[Link].
com Example 1: Classification of leases IAS 17: Leases
LessieCorp plans to lease a new lorry from LorryCars . LorryCars made an offer to LessieCorp with 2 options:
General information:
1. Lorry would be leased for 4 years under non-cancellable lease that starts 1 January 20X1.
2. Rentals are paid annually on 31 December starting year 20X1.
3. In these rentals, insurance fee of 300 EUR is included.
4. At the end of lease, lorry would have market value of 12 400 EUR.
5. Normal economic life of lorry is 6 years.
6. LorryCars sells this type of lorry for 35 000 EUR when paid cash.
7. LessieCorp's incremental borrowing rate is 3% (and it is close to the rate implicit in the lease).
Option 1: LessieCorp would pay annual rentals amounting to 6 800 EUR. At the end of lease term, LessieCorp has an option to buy lorry for its market value
or lease it for additional 2 years with the same rental fees.
Option 2: LessieCorp would pay annual rentals amounting to 9 500 EUR. At the end of lease term, LessieCorp has an option to buy lorry either for
200 EUR, or lease it for another 2 years with rental fee of 100 EUR per annum.
Advise LessieCorp on correct classification of above presented leases.
1. Calculating present value of minimum lease payments
Option 1 Option 2
Discount factor 1/ Present value Present value
Year Cash flow Cash flow
(1+0,03)^year (cash flow*DF) (cash flow*DF)
1 0.971 6,500.00 6,310.68 9,200.00 8,932.04
2 0.943 6,500.00 6,126.87 9,200.00 8,671.88
3 0.915 6,500.00 5,948.42 9,200.00 8,419.30
4 0.888 6,500.00 5,775.17 9,400.00 8,351.78
Total 24,161.14 34,375.00
FV at inception: 35,000.00 35,000.00
%: 69.03% 98.21%
2. Assessment of leases
Option 1 Option 2
Transfer of ownership at the end of lease term no no
Option to purchase asset for price < fair value no yes
Lease term = major part of economic life no yes
Present value of MLP close to fair value no yes
Leased asset - specialized nature no no
Losses from cancellation borne by lessee ? ?
Gains / losses from fluctuations to the lessee ? ?
Option to continue rent for rental under market no yes
Operating lease Finance lease
[Link] Example 2: Lease of land and building IAS 17: Leases
On 1 January 20X1, LessieCorp decided to enter into a new lease agreement related to specialized production hall with land. Lease agreement has following
characteristics:
1. Lease term is 40 years which is remaining economic life of a building. At the end, building has no residual value .
2. No ownership to building or land is transferred to LessieCorp after the end of agreement.
3. Annual rentals are paid on 31 December each year amounting to 43 750 EUR.
4. LessieCorp's incremental borrowing rate is 3,1%.
5. At the end of 20X0, fair value of building and land was 800 000 EUR and 200 000 EUR.
Advise LessieCorp on correct classification of this lease.
1. Assessment of leases
Land operating lease (indefinite life, no ownership transferred)
Building needs to be assessed separately
2. Assessment of building element
2.1 Rentals related to building element
Fair value of buildings: 800,000 A
Total fair value (800 000 + 200 000): 1,000,000 B
Percentage of building element: 80% A/B
Total rentals:
Rentals related to building element
35,000
(80%*43 750) 8,750
2.2 Present value of minimum lease payments
N. of payments: 40
Amount of 1 payment at the end of each year: 35,000
Formula used:
Present value: 796,097 =PV(3,1%;40;35 000; 0))
Percentage of present value / fair value
99.51%
(796 097 / 800 000)
2.3 Assessment of buildings' lease
Transfer of ownership at the end of lease term no
Option to purchase asset for price < fair value no
Lease term = major part of economic life yes
Present value of MLP close to fair value yes
Leased asset - specialized nature yes
Losses from cancellation borne by lessee ?
Gains / losses from fluctuations to the lessee ?
Option to continue rent for rental under market no
Finance lease
[Link] Example 3: Finance lease in lessee's financial statements (in arrears) IAS 17: Leases
On 1 January 20X1 Stamper Co, producer of metal casts, acquires stamping machine under finance lease. Cash price of machine was 500 000 EUR and
Stamper incurred additional costs of 2 000 EUR for arranging lease contract. Economic life of stamping machine is 6 years. Lease term is 5 years, annual
lease payments are 110 000 EUR payable 31 December each year. At the end of lease term, Stamper has an option to purchase machine for 1 000 EUR
and will exercise it.
