LKAS 17 ORIENTATION Objective Scope Definition Classification of

LKAS 17

ORIENTATION Objective Scope Definition Classification of Leases Finance Lease Operating Lease Finance Leases and Operating Leases Calculations Sale and lease back Disclosures

OBJECTIVE The objective of this Standard is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to leases.

Where can this stand apply? Where shall not be applied?

DEFINITION OF A LEASE

A 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 Finance lease Operating lease

FINANCE LEASES V OPERATING LEASES Finance Lease Operating Lease A lease is a finance lease if it transfers substantially all the risks and rewards incident to ownership A lease is an operating lease if it does not transfer substantially all the risks and rewards incident to ownership Substance over Form

RISKS AND REWARDS INCIDENT TO OWNERSHIP Risks Ø Ø Ø Losses from idle capacity Technological obsolescence Changes in value due to changing economic conditions etc. Rewards Ø Ø Ø Expectation of service potential or profitable operation over the asset’s economic life Gain from appreciation in value Realisation of a residual value etc.

FINANCE LEASE OR OPERATING LEASE? Renewal options (4) Conclude on whether substantially all the risks and rewards have been transferred from the lessor to the lessee (3) Determine the net present value (NPV) of the minimum lease payments Cancellation provisions (2) Determine the lease term (1) Identify the business purpose behind the lease and its economic impact together with the economic issues at the end of the lease term Rights and obligations at end of lease

FINANCE LEASE OR OPERATING LEASE? Examples of situations which would normally lead to a lease being classified as a finance lease: Ø The lessor transfers ownership of the asset to the lessee at the end of the lease term Ø The lessee has the 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 such that, at the inception of the lease, it is reasonably certain that the option will be exercised

FINANCE LEASE OR OPERATING LEASE? Examples of situations which would normally lead to a lease being classified as a finance lease (cont’d): Ø Ø The lease term is for the major part of the economic life of the asset even if title is not transferred The leased assets are of a specialised nature such that only the lessee can use them without major modifications being made The leased assets cannot be easily replaced At the inception of the lease, the present value of the minimum lease payments (MLP) amounts to at least substantially all of the fair value of the leased asset

FINANCE LEASE OR OPERATING LEASE? Other indicators which individually or in combination could also lead to a lease being classified as a finance lease: Ø Ø Ø If the lessee cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee The lessee bears gains/losses from changes in the fair value of the residual The lessee has the ability to continue the lease for a secondary period at a rate which is substantially lower than market rate

ACCOUNTING FOR FINANCE LEASE

FINANCE LEASE – ACCOUNTING BY LESSEE Substance of the transaction should be considered. Ø At the beginning of the lease term, the lessee recognizes, § The leased asset and § The obligation to make lease payments as a liability Ø The asset and liability are measured at the lower of § The fair value of the asset § The present value of the minimum lease payments

FINANCE LEASE – ACCOUNTING BY LESSEE CONT. . Ø Ø Lease payments are split between finance charge and the repayment of the outstanding liability. The depreciation policy for assets held under finance leases should be consistent with that for owned assets. § If the lessee will obtain ownership of the asset at the end of the lease, depreciation is made over the useful life of the asset. § Otherwise the asset should be depreciated over the shorter of the lease term or the life of the asset.

DOUBLE ENTRIES IN THE BOOKS OF THE LESSEE – FINANCE LEASE Ø Ø Ø Recognize the asset Non-Current asset Lessor Lease rental repayment Lessor Cash/ Bank Annual Interest Expense (P&L) Lessor Dr Cr

DOUBLE ENTRIES IN THE BOOKS OF THE LESSOR – FINANCE LEASE Ø Ø Ø Asset transferred Receivable Non-current asset For the lease installment received Cash/Bank Lessee For the interest Lessee Interest income Dr Cr

OPERATING LEASE

DEFINITION An operating lease is a lease other than finance lease Lease that does not transfer substantially all of the risks and rewards to the lessee. Lessor Asset Lessee Right to use asset

OPERATING LEASE – ACCOUNTING BY LESSEE / LESSOR Lessee Lessor Statement of financial position §Prepaid/accrued §Leased asset lease rental § Accrued/deferred payable Statement of comprehensive income §Lease rental expense lease rental receivable §Depreciation expense §Lease rental income

ACCOUNTING BY LESSEE An asset is not recognized Rental under operating lease are charged to the income statement on a straight line basis over the term of lease, unless another systematic and rational basis is more appropriate. Any difference between amount charged and amounts paid will be prepayments or accruals.

ACCOUNTING BY LESSOR Lease income from operating leases shall be recognized in income on straight line basis over the lease term, Unless another systematic basis is more representative of the time pattern in which use benefit derived from the leased asset diminished. The depreciation policy for depreciable leased assets shall be consistent with the lessor’s normal depreciation policy for similar assets and depreciation shall be calculated in accordance with LKAS 16.

