Lease

Q1 -Example: Operating
lease
• Flora Co entered an operating lease
agreement in order to obtain use of a
photocopier for a period of three years
starting on 1 October 20X9. The terms of the
lease stated that payment of $2,500should be
made annually in arrears for each of the three
years of the lease in addition to an initial non-
refundable deposit of $1,500.
• What expense is recognised in Flora Co's
financial statements for the year ended 31
December 20X9?
 Q1 -Example: Operating
lease
answer
• Dr. Rent expenses 750
((2,500*3)+1,500^)/3*3m(Oct-Dec)/12m
• Cr. Cash/ Payable 750
• Remarks: 1,500 represents non-refundable
deposit( can not get back the $)
• Remarks: Look at whole period first rather
than 1 year (cannot:1500/3+2500*3/12)
Q2 - Example: Operating lease
incentives
• Fauna Co enters into an operating lease
agreement on 1 August 20X8 in order to
obtain use of a machine. The lease term is
four years and $5,000 is payable annually in
advance.
• As an incentive, the lessor has agreed a
reduction of 40 per cent off the first year's
rental payment.
• What expense is recorded by Fauna Co in
the year ended 31 December 20X8 in respect
of this agreement?
 Q2 - Example: Operating
lease incentives answer
• Dr. Rent expenses1,250 1,875
((5,000*60%4yr-2,000)total/4yr*5m(Aug-
Dec)/12m
• Cr. Cash/ Payable1,250 1,875

• Remarks: Look at the total “expenses” for the

whole lease period first instead of focusing on 1
year only.
Q3 - Example: Finance lease
with payments in arrears
• On 1 January 20X0, Gordon Co leased an
asset with a fair value of $38 million and a
useful life of five years. The lease term was
five years and the interest rate implicit in the
lease was 9.9 per cent.
• The company is required to make five annual
instalments of $10 million on 31 December,
with the first payment on 31 December 20X0.
• Show the lease obligation working for each
year of the lease and identify amounts to be
recognised in income statement in 20X0.
 Q3 - Example: Finance lease
with payments in arrears
answer
• Date Amount Interest Principal lease
• Expenses Obligation
• 1/1/20X0 $38m
FV=PVM
• 31/12/20X0 $10m $3.762m $6.238m $31.762m
• 31/12/20X1 $10m $3.144m $6.856m $24.906m
• 31/12/20X2 $10m $2.466m $7.534m $17.372m
• 31/12/20X3 $10m $1.72m $8.28m $9.092m
• 31/12/20X4 $10m $0.9m $9.1m
• Finance cost $3.762m
• Amortization expenses on leased equipment $7.6m
 Q4 - Example: Finance lease
with deposit and payments in
arrears
• On 1 January 20X5 Jennifer Co acquired a machine
from Alice Co under a finance lease. The cash price of
the machine was $7,710 while the minimum payments
in the lease agreement totalled $10,000. The agreement
required the immediate payment of a $2,000 deposit
with the balance being settled in four equal annual
instalments commencing on 31 December 20X5. The
finance charge of $2,290 represents interest of 15 per
cent per annum, calculated on the remaining balance of
the liability during each accounting period.
• Required
• Show the breakdown of each instalment between
interest and capital, using the actuarial method.
 Q4 - Example: Finance lease
with deposit and payments in
arrears answer
• Date Amount Interest Principal lease
• Expenses Obligation
• 1/1/20X5 $5710
• 31/12/20X5 $2000 $856 $1144 $4566
• 31/12/20X6 $2000 $685 $1315 $3251
• 31/12/20X7 $2000 $488 $1512 $1739
• 31/12/20X8 $2000 $261 $1739 $0
Q5 - Example: Finance lease
with payments in advance
• Jesmond acquired an asset by way of a five
year term finance lease on 1 July 20X0. The
asset had a fair value of $102,500 and a
useful life of five years and the lease contract
required 5 payments in advance of $25,000.
The interest rate implicit in the lease is 11%.
Jesmond’s year end is 30 June.

• Draw up the lease liability table for Jesmond

for the whole five-year period, identifying
amounts for inclusion in the income
statement of the year ended 30 June 20X1.
Q5 - Example: Finance lease with
payments in advance answer
• Date Amount Interest Principal lease
• Expenses Obligation
• 1/7/20X0 11% $102,500
• 1/7/20X0 $25000 (77,500-25,000)*11%
$25,000 $77,500
• 30/6/20X1 $25000 $8,525 $16,475 $61,025
• 30/6/20X2 $25000 $6,712.7 $18,287.25 $42,737.7
• 30/6/20X3 $25000 $4,701 $20,298 $22,438.9
• 30/6/20X4 $25000 $2468.28 $22,531.72 $ -93
• Interest expenses : 8,525
• Amortization expenses: 20,500
 Q6 - Example: Lessee
disclosures
• These disclosure requirements will be
illustrated for Gordon Co (previous example).

