AC3202 Corporate Accounting I

Weeks 7–9

HKAS 17 Leases
Wiley text: Chapter 21
(HKFRS 16 supersedes HKAS 17
Leases)

1
 Intended Learning Outcomes
LO1: Identify the type of leases that are within the scope of
HKAS 17 and define the terminologies used in relation to
leases.

LO2: Classify leases into operating and finance leases by

looking into the substance of the transactions and
applying HKAS 17.

LO3: Account for operating leases from the perspective of a

lessee and a lessor respectively.

LO4: Account for finance leases from the perspective of a

lessee and a lessor respectively.

LO5: Prepare disclosures for lessees and lessors in respect of

finance leases.
2
 Contents

1. Introduction – What is a lease?

2. Classification of leases
3. Guidance on treatment of leases of
land and building
4. Accounting for operating leases
 Lessee and Lessor
5. Accounting for finance lease-Lessee
6. Accounting for finance lease-Lessor
7. Disclosures
3
1. Introduction–
What is a lease?

4
 1. What is a lease?

 HKAS 17 defines a lease as an agreement

whereby the lessor (the owner of an asset )
conveys to the lessee (renter) in return for a
payment or series of payments the right to use
an asset for an agreed period of time.

 Leasing is an important activity for many

entities. It is a means of gaining access to
assets, of obtaining finance and of reducing an
entity’s exposure to the risks of asset
ownership.

5
 2. Classification of leases

Operating lease Vs Finance lease

6
 2.1 Classification of Leases- Lessee

HKFRS 16 introduces a single lessee accounting

model and requires a lessee to recognise assets
and liabilities for all leases with a term of more than
12 months, unless the underlying asset is of
low value.

A lessee is required to recognise a right-of-use asset

representing its right to use the
underlying leased asset and a lease liability
representing its obligation to make lease payments.

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 2.2 Classification of Leases- Lessor

A lessor shall classify each of its leases as either an

operating lease or a finance lease.

• A lease is classified as a finance lease if it

transfers substantially all the risks and rewards
incidental to ownership of an underlying asset.

• A lease is classified as an operating lease if

it does not transfer substantially all the risks
and rewards incidental to ownership of an
underlying asset.

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 2.2 Classification of Leases – Lessor
 Rationale for the accounting treatment: substance
over form

 Assets are defined as “a resource controlled (the risk

and benefits) by the enterprise as a result of past events
and from which future economic benefits are expected
to flow to the enterprise”.

 Thus, it is “control” not “ownership” that is essential in

determining whether a lease fits the description of
assets (and whether a lease should be on or off the
Balance Sheet).

 This follows the “substance over form” principle.

 i.e. Transactions and other events are accounted for
and presented in accordance with their substance and
financial reality and not merely with legal form.
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 2.2 Classification of Leases - Lessor
 HKAS 17, Para. 10 provides the following examples of
situations that individually or in combination would
normally lead to a lease transaction being classified as a
finance lease as risks and benefits are considered to be
substantially transferred:
a) The Ownership is transferred to the lessee at the end
of the lease term;
b) The lease contains a bargain purchase option;
c) The lease term is for the major part of the economic
life of the asset even if title is not transferred;
d) At the inception of the lease, the present value of the
minimum lease payments amounts to at least
substantially all of the fair value of the leased asset;
and
e) The leased assets are of a specialized nature such that
only the lessee can use them without major
modifications being made. 10
2.2 Classification of Leases - Lessor

Lease Criteria for a

agreement finance lease
exists. not met.

Record lease as
an Operating
Lease. Finance
Lease
Example 1
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3. Guidance on treatment of
leases of land and building

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 3. Guidance on treatment of leases of
land and building
 Leases of land and of building are classified as operating
or finance leases in the same way as leases of other assets.

 Separate the land and building elements for the purposes

of lease classification.

 In determining whether the land element is an operating

or a finance lease, an important consideration is that land
normally has an indefinite economic life.

 A lease of both land and buildings should be assessed

separately.
 MLP must split into two elements in proportion to their
relative fair values:
 A lease of land; and

 A lease of building.

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 3. Guidance on treatment of leases of
land and building
 Separate measurement of the land and buildings
elements is not required when:
 The lease payment cannot be allocated reliably between
the land and the buildings in which case the entire lease is
classified as a finance lease, unless that both elements are
operating leases; or

 The lessee’s interest in both the land and the buildings is

classified as an investment property in accordance with
HKAS 40 and the fair value model is adopted.