How would this transaction appear in the financial statements of Stamper Co. at 31 December 20X1?
1. Initial recognition
1.1 Asset
Fair value of stamping machine: 500,000
Directly attributable expenses: 2,000
Cost of asset (500 000 + 2 000) 502,000
1.2 Accounting treatment
Recognition of asset / finance lease liability:
Debit Property - Stamping machine 502,000
Credit Cash -2,000
Credit Finance lease liability -500,000
0
2. Subsequent measurement
2.1 Allocation of minimum lease payments
Ending balance
Year Cash flow Interest FL liability
of FL liability
0 500,000 -500,000
1 -110,000 -16,617 -93,383 -406,617
2 -110,000 -13,513 -96,487 -310,130
3 -110,000 -10,307 -99,693 -210,436
4 -110,000 -6,993 -103,007 -107,430
5 -111,000 -3,570 -107,430 0
3.32%
Interest rate implicit in the lease,
Formula used: =IRR(C30:C35)
2.2 Calculation of depreciation
Cost of stamping machine: 502,000
Useful life in years: 6
Annual depreciation charge (502 000 / 6): 83,667
2.3 Accounting treatment
Depreciation expense for machine: Annual payment in the 1st year:
Debit Depreciation expenses 83,667 Debit Interest expense 16,617
Credit Accum. dep. - stamping machine -83,667 Debit Finance lease liability 93,383
0 Credit Cash -110,000
0
3. Disclosures
3.1 Asset related disclosures
Assets held under finance leases - net carrying amount 418,333
(502 000 - 83 667)
3.2 Finance lease liability related disclosures
Minimum lease payments:
due not later than 1 year 110,000
due later than 1 year but not later than 5 years 331,000
due later than 5 years 0
Total 441,000
less future finance charges -34,383
Present value of minimum lease payments: 406,617
Present value of minimum lease payments:
due not later than 1 year 96,487
due later than 1 year but not later than 5 years 310,130
due later than 5 years 0
Total 406,617
[Link] Example 4: Finance lease in lessee's financial statements (in advance) IAS 17: Leases
How would the situation change if annual rentals of 110 000 EUR were payable on 1 January each year, starting year 20X1?
1. Initial recognition
1.1 Asset
Fair value of stamping machine: 500,000
Directly attributable expenses: 2,000
Cost of asset (500 000 + 2 000) 502,000
1.2 Accounting treatment
Recognition of asset / finance lease liability:
Debit Property - Stamping machine 502,000
Credit Cash -112,000
Credit Finance lease liability -390,000
0
2. Subsequent measurement
2.1 Allocation of minimum lease payments
Ending balance
Year Cash flow Interest FL liability
of FL liability
0 390,000 0 0 -390,000
1 -110,000 -19,860 -90,140 -299,860
2 -110,000 -15,270 -94,730 -205,130
3 -110,000 -10,446 -99,554 -105,575
4 -110,000 -5,376 -104,624 -952
5 -1,000 -48 -952 0
5.09%
Interest rate implicit in the lease,
Formula used: =IRR(C27:C32)
2.2 Calculation of depreciation
Cost of stamping machine: 502,000
Useful life in years: 6
Annual depreciation charge (502 000 / 6): 83,667
2.3 Accounting treatment
Depreciation expense for machine: At the end of 1st year:
Debit Depreciation expenses 83,667 Debit Interest expense 19,860
Credit Accum. dep. - stamping machine -83,667 Credit Accrued interest expense -19,860
0 0
In the beginning of 2nd year (when instalment is paid):
Debit Accrued interest expense 19,860
Debit Finance lease liability 90,140
Credit Cash -110,000
0
3. Disclosures
3.1 Asset related disclosures
Assets held under finance leases - net carrying amount 418,333
(502 000 - 83 667)
3.2 Finance lease liability related disclosures
Minimum lease payments:
due not later than 1 year -110,000
due later than 1 year but not later than 5 years -331,000
due later than 5 years 0
Total -441,000
less future finance charges 51,000
Present value of minimum lease payments: -390,000
Present value of minimum lease payments:
due not later than 1 year -90,140
due later than 1 year but not later than 5 years -299,860
due later than 5 years 0
Total -390,000
[Link] Example 5: Finance lease in lessor's financial statements IAS 17: Leases
On 1 January 20X1 FinanceLease Co. entered into finance lease of stamping machine as a lessor. Cash price of machine was 500 000 EUR. FinanceLease Co.
incurred additional costs of 3 000 EUR for arranging lease contract. Economic life of stamping machine is 6 years. Lease term is 5 years, annual lease
payments are 110 000 EUR payable 31 December each year. At the end of lease term, machine has an unguaranteed residual value of 1 000 EUR.
