LEASES Ok - lets have a think about this Remember that when we say operating lease - we mean the risks

and rewards areNOT taken by the lessee. So have we sold the asset or not? Revenue recognition tells us that when the risks and rewards for goods are passed on then we have made a sale and can recognise the revenue So, no the lessor has NOT in substance sold the asset. Therefore the lessor keeps the asset on its SFP Income from an operating lease, (not including services such as insurance and maintenance), should be shown straight-line in the income statement over the length of the lease (unless the item is used up on a different basis - if so use that basis)

SFP
Keep the Asset there

Income statement
Operating Lease rentals received

Negotiating costs etc

Any initial direct costs incurred by lessors should be added to the carrying amount of asset on the SFP and expensed over the lease term (NOT the assets life)

Operating Lease Incentives

The lessor should reduce the rental income over the lease term, on a straight-line basis with the total of these

Mindmaps

Quiz
Question 1
Snotty ltd acquired a new bogie making machine for 22,000 to rent out over 5 years (for 1,000 per month in advance) and then dispose of it (not by eating it) but by selling it for its expected RV then of 1,000. In Year 1 they did a deal with a company (Greenies) - and rented out the machine for 2 years They had to pay 500 on handkerchiefs while negotiating the deal What amounts should be recognised in the Snottys statement of financial position and its income statement at the end of year 1
GIMMIE THE ANSWER!

Question 2
Lease payments on land are 1,000 per month in advance for a period of five years. As an incentive however, the first 6 months are given rent free What would the income statement of the lessor look like

Notes

Lets have a little ponder over this before we dive into the details If we sell an item and lease it back - have we actually sold it? Have we got rid of the risk and rewards? Well if we finance lease it back - it means we keep the risks and rewards - so in effect - we have NOT sold it If we operating lease it back - we have transferred the risks and rewards so an effective sale has been made

Finance Lease Back

The accounting for a sale and finance leaseback results in any profit being recognised over the lease term.

Why?

Why would a company sell and finance lease back then? The simple answer is to raise finance. They get the proceeds now and then have to repay over the lease term - whilst keeping use of the asset It gives companies the opportunity to release capital caught up in the business for investment in other projects This transaction is essentially a financing arrangement. The seller (who is subsequently the lessee) does not dispose of the risks and rewards of ownership (because the leaseback is through a finance lease) and no profit should be recognised immediately on disposal.

Accounting treatment
The accounting entries are:

Step 1
Derecognise the carrying amount of the asset now sold Cr Asset Recognise the sales proceeds Dr Cash Calculate the profit on sale (proceeds less carrying amount) Cr Deferred Income

Step 2
Recognise the finance lease asset Dr Asset and the associated liability Cr Finance lease liability at the lower of FV and PV of MLP as usual

Step 3
Amortise the profit on sale as income over the lease term Dr. Deferred Income Cr. Income statement The effect is to adjust the expense recognised in profit or loss to an amount equal to the depreciationexpense before the leaseback transaction. NB: IF the carrying amount exceeds fair value, the asset should be written down to fair value prior to the sale and leaseback and the loss recognised as an impairment loss.