 According to HKAS 40, lessee can classify a property

interest held under an operating lease as an investment
property. The property interest is accounted for as if it
were a finance lease and the fair value model is used for
the asset recognized.

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4. Accounting for Operating Leases

 4.1 Book of lessee

 4.2 Book of lessor

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 4. Accounting For Operating Leases

 Lease payments (income) under an OL should be

recognized as an expense (income) in the Statement
of Comprehensive Income (Income Statement) 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 (derived from
the leased asset to be diminished).

Lessee Lessor
Dr. Rent expense Dr. Cash
Cr. Cash Cr. Rent revenue
 For lessee, only lease term shorter than 12 months
or underlying asset is of low value can be classified
as operating leases. 16
 4.2 Accounting For Operating Leases
Lessor
 Lease income under an OL should be recognized as income
in the Income Statement on a straight line basis over the
lease term.

Uniform periodic receipts

Dr. Cash
Cr. Rent Revenue

Varying periodic receipts (early receipts > late receipts)

Dr. Cash Dr. Cash
Cr. Rent Revenue Dr. Unearned Rent Revenue
Cr. Unearned Rent Revenue Cr. Rent Revenue

Varying periodic receipts (early receipts < late receipts)

Dr. Cash Dr. Cash
Dr. Rent Receivable Cr. Rent Revenue
Cr. Rent Revenue Cr. Rent Receivable17
 4.2 Accounting For Operating Leases
Lessor
 Initial direct costs incurred by lessor
 To be added to the carrying value of the leased
asset and recognised as an expense (‘lease
expense’) over the lease term.
 E.g. commissions and legal fees incurred by the
lessor in negotiating and arranging a lease

 Depreciation of the leased asset recorded as usual

by lessor

Example 2
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5. Accounting for Finance Lease

Lessee

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 5.1 Some Definitions –
terminology associated with
finance lease

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 5.1 Terminology Associated With
Finance Lease

 Bargain purchase option (BPO): the option for the

lessee to purchase the leased asset in the future at a
price substantially below the fair market value. The
option is so attractive that it is reasonably certain
that it will be exercised.

 Residual value – the fair value of the leased asset at

the end of the lease term. A residual value can be
guaranteed or unguaranteed.

 Guaranteed residual value (GRV) is that part of the

residual value of the leased asset guaranteed by the
lessee or by a party related to the lessee.
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 5.1 Terminology Associated With
Finance Lease
 Guarantee residual value (GRV)
 The lessee has an obligation to not only return the
leased asset at the end of the lease term but also to
guarantee that the residual value will be a certain
amount.

 GRV is included in the lease payments only to the

extent that the guaranteed amount exceeds the
expected residual value of the underlying asset at
the end of the lease.

 For measurement of the lease liability, the lessee

includes only the expected residual value probable of
being owned by the lessee under the residual value
guaranteed.

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 5.1 Terminology Associated With
Finance Lease

 Unguaranteed residual value (URV) is that portion

of the residual value of the leased asset, the
realisation of which by the lessor is not assured or
is guaranteed solely by a party related to the
lessor.

 Contingent rent – the amount of the lease

payment that is not fixed but is based on the
future amount of a factor that changes other than
with the passage of time (e.g. % of future sales,
future interest rates).

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 5.1 Terminology Associated With
Finance Lease
Lessee
Minimum lease payments (MLPs)
Periodic lease payments
+
[the bargain purchase option
or
the GRV is included in the lease payments only to the
extent that the guaranteed amount exceeds the
expected residual value of the underlying asset at the
end of the lease.]

excluding contingent rent, cost for services and taxes

(executory costs) to be paid by and reimbursed to the
lessor.

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 5.1 Terminology Associated With
Finance Lease
 Implicit interest rate: the rate that is used by the lessor in
calculating the desired periodic lease payment.
 It is a discount rate that, at the inception of the lease,

causes the aggregate present value of (a) the minimum

lease payments (from the standpoint of lessor) and (b) the
unguaranteed residual value to be equal to the sum of (i)
the fair value of the leased asset and (ii) any initial direct
costs of the lessor.
 The discount rate that equates the following:

PV of (Periodic lease payment + BPO or GRV)+ PV of URV

= FV of the leased asset + Lessor’s IDC

 Initial direct costs (IDC): incremental costs that are directly

attributable to negotiating and arranging a lease, except for
such costs incurred by manufacturer or dealer lessors.
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 5.1 Terminology Associated With
Finance Lease

 If the implicit rate of interest in a lease is not

determinable, then the lessee’s incremental
borrowing rate should be used.