How would this transaction appear in the financial statements of FinanceLease Co. at 31 December 20X1?
1. Initial recognition
1.1 Asset - net investment in the lease
Cash price of stamping machine: 500,000
Directly attributable expenses: 3,000
Net investment in the lease (500 000 + 3 000) 503,000
1.2 Accounting treatment
Recognition of net investment in the lease:
Debit Assets - net investment in the lease 503,000
Credit Cash - paid for machine -3,000
Credit Cash - paid for expenses -500,000
0
2. Subsequent measurement
2.1 Allocation of minimum lease payments
Lease Ending balance of
Year Cash flow Interest
receivable FL receivable
0 -503,000 503,000
1 110,000 15,660 94,340 408,660
2 110,000 12,723 97,277 311,383
3 110,000 9,694 100,306 211,077
4 110,000 6,571 103,429 107,649
5 111,000 3,351 106,649 1,000
3.11%
Interest rate implicit in the lease,
Formula used: =IRR(C32:C37)
2.2 Accounting treatment
Annual payment in the 1st year:
Debit Cash 110,000
Credit Finance income -15,660
Credit Net investment in the lease -94,340
0
3. Disclosures
Gross investment in the lease:
due not later than 1 year 110,000
due later than 1 year but not later than 5 years 331,000
due later than 5 years 0
Total 441,000
less unearned finance income -32,340
Present value of minimum lease payments: 408,660
Present value of minimum lease payments:
due not later than 1 year 97,277
due later than 1 year but not later than 5 years 311,383
due later than 5 years
Total 408,660
Unearned finance income in respect of finance leases: 32,340
Unguaranteed residual value accruing to the lessor: 1,000
[Link] Example 6: Manufacturer's lease IAS 17: Leases
In January 20X1, CarProd, manufacturer of cars, offered the following finance lease related to the newest model of car produced:
1. Newest model of car has fair value equal to its selling price, that is 30 000 EUR. Cost of manufacture is 27 000 EUR.
2. Lease would be non-cancellable for 4 years, with annual installments of 8 500 EUR paid in arrears.
3. At the end of lease term, ownership of the car automatically passes to the client at no additional cost.
CarProd incurred further cost of 1 000 EUR related to negotiating contract. How would this transaction appear in the financial statements of CarProd at 31
December 20X1?
1. Initial recognition
1.1 Asset - net investment in the lease
Cash price of new model: 30,000
Net investment in the lease: 30,000
1.2 Accounting treatment
Recognition of net investment in the lease / sale of asset:
Debit Assets - net investment in the lease 30,000
Credit Inventory - new model of car -27,000
Credit Cash - paid for expenses -1,000
Credit Profit on sale (30 000 - 27 000 - 1000) -2,000
Note: This is simplified accounting. CarProd would probably show
30 000 EUR as revenues, 27 000 EUR as costs of sales and 1 000
0 EUR as marketing or other expenses.
2. Subsequent measurement
2.1 Allocation of minimum lease payments
Ending balance
Year Cash flow Interest Lease asset
of FL asset
0 -30,000 30,000
1 8,500 1,560 6,940 23,060
2 8,500 1,200 7,300 15,760
3 8,500 820 7,680 8,080
4 8,500 420 8,080 0
5.20%
Interest rate implicit in the lease,
Formula used: =IRR(C32:C36)
2.2 Accounting treatment
Annual payment in the 1st year:
Debit Cash 8,500
Credit Finance income -1,560
Credit Net investment in the lease -6,940
0
3. Disclosures
Gross investment in the lease:
due not later than 1 year 8,500
due later than 1 year but not later than 5 years 17,000
due later than 5 years 0
Total 25,500
less unearned finance income -2,440
Present value of minimum lease payments: 23,060
Present value of minimum lease payments:
due not later than 1 year 7,300
due later than 1 year but not later than 5 years 15,760
due later than 5 years 0
Total 23,060
Unearned finance income in respect of finance leases: 2,440
[Link] Example 7: Operating lease in lessee's financial statements IAS 17: Leases
On 1 January 20X1, LessieCorp entered into an operating lease for new lorry under the following conditions:
1. Lease is non-cancellable for 4 years.
2. Rentals amounting to 9 200 EUR are to be paid annually, on 31 December, starting 20X1.
How would this transaction appear in the financial statements of LessieCorp at 31 December 20X1?
