residual value – unguaranteed 600,000
Annual rental payable in advance 900,000 Gross Investment 7,800,000
Initial Direct Cost 250,000 Net Invesment (5,250,000)
Useful life and lease term 8 years Unearned interest income 2,550,000
Requirements:
a. Gross investment in the lease?
b. Net investment in the lease ?
c. Total interest income over the lease term?
d. Interest income for the current year?
Gross rentals (900,000 x 8) 7,200,000 Jan. 1 ,2020
Residual value unguaranteed 600,000 Lease receivable 7,800,000
Lease receivable – Gross investment 7,800,000 Unearned interest income 2,550,000
Equipment 5,000,000
Cost of Equipment 5,000,000 Cash 250,000
Initial Direct Cost 250,000 Dec. 31,2020
Net investment 5,250,000 Unearned interest income 522,000
Interest Income 522,000
Gross Investment 7,800,000
Net Invesment (5,250,000) What is the journal entry assuming the equipment’s FV on the en
Unearned interest income 2,550,000 of lease term is 550,000
ILLUSTRATION: Lessor Company is in the business of leasing new hi-tech
DIRECT FINANCE equipment. As lessor, it expects a 10% return on the net
investment. All leases are classified as direct finance lease. At the
LEASE end of the lease terms the equipment will revert to the Lessor
Company. On January 1,2020 an equipment is leased to another
entity with the following information.
Cost of Equipment 340,500
Initial Direct Cost 25,500
Useful life 6 years
Lease Term 5 years

Requirements:
Case 1 (beginning Jan 1. 2020)
Case 2: (beginning on December 31,2020)
a. Annual Rental Payment
b. Gross investment in the lease?
c. Total interest income over the lease term?
20XX Presentation title 20
 Lessor Company is a dealer in machinery. On January 1, 2020, a
machinery is leased to another entity with the following
ILLUSTRATION: provisions:
SALES TYPE LEASE
Annual rental payable at the end of each year 800,000
Lease term 5 years
Useful life of machinery 5 years
Cost of machinery 2,000,000
Estimated residual value 200,000
Initial direct cost paid by lessor 100,000
Implicit interest rate 10%
PV of OA of 1 for 5 periods at 10% 3.7908
PV of 1 for 5 periods at 10% 0.6209

At the end of the lease term on December 31, 2024, the machinery
will revert to Lessor Company.

The perpetual inventory system is used.

Lessor Company is a dealer in machinery. On January 1, 2020, a
machinery is leased to another entity with the following Gross rentals (800,000 x 5) 4,000,000
provisions: Residual value guarantee 200,000
Lease receivable – Gross investment 4,200,000
Annual rental payable at the end of each year 800,000
Lease term 5 years PV of gross rentals (800,000 x 3.7908) 3,032,640
Useful life of machinery 5 years PV of RV – Guarantee 124,180
Cost of machinery 2,000,000 Total PV – Net investment 3,156,820
Estimated residual value 200,000
Initial direct cost paid by lessor 100,000 Lease receivable 4,200,000
Implicit interest rate 10% Total present value (3,156,820)
PV of OA of 1 for 5 periods at 10% 3.7908 Unearned interest income 1,043,180
PV of 1 for 5 periods at 10% 0.6209
Sales (equal to Total PV) 3,156,820
At the end of the lease term on December 31, 2024, the machinery Cost of goods sold (2,000,000)
will revert to Lessor Company. Initial direct cost (100,000)
Gross income 1,056,820
The perpetual inventory system is used.
 Lease receivable 4,200,000
Cost of goods sold 2,000,000
Gross rentals (800,000 x 5) 4,000,000 Sales 3,156,820
Residual value guarantee 200,000 Unearned interest income 1,043,180
Lease receivable – Gross investment 4,200,000 Inventory 2,000,000

PV of gross rentals (800,000 x 3.7908) 3,032,640 Cost of goods sold 1,000,000

PV of RV – Guarantee 124,180 Cash 1,000,000
Total PV – Net investment 3,156,820

Lease receivable 4,200,000

Total present value (3,156,820)
Unearned interest income 1,043,180

Sales (equal to Total PV) 3,156,820

Cost of goods sold (2,000,000)
Initial direct cost (100,000)
Gross income 1,056,820
20XX Presentation title 24
Sale and
Leaseback
A sale and leaseback is an arrangement whereby one party (seller-lessee) sells an asset to
another party (buyer-lessor) and then immediately leases the asset back from the new
owner.

May occur when the seller-lessee is experiencing

SELLER-LESSEE cash flow or financing problem, considering tax
advantages, or wanting to avoid the burden of
paying the executory costs (RMIT).

Buyer-lessor has a reduced default risk due to ability

BUYER-LESSOR to directly investigate the seller-lessee’s credit,
acquires important tax advantages in the form of
depreciation, and is guaranteed the residual value at
termination.