 Lessee’s incremental borrowing rate of interest: the

rate of interest the lessee would have to pay on a
similar lease or at the inception of the lease, the
lessee would incur to borrow over a similar term, and
with a similar security, the funds necessary to
purchase the asset.

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 5.1 Terminology Associated With
Finance Lease
 Inception date:
 The earlier of the date of the lease agreement
and the date of commitment by the parties to
the principal provisions of the lease (the date
when the lease is signed and classified for
accounting purposes).

 Commencement date:
The date on which a lessor makes an
underlying asset available for use by a
lessee.

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 5.1 Terminology Associated With
Finance Lease

 right-of-use asset
 An asset that represents a lessee’s right to

use an underlying asset for the lease term.

 short-term lease
 A lease that, at the commencement date,

has a lease term of 12 months or less.

 A lease that contains a purchase option is

not a short-term lease.

 operating lease
 A lease that does not transfer substantially all
the risks and rewards incidental to ownership
of an underlying asset.
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 5.2 Initial recognition – Finance lease
Lessee
1. At the commencement of the lease term, lessees shall
recognize finance leases as leased assets and lease
liabilities in Statement of Financial Position (Balance
Sheet) at the lower of the present value of the
minimum lease payments (PVMLP) or the fair value of
the leased asset at the inception of the lease.

To record the leased asset and liabilities

Dr. Leased asset
Cr. Lease liability (Obligation under Finance Leases)

Leased assets and liabilities

at the lower of

Fair value of the leased

PVMLP
asset
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 5.2 Initial recognition – Finance lease
Lessee
PVMLP = PV (periodic lease payments**) + PV (BPO or
(GRV – expected RV))

**exclude contingent rent, executory costs to be paid and

reimbursed to the lessor : cost for services and taxes e.g.
insurance expense

 How to calculate the PVMLP? i.e. discount the MLP into

present value

 PVMLP’s discount factor is

 the interest rate implicit in the lease, if known, if not;

 the lessee’s incremental borrowing rate should be used.

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 5.2 Initial recognition – Finance lease
Lessee

 Unguaranteed residual value (URV) is not included in

the amount capitalized.

 PV of URV is usually small. Fair value of the asset is

often a sufficiently close approximation to the PVMLP
and may in these circumstances be substituted for it.

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 5.2 Initial recognition – Finance lease
Lessee

2. Any Initial direct costs (e.g. costs directly

attributable to negotiating and arranging a lease –
commissions, legal fees, and costs of preparing and
processing documentation for new leases) of the
lessee are added to the amount recognised as an
asset.

To record any initial direct costs of the lessee:

Dr. Leased asset

Cr. Cash

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5.3 Subsequent Measurement – Finance lease
Lessee

 A finance lease gives rise to depreciation

expense for depreciable assets as well as
finance expense for each accounting period.

 An entity applies HKAS 36 Impairment of

Assets to determine impairment of leased
assets.

 Contingent rents shall be charged as expenses

in the periods in which they are incurred.

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 5.3.1 Depreciation of leased asset
Finance lease : Lessee
 Depreciation policy for depreciable leased assets
 consistent with that for depreciable assets which are
owned;
 depreciation calculated in accordance with HKAS 16
PP&E and HKAS 38 Intangible Assets.
 Depreciation period:
1. If reasonably assured that the lessee will obtain
ownership by the end of the lease term or contractual
right to use the asset for any secondary period at the end
of the lease, depreciate the leased asset over the useful
life e.g. BPO, title automatically transferred to the lessee;

2. If there is no reasonable certainty that the lessee will

obtain ownership by the end of the lease term, the asset
should be fully depreciated over the shorter of the lease
term OR its useful life.
Dr. Depreciation on leased asset
Cr. Accumulated depreciation on leased asset 34
 5.3.2 Lease liabilities and finance charges –
Finance lease : Lessee
 Minimum lease payments apportioned between the finance
charge (interest expense) and the reduction of the
outstanding liability.
 The interest expense should be allocated to periods during the
lease term so as to produce a constant periodic rate of interest
on the remaining balance of the liability.
 To record the first prepayment on the date of the lease
Dr. Lease Liabilities (Obligation under finance leases)
Cr. Cash
 To record the following periodic payments of interest
expenses and principals
Dr. Interest Expense
Dr. Lease Liabilities (Obligation under finance leases)
Cr. Cash
 Interest expense = interest rate x beginning balance of the
“Lease liabilities” account
 Principal payment = lease payment – interest expense
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 5.3.2 Lease liabilities and finance charges –
Finance lease : Lessee
 Lease liabilities shall be separately presented as
current liabilities and non-current liabilities on the
face of the Statement of Financial Position (Balance
Sheet).

