Government Accounting
&
Accounting for non-profit organizations
by: ZEUS VERNON B. MILLAN
Chapter 13
Leases
Learning Objectives
1. Differentiate between a finance lease and
an operating lease.
2. Account for finance leases by lessees and
by lessors.
3. Account for operating leases by lessees
and by lessors.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Definition of a Lease
• 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 of time.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Classification of Leases
1. Finance lease – is a lease that transfers
substantially all the risks and rewards
incidental to ownership of an asset.
2. Operating lease – is a lease that does not
transfer substantially all the risks and
rewards incidental to ownership of an
asset.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Finance lease
Any of the following would lead to a finance lease
classification:
1. Transfer of ownership
2. Bargain purchase option
3. The lease term is for the major part of the
economic life of the asset (‘75% criterion’).
4. The present value of the minimum lease
payments is at least substantially all of the fair
value of the leased asset (‘90% criterion’).
5. The leased asset is specialized nature.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Lease of Land and Building
• The land and building elements of a lease contract are
classified separately as either operating or finance
lease.
• Lease payments are allocated based on relative fair
values.
• If no reliable allocation basis exists, the entire lease is
classified as a finance lease, unless it is clear that both
elements are operating leases.
• If the land element is immaterial, both elements are
treated as a single unit and classified as finance or
operating lease. The economic life of the buildings is
regarded as the economic life of the entire leased asset.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Inception and Commencement
• Inception of the lease – is the earlier of the date of the
lease agreement and the date of commitment by the
parties to the principal provisions of the lease. It is on
this date that:
a. A lease is classified as either an operating or a
finance lease; and
b. In the case of a finance lease, the amounts to be
recognized at the commencement of the lease
term are determined.
• Commencement of the lease term – is the date from
which the lessee is entitled to exercise its right to use
the leased asset. It is on this date that any asset or
liability resulting from the lease is initially recognized.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Accounting for Finance lease by Lessees
• At the commencement date, a lessee recognizes
the asset acquired under a finance lease and the
related lease liability measured at the lower of the:
a. fair value of the leased property at inception
date; and
b. present value of the minimum lease payments
at inception date
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Minimum Lease Payments
•
Minimum lease payments include the following:
1. Rentals, excluding contingent rent, costs for
services and taxes reimbursable to the lessor;
2. Bargain purchase option; and
3. Guaranteed residual value
• The MLP are discounted using the interest rate
implicit in the lease, if this is determinable; if not,
the lessee’s incremental borrowing rate is used.
• Initial direct costs are capitalized as part of the
asset recognized.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Subsequent measurement
• The lease liability is subsequently measured
at amortized cost.
• The leased asset is accounted for similar to
an owned asset. Accordingly, the leased
asset is depreciated using the entity’s
existing depreciation policies.
• If there is no reasonable certainty that the
lessee will obtain ownership by the end of
the lease term, the asset shall be
depreciated over the shorter of its useful
life and the lease term.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Accounting for Finance lease by Lessors
• A lessor recognizes the lease payments
receivable under a finance lease at an amount
equal to the net investment in the lease.
• Initial direct costs are included in the initial
measurement of the finance lease receivable
and reduce the amount of revenue recognized
over the lease term. The interest rate implicit
in the lease is defined in such a way that the
initial direct costs are included automatically in
the finance lease receivable. Therefore, there
is no need to add the initial direct costs
separately.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Interest rate implicit in the lease
• Interest rate implicit in the lease – is the
discount rate that, at the inception of the
lease, causes the aggregate present value of:
1. The minimum lease payments; and
2. The unguaranteed residual value,
to be equal to the sum of (a) the fair value of
the leased asset and (b) any initial direct costs
of the lessor.
• The lease receivable (net investment) is
subsequently measured at amortized cost.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
Operating lease
• A lessee (lessor) under an operating lease
recognizes the lease payments as expense
(income) on a straight line basis over the lease
term, unless another systematic basis is more
representative of the time pattern of the user’s
benefit.
• Initial direct costs incurred by lessors are added to
the carrying amount of the leased asset and
recognized as expense over the lease term on the
same basis as the lease income.
• Initial direct costs incurred by lessees (such as
lease bonus paid to the lessor) are treated as
prepaid rent and recognized as expense on the
same basis as the lease expense.
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
APPLICATION OF
CONCEPTS
PROBLEM 13-3: FOR CLASSROOM DISCUSSION
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
 QUESTIONS????
 REACTIONS!!!!!
GOVT ACCTG & ACCTG FOR NPOs by:
Z.B.Millan
END
GOVT ACCTG & ACCTG FOR NPOs by: Z.B.Millan