Sale transaction Lease transaction

20XX Presentation title 27
Accounting for  Seller/ Lessee and Buyer/ Lessor shall determine whether the
transfer qualifies as a sale based on the requirements for satisfying
Sale and a performance obligation in PFRS 15
Leaseback

20XX Presentation title 28

Transfer of asset is a sale

a. Measure ROUA arising from the leaseback @

proportion of the previous CA of the asset that
SELLER-LESSEE related to the ROU retained by the seller-lessee
b. Recognized only the amount of any G/L that
relates to the rights transferred to buyer-lessor.

a. Account for the purchase of asset.

BUYER-LESSOR
b. Account for the lease applying lessor accounting

Adjustments is needed if:

a. Sales Price is not equal to the FV of Asset
b. Lease payment are not at Market Rates.
Adjustments will be accounted for as follows:
a. Any below-market terms shall be accounted for a PREPAYMENT.
b. Any above-market terms shall be accounted for as ADDITIONAL FINANCING.
 At the beginning of the current year, an entity sold a machinery with
ILLUSTRATION: SALE a remaining life of 8 years for P1,600,000 which is equal to the fair
PRICE AT FAIR VALUE value of the machinery.
(OPERATING LEASE The entity immediately leased the machinery back for 1 year at the
MODEL) prevailing monthly rental of P37,500.

The machinery has a book value of P1,500,000 and an accumulated

depreciation of P100,000.

The seller-lessee used the operating lease model because the lease
is short-term or one year.
At the beginning of the current year, an entity sold a machinery with
a remaining life of 8 years for P1,600,000 which is equal to the fair
To record the sale:
value of the machinery.
Cash 1.6M
Accum. Depn. 100K
The entity immediately leased the machinery back for 1 year at the
Machinery 1.5M
prevailing monthly rental of P37,500.
Gain on Right Transferred 200K
To record rental for the year:
The machinery has a book value of P1,500,000 and an accumulated
Rent Expense 450K
depreciation of P100,000.
Cash 450K
The seller-lessee used the operating lease model because the lease
is short-term or one year.

To record the purchase:

Machinery 1.6M
Cash 1.6M
To record rental for the year:
Cash 450K
Rent Income 450K
To record depreciation of machinery:
Depreciation 200K
Accum. Depn. 200K
 On January 1, 2023, an entity sold an equipment with remaining life
of 8 years and immediately leased it back for 3 years at the prevailing
ILLUSTRATION: SALE market rental.
PRICE AT FAIR VALUE
Sale price at fair value 1.6M
(Finance Lease Model) Carrying amount of equipment 1.5M
Annual rental payable at the end of
each year 450K
Implicit interest rate 12%
Present value of an OA of 1 at 10%
for three periods 2.4018
 On January 1, 2023, an entity sold an equipment with remaining life
of 8 years and immediately leased it back for 3 years at the prevailing
market rental.

Sale price at fair value 1.6M

Carrying amount of equipment 1.5M
Annual rental payable at the end of
each year 450K
Implicit interest rate 12%
Present value of an OA of 1 at 10%
for three periods 2.4018

Present value of rentals:

(450K x 2.4018) = 1,080,810
 On January 1, 2023, an entity sold an equipment with remaining life
of 8 years and immediately leased it back for 3 years at the prevailing
market rental.

Sale price at fair value 1.6M

Carrying amount of equipment 1.5M
Annual rental payable at the end of
each year 450K
Implicit interest rate 12%
Present value of an OA of 1 at 10%
for three periods 2.4018

IFRS 16, par. 100, provides that the seller- Cost of ROUA:
lessee shall measure the right of use asset PV of rentals
x Carrying amount
arising from the leaseback at the proportion Fair value
of the previous carrying amount of the asset
1,080,810
that relates to the right of use retained by x 1.5M = 1,013,259
1.6M
the seller-lessee.
On January 1, 2023, an entity sold an equipment with remaining life
of 8 years and immediately leased it back for 3 years at the prevailing
market rental.

Sale price at fair value 1.6M

Carrying amount of equipment 1.5M
Annual rental payable at the end of
each year 450K
Implicit interest rate 12%
Present value of an OA of 1 at 10%
for three periods 2.4018

Gain on right transferred:

IFRS 16, par. 100, provides that the gain or Fair value − PV of rentals
loss that pertains to the right retained by x Gain or Loss
Fair value
the lessor is NOT recognized. The gain or
loss that pertains to the rights transferred to 1.6M − 1,080,810
x 100K = 32,449
the buyer-lessor is recognized. 1.6M
On January 1, 2023, an entity sold an equipment with remaining life
of 8 years and immediately leased it back for 3 years at the prevailing To record the sale and leaseback:
market rental. Cash 1.6M
Right of Use Asset 1,013,259
Sale price at fair value 1.6M Equipment 1.5M
Carrying amount of equipment 1.5M Lease Liability 1,080,810
Annual rental payable at the end of Gain on Right Transferred 32,449
each year 450K To record the annual rental (1st year):
Implicit interest rate 12% Interest Expense 129,697
Present value of an OA of 1 at 10% Lease liability 320,303
for three periods 2.4018 Cash 450K
To record the annual depreciation of
ROUA:
Depreciation 337,753
Accum. Depn. 337,753
On January 1, 2023, an entity sold an equipment with remaining life
of 8 years and immediately leased it back for 3 years at the prevailing To record the purchase of the underlying
market rental. asset:
Equipment 1.6M
Sale price at fair value 1.6M Cash 1.6M
Carrying amount of equipment 1.5M To record the annual rental:
Annual rental payable at the end of Cash 450K
each year 450K Rent Income 450K
Implicit interest rate 12% To record the annual depreciation of
Present value of an OA of 1 at 10% equipment:
for three periods 2.4018 Depreciation 200K
Accum. Depn. 200K
 On January 1, 2023, an entity sold a building with remaining life of 10
years and immediately leased it back for 5 years.
ILLUSTRATION: SALE
PRICE ABOVE FAIR Sale price 9,000,000
Fair value of building 8,000,000
VALUE Carrying amount of building 4,500,000
Annual rental payable at the end
of each year 1,500,000
Implicit interest rate 12%
Present value of an OA of 1
at 12% for five periods 3.60
On January 1, 2023, an entity sold a building with remaining life of 10
years and immediately leased it back for 5 years.

Sale price 9,000,000

Fair value of building 8,000,000
Carrying amount of building 4,500,000
Annual rental payable at the end
of each year 1,500,000
Implicit interest rate 12%
Present value of an OA of 1
at 12% for five periods 3.60

Present value of lease liability:

(1,500,000 x 3.60) = 5,400,000
On January 1, 2023, an entity sold a building with remaining life of 10
years and immediately leased it back for 5 years.

Sale price 9,000,000

Fair value of building 8,000,000
Carrying amount of building 4,500,000
Annual rental payable at the end
of each year 1,500,000
Implicit interest rate 12%
Present value of an OA of 1
at 12% for five periods 3.60

IFRS 16, par. 101, provides that if the sale Any excess sale price over fair value shall
price does not equal the fair value of the be accounted for as additional financing
underlying asset, the seller-lessee shall provided by the buyer-lessor to seller-
make adjustment to measure the sale price lessee.
at fair value.
On January 1, 2023, an entity sold a building with remaining life of 10 Sale price 9,000,000
years and immediately leased it back for 5 years. Fair value 8,000,000
Excess sale price over FV 1,000,000
Sale price 9,000,000
Fair value of building 8,000,000 PV of lease liability 5,400,000
Carrying amount of building 4,500,000 Additional financing (1,000,000)
Annual rental payable at the end PV of LL related to rentals 4,400,000
of each year 1,500,000
Implicit interest rate 12%
Present value of an OA of 1
at 12% for five periods 3.60

Fair Value Proportion Carrying Amount Gain

Rights retained 4,400,000 0.55 2,475,000 1,925,000

Rights transferred 3,600,000 0.45 2,025,000 1,575,000

Total 8,000,000 1.00 4,500,000 3,500,000

On January 1, 2023, an entity sold a building with remaining life of 10
years and immediately leased it back for 5 years. To record the sale and leaseback:
Cash 9.0M
Sale price 9,000,000 Right of Use Asset 2.475M
Fair value of building 8,000,000 Equipment 4.5M
Carrying amount of building 4,500,000 Lease Liability 4.4M
Annual rental payable at the end Financial Liability 1M
of each year 1,500,000 Gain on Right Transferred 1.575M
Implicit interest rate 12% To record the annual rental (1st year):
Present value of an OA of 1 Interest Expense 648,000
at 12% for five periods 3.60 Lease Liability 694,222
Finance lease liability 157,778
Cash 1.5M
To record the annual depreciation of
ROUA:
Depreciation 495,000
Fair Value Proportion Accum. Amount
Carrying Depn. 495,000
Gain

Rights retained 4,400,000 0.55 2,475,000 1,925,000

Rights transferred 3,600,000 0.45 2,025,000 1,575,000

Total 8,000,000 1.00 4,500,000 3,500,000

On January 1, 2023, an entity sold a building with remaining life of 10
years and immediately leased it back for 5 years. To record purchase:
Building 8.0M
Sale price 9,000,000 Financial Asset 1.0M
Fair value of building 8,000,000 Cash 1.0M
Carrying amount of building 4,500,000 To record the rental for first year:
Annual rental payable at the end Cash 1,222,222
of each year 1,500,000 Rent Income 1,222,222
Implicit interest rate 12% To record interest on financial asset:
Present value of an OA of 1 Cash 277,778
at 12% for five periods 3.60 Financial Asset 157,778
Interest Income 120,000
To record depreciation:
Depreciation 800,000
Accum. Depn. 800,000

Rental Income 4,400,000 0.81481481481 1,222,222

Financial Asset 1,000,000 0.18518518519 277,778
5,400,000 1.00000000000 1,500,000