DOUBLE ENTRIES IN THE BOOKS OF THE LESSEE – OPERATING LEASE Ø Lease rental repayment Rental expense Cash or accrued lease rental payable Dr Cr

DOUBLE ENTRIES IN THE BOOKS OF THE LESSOR – OPERATING LEASE Ø At the Beginning Leased asset Cash or creditor Ø Dr Cr At the end of the year Depreciation expense Leased asset Cash or accrued lease rental Lease rental income Dr Cr

OPERATING LEASE - EXAMPLE Example 26 On 1 January 2014, X signs a 5 -year lease for equipment � The cost of the equipment was 30, 000 � Total lease payments are 20, 000 (4, 000/year) � Unguaranteed residual value is 15, 000 � Economic life of equipment is 10 years � Questions � What are the journal entries to be recorded at 1 January 2014 and 31 December 2014?

OPERATING LEASE - SOLUTION (LESSEE) 27 No entry at 1 January 2014 At 31 December 2014: Dr Rental expense 4, 000 Cr Cash or accrued lease rental payable 4, 000

OPERATING LEASE - SOLUTION (LESSOR) At 1 January 2014: 28 Dr Leased asset 30, 000 Cr Cash or creditor 30, 000 At 31 December 2014: Dr Depreciation expense 3, 000 Cr Leased asset Dr Cash or accrued lease rental Cr Lease rental income 3, 000 4, 000

EXERCISE

Samson PLC has purchased a machine on 01 st of April 2014 under the terms of lease for 5 million for the period of 5 years at the rate of 12%. First payment coming at the end of the first year. The lease agreement specifies that Samson PLC gets to keep the machine at the end of the lease. Question Indicate the amortization schedule & calculate the appropriate amounts to be included in the financial statements of the lessee for the year ended 31 st March 2015.

AMORTISATION SCHEDULE Year 0 1 2 3 4 5 Opening Balance 5, 000. 0 0 4, 212, 885. 0 0 3, 331, 316. 2 0 2, 343, 959. 1 4 1, 238, 119. 2 4 Installment Interest - - 1, 387, 115. 00 600, 000. 00 1, 387, 115. 00 505, 546. 20 1, 387, 115. 00 399, 757. 94 1, 387, 115. 00 281, 275. 10 1, 387, 115. 00 148, 574. 31 6, 935, 575. 00 Closing Capital Balance 5, 000. 0 0 787, 115. 0 4, 212, 885. 0 0 0 881, 568. 8 3, 331, 316. 2 0 0 987, 357. 0 2, 343, 959. 1 6 4 1, 105, 839. 9 1, 238, 119. 2 0 4 1, 238, 119. 2 4 - 1, 935, 153. 55 5, 000. 00

LEASE SCHEDULE

BALANCE SHEET CLASSIFICATION

SALE AND LEASEBACK TRANSACTIONS

DEFINITION Sale and leaseback transaction is an arrangement in which one party sells a property to a buyer and the buyer immediately leases the property back to the seller.

Advantages of sale and leaseback Releases cash tied up in assets already owned Ø Cheaper than borrowing money Ø All the risks & rewards of the asset are transferred to the buyer Ø The lessee can still use the asset Ø No extra time required for re-training on new equipment Ø Disadvantages of sale and leaseback Ø Loss control over the asset Ø In the long term it is more expensive

Accounting Treatment for Sales & Leaseback Transactions Ø Sale & Leaseback Under Finance Lease If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over the carrying amount shall not be immediately recognized as income by a seller-lessee. Instead, it shall be deferred and amortized over the lease term.

Ø Sale & Leaseback Under Operating Lease Any profit or loss arising is accounted for as follows If the transaction is; At fair value Recognize immediately Below fair value Future lease rentals Recognize at market rate immediately Future lease rentals below market rate Above fair value Deferred & amortized over the lease period Excess over fair value should be deferred & amortized over the lease period

DISCLOSURES

KEY DISCLOSURES – FINANCE LEASES (LESSEES) Requirements of SLFRS 7 Ø Net carrying amount at the end of the reporting period Ø A reconciliation between the total of future minimum lease payments Ø Contingent rents recognized as an expense in the period Ø General description of the lessee’s material leasing arrangements Ø Requirements for disclosure in accordance with LKAS 16, LKAS 38, LKAS 40 and LKAS 41 apply to lessees for assets leased under finance leases Ø

KEY DISCLOSURES – OPERATING LEASES (LESSEES) Ø Total of future minimum lease payments Ø Lease and sublease payments recognized as an expense in the period Ø General description of the lessee’s significant leasing arrangements

KEY DISCLOSURES – FINANCE LEASES (LESSORS) Ø Requirements in SLFRS 7 Ø Reconciliation between the gross investment in the lease at the end of the reporting period Ø Unearned finance income Ø Unguaranteed residual values accruing to the benefit of the lessor

KEY DISCLOSURES – FINANCE LEASES (LESSORS) Ø Accumulated allowance for uncollectible minimum lease payments receivable Ø Contingent rents recognized as income in the period Ø General description of the lessor’s material leasing arrangements.

KEY DISCLOSURES – OPERATING LEASES (LESSORS) Requirements of SLFRS 7 Ø Future minimum lease payments under noncancellable operating leases Ø Total contingent rents recognized as income in the period Ø General description of the lessor’s leasing arrangements Ø disclosure requirements in LKAS 16, LKAS 38, LKAS 40 and LKAS 41 apply to lessors for assets provided under operating leases Ø

SUMMARY

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