 Contingent rents shall be charged as expenses in the

periods in which they are incurred.

 the amount of the lease payment that is not fixed

but is based on the future amount of a factor that
changes other than with the passage of time (e.g.
% of future sales, future interest rates).

Dr. Lease Expense

Cr. Cash Example 3
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 5.4 GRV, BPO and
Acquisition of leased assets

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 5.4.1 Accounting for
Guaranteed Residual Value (GRV)

 To record the guaranteed residual value

 The guaranteed residual is that part of the residual

value of the leased asset guaranteed by the lessee
or by a party related to the lessee.

 If the expected RV is greater than GRV, then, lessee

simply returns the leased asset to lessor.

 If the expected RV is less than GRV, lessee must

record a loss on the lease to cover the deficiency.

Example 4
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 5.4.2 Accounting for
Bargain Purchase Option (BPO)
 To record the exercising of bargain purchase option
 Difference between purchase payment and remaining balance
of lease liabilities is recognized as interest expense.
 No gain or loss is recognized when a leased asset is
purchased.
 As with exchange of similar assets, the fair value of the
equipment is ignored. Leased asset is transferred to the
regular asset account.
 The final lease (BPO) payment
Dr. Lease liabilities (remaining balance)
Dr. Interest expense (interest rate x liabilities balance o/s)
Cr. Cash (the BPO payment)
 Transfer from leased asset to its own asset
Dr. Asset (e.g. Equipment)
Dr. Accumulated depreciation on leased asset
Cr. Leased asset
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 5.4.3 Acquisition of leased asset
during lease term

 Settlement of lease liabilities, disposal of leased

asset and acquisition of asset

Dr. Asset (plug-in balance)

Dr. Lease liabilities (remaining balance)
Dr. Interest expense (based on the balance)
Dr. Accumulated depreciation on leased asset
Cr. Leased asset
Cr. Cash (actual payment)

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6. Accounting for Finance Lease

Lessor

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 6.1 Direct–financing lease
 Under a finance lease, substantially all the risks
and rewards incidental to ownership are
transferred by the lessor to the lessee in return for
a stream of lease payments receipts.

 Thus, the lessor shall recognize the asset held

under a finance lease as a receivable in the
Statement of Financial Position (Balance Sheet).

 Lease payments receivable are treated by the lessor as

repayments of principal and finance income to
reimburse and reward the lessor for its investment and
service.

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 6.1.1 Initial recognition – Finance Lease
Lessor

 To record lease payment receivable,

i.e. lease investment at an amount equal to net
investment in the lease
Dr. Lease payments receivable
Cr. Asset purchased for lease (present/fair value)

 The net investment (NI) in the lease is the present

value of the gross investment (GI) in the lease
discounted at the interest rate implicit in the lease.

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 6.1.1 Initial recognition – Finance Lease
Lessor
 The GI in the lease is the aggregate of
 (i) the MLP under a finance lease from the standpoint of the
lessor; and
 (ii) any URV accruing to the lessor.

 The net investment in the lease can also be defined as the gross
investment in the lease less unearned finance income.
(i.e. NI = GI – UFI)

 In other words, the unearned finance income is the difference

between
 (i) The gross investment in the lease

 (ii) The net investment in the lease

(i.e. UFI = GI – NI)

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6.1.1 Initial recognition – Finance Lease
Lessor

Lessee & Lessor Accounting for Residual Value

 The lessor works on the assumption that it will

realize the residual value at the end of the lease
term whether guaranteed or unguaranteed.

 Only guaranteed RV is included in the MLP

calculation for the lessee.

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 6.1.1 Initial recognition – Finance Lease
Lessor
 Initial direct costs are often incurred by lessors and
include amounts such as commissions, legal fees and
internal costs that are incremental and directly
attributable to negotiating and arranging a lease.

 Initial direct costs are included in the initial measurement

of the finance lease receivable and reduce the amount of
income recognised over the lease term.

 To record initial direct cost:

Dr. Lease payments receivable
Cr. Cash

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 6.1.2 Subsequent measurement –
Finance Lease : Lessor

 The recognition of finance income shall based on a

pattern reflecting a constant periodic rate of return
on the lessor’s net investment in the finance lease.

 Under a finance lease, because the PVMLP equals the

lessor’s investment in the property, no income accrues to
the lessor at the inception of the lease.

 The lessor’s only source of income from the lease

transaction is interest over the lease term.