1. Accounting treatment
No asset is recognized under operating lease. Rentals are included in expenses.
Debit Expenses - rentals under operating lease 9,200
Credit Cash -9,200
0
2. Disclosures
Future minimum lease payments under non-cancellable operating lease:
due not later than 1 year 9,200
due later than 1 year but not later than 5 years 18,400
due later than 5 years 0
Total 27,600
IAS 17: Leases
[Link] Example 8: Operating lease with incentive in lessor's financial statements
On 1 January 20X1, Lessor Co. made a following offer for operating lease to one of its biggest clients:
1. Lease relates to machinery in total fair value of 1 000 000 EUR.
2. Lease is uncancellable for 6 years, whereas machines have an economic life of 10 years.
3. Annual rentals of 170 000 EUR are payable in arrears on 31 December each year.
4. First rental is decreased to 50 000 EUR as a bonus to great customer.
How would this transaction appear in the financial statements of Lessor Co. at 31 December 20X1?
1. Accounting treatment
1.1 Asset related accounting:
Recognition of assets at inception:
Debit PPE - machinery 1,000,000
Credit Cash -1,000,000
0
Depreciation charge of PPE for 20X1:
Debit Depreciation expenses (1 000 000 / 10) 100,000
Credit PPE - cummulated depreciation -100,000
0
1.2 Rentals related accounting:
Cash received on 31 December 20X1:
Debit Cash 50,000
Credit Rental income -50,000
0
Discount on 1st rental payment:
Debit Incentive 120,000
Credit Rental income -120,000
0
Reduction of rental income on straight-line basis:
Debit Rental income (120 000/6) 20,000
Credit Incentive -20,000
0
Rental income in the 1st year (50 000 + 120 000 - 20 000) 150,000
Accounting in the next years:
Debit Cash 170,000
Credit Rental income -170,000
0
Debit Rental income 20,000
Credit Incentive -20,000
0
2. Disclosures
Future minimum lease payments under non-cancellable operating lease:
due not later than 1 year 170,000
due later than 1 year but not later than 5 years 680,000
due later than 5 years 0
Total 850,000
[Link] Example 9: Sale and leaseback IAS 17: Leases
SecuritorCorp purchased 3 security systems for 10 000 EUR each. Due to cash shortage, SecuritorCorp decided to sell them after 1 year and lease
them back. Fair value at sale was 9 500 EUR each and carrying amount 9 000 EUR each. Details of transactions are as follows:
1. Sales price 9 500 EUR, operating non-cancellable lease for 4 years, annual rentals 2 000 EUR.
2. Sales price 7 000 EUR, operating non-cancellable lease for 4 years, annual rentals 1 500 EUR (market rentals = 2 000 EUR).
3. Sales price 12 000 EUR, operating non-cancellable lease for 4 years, annual rentals 2 700 EUR.
All rentals are to be paid in arrears. How would SecuritorCorp account for these transactions in 20X1?
1. Operating lease with sale at fair value
Sale:
Debit Cash 9,500
Credit PPE -9,000
Credit Profit on sale of PPE (9 500 - 9 000) -500
0
Annual rental:
Debit Rental expense 2,000
Credit Cash -2,000
0
2. Operating lease with sale below fair value
Sale:
Debit Cash 7,000
Credit PPE -9,000
Debit Deferred loss on sale of PPE 2,000
0
Annual rental:
Debit Rental expense 2,000
Credit Cash -1,500
Credit Deferred loss on sale (2 000/4) -500
0
3. Operating lease with sale above fair value
Sale:
Debit Cash 12,000
Credit PPE -9,000
Credit Profit on sale of PPE (FV-CA) -500
Credit Deferred profit on sale of PPE -2,500
0
Annual rental:
Debit Deferred profit on sale of PPE (2 500/4) 625
Debit Rental expense (2 700 - 625) 2,075
Credit Cash -2,700
0