 There is no annual depreciation of assets under finance

leases on the lessor’s book, because the leased assets
are considered “sold”.

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 6.1.2 Subsequent measurement –
Finance Lease : Lessor

 To record the first periodic prepayment on the date of

lease
Dr. Cash
Cr. Lease payments receivable

 To record the following periodic payments and to

recognize interest revenue
Dr. Cash
Cr. Interest revenue*
Cr. Lease payments receivable (plug-in balance)

*Interest revenue
= beginning balance of Lease Payments Receivable x effective rate

48
 6.1.3 Sale of Asset to Lessee
during Lease Term
 To recognize interest revenue before the sale, close
the lease receivable account, and recognize gain or
loss, if any.

Dr. Cash
Cr. Interest Revenue
Cr. Lease Payments Receivable
Cr. Gain on Sale of Leased Asset (plug-in bal.)

 Compared to purchase of leased assets by lessee: no

gain or loss for lessee

Example 5
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 6.2 Manufacturer or dealer lessor
 Manufacturer or dealer lessors should recognize selling
profit or loss in income for the period, in accordance with
the policy followed by the enterprise for outright sales.

 If artificially low rates of interest are quoted, selling profit

should be restricted to that would apply if a market rate of
interest were charged.

 Initial direct cost: recognized as an expense in the

Statement of Comprehensive Income (Income Statement)
at the commencement of the lease term when the selling
profit is recognised because they are mainly related to
earning the manufacturer’s or dealer’s profit (para. 46,
HKAS 17).

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 6.2 Manufacturer or dealer lessor
 A finance lease of an asset by a manufacturer or dealer lessor
gives rise to two sources of income: [if price (present/fair value)
is different from the lessor’s cost]

 Profit or loss resulting from an outright sale of the asset

being leased at the lease inception date
 Manufacturer or dealer lessor's profit = FV - cost of leased asset

 Interest revenue over the lease term

 Interest revenue = Gross investment - FV

 To record the lease

Dr. Lease Payments Receivable
Cr. Sales (present/fair value)

Dr. Cost of Goods Sold (lessor’s cost)

Cr. Finished Goods or Asset purchased for lease 51
7. Disclosures

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 7.1 Statement of financial position
(Balance sheet)

 Lessee – “Lease Liabilities” or “Obligations under

Finance Lease” shall be separately presented as
current liabilities and non-current liabilities on the
face of the statement of financial position (balance
sheet).

 Lessor – “Lease Payments Receivables” shall be

separately presented as current assets and non-
current assets on the face of the statement of
financial position (balance sheet).

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 7.1 Statement of financial position (B/S) –
Disclosures for Finance Lease (Example 3)

(a) (b) (c) (d)

Periodic Interest Reduction in lease Lease liabilities
Date payment $ expense $ liabilities $ $
10% x beginning
(a) – (b)
balance of (d)
1-Jan-16 250,192
1-Jan-16 60,000 --- 60,000 190,192
31-Dec-16 60,000 19,019 40,981 149,211
31-Dec-17 60,000(N1) 14,921 45,079(N2) 104,132
31-Dec-18 60,000(N3) 10,413 49,587(N4) 54,545
31-Dec-19
60,000 5,455 54,545 ---

TOTAL 300,000 49,808 250,192

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 7.1 Statement of financial position (B/S) –
Disclosures for Finance Lease (Example 3)
Lessee - Obligation under Finance Lease
Balance as at 31 December 2016 $149,211
Less: Amounts under current liabilities 45,079
Balance under non-current liabilities 104,132

Lessor – Lease Payments Receivable

Balance as at 31 December 2016 $149,211
Less: Amounts under current assets 45,079
Balance under non-current assets 104,132

55
 7.2 Notes to accounts for finance leases

 The entity shall disclose the total of future MLP at

the end of the reporting period (i.e. B/S date),
and their present value, for the following periods:
 Not later than one year

 Later than one year and not later than five

years
 Later than five years.

56
 7.2 Notes to accounts for finance leases –
Disclosures for Finance Lease (Example 3)

 Finance lease liabilities – MLP

Not later than 1 year $60,000(N1)

Later than 1 year and not later than 5 years 120,000(N3)
Later than 5 years -0-
Total 180,000
Less: Future finance charges on the finance lease (30,789)
Present value of finance lease liabilities $149,211

 The present value of finance lease liabilities is as follows:

Not later than 1 year $45,079(N2)

Later than 1 year and not later than 5 years 104,132(N4)
Later than 5 years -0-
Total $149,211

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The End!!!

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