• We will assume that Gordon Co makes up its

accounts to 31 December and uses the
actuarial method, as shown in the example
above, to apportion finance charges.
Q6 - Example: Lessee disclosures
• FP
answer
• PPE –Cost $38
• A.D.$7.6
• N.B.V.$30.4
Liability:
Current liability $6.856*
Non-current liability $24.906*
Income statement:
Finance cost $3.762
*6.856+24906=31762
 Q7 - Self-test question 1
• Potter leases an asset (as lessee) on 1 January 20X1, incurring
$20,000 of costs in setting up the agreement. Potter agrees to pay a
non-refundable deposit of $58,000 on inception together with six
annual instalments of $160,000, payable in arrears.
• Potter also guaranteed to the lessor that the lessor would receive at
least $80,000 when the asset is sold in the general market at the end
of the lease term.
• The fair value of the asset (equivalent to the present value of minimum
lease payments) on1 January 20X1 is $800,000. Its useful life to the
company is five years.
• The interest rate implicit in the lease has been calculated as 10 per
cent.

• Required
• (a) Prepare the relevant extracts from the financial statements of Potter
in respect of the above lease for the year ended 31 December 20X1.
• (b) Explain what would happen at the end of the lease if the asset
could be sold by the lessor:
• (i) For $80,000 (ii) For only $60,000
 Q7 - Self-test question 1 answer
• Date Amount Interest Principal lease
• Expenses Obligation
• 1/1/20X1 $742000
• 1/12/20X1 $160000 74200 $85800 $656200
• 31/12/20X2 $ 160000 $65620 $94380 $561820
• 31/12/20X3 $ 160000 $56182 $103818 $458002
• 31/12/20X4 $ 160000 $45801 $114200 $343802
• 31/12/20X5 $ 160000 $34381 $125620 $ 218182
• $160,000 21,818 $ 138,182 $80,000
• Interest expenses 74200
• Amortization expenses: 148,000(800,000+20,000-80,000)/5
 Q8 - Example: Finance leases:
lessor
• Hire Co leased an assetaccounting
to another company with
effect from 1 January 20X8. The terms of the lease
were as follows:
- Lease term of eight years
-Rentals of $11,000 are payable in advance
-The interest rate implicit in the lease is 12.8 %
• The fair value of the asset on 1 January 20X8 was
$59,500 and legal fees associated with the lease
amounting to $500 were payable by Hire Co on this
date.

• What amounts are recognised in Hire Co's

financial statements for the year ended 31
December 20X8 in respect of the lease?
 Q8 - Example: Finance
leases: lessor accounting
answer
Sales and Leaseback
 Q9 - Example: Sale and “finance”
leaseback A lease that transfers
substantially
Major part of economic life of asset
all the risks and rewards of
Ownership to the lease.
• Osborne Co owned an asset with a carrying
amount of $840,000 on 1 March 20X8. On
this date Osborne Co sold the asset to a
bank for $1,320,000, being the present value
of the minimum lease payments, and then
undertook to lease it back under a 40-year
finance lease.
• The annual rental is $39,000 payable in
advance.End of reporting period for Osborne
Co is 28 February.
• Required
• How should the transaction be accounted for
by Osborne Co?
 Q9 - Example: Sale and
finance leaseback answer
• Dr. Cash 1,320,000
• Cr. Asset 840,000
• Cr. Deferred income 480,000
• Dr. Asset 1,320,000
• Cr Cash 1,320,000
• Dr. Finance lease payable 39,000
• Cr Cash 39,000
Dr. Deferred income 480,000/40yr
• Cr income statement 480,000/40 yr
 Q10 - Example: Sale & “operating”
leaseback
• On 1 January 20X2 Cable Co owned an asset with a
carrying amount of $80,000. The fair value of the asset on
that date was $90,000.
• In order to improve its liquidity position, Cable Co has
negotiated possible agreements to sell the asset and lease
it back under an operating lease for seven years. The
financial controller is assessing 4 agreements.
• The agreements are as follows:
• 1- Sale for $90,000 with annual future lease payments at a market rate
of $15,000
• 2- Sale for $75,000 with annual future lease payments of $15,000
• 3- Sale for $50,000 with annual future lease payments of $10,000
(x15,000)
4-Sale for $110,000 with annual future lease payments of $17,500

• How would each of these agreements be accounted for in

Cable Co's financial statements?
 Q10 - Example: Sale and
operating leaseback answer

• A) Dr. Cash 90,000 Cr. NBV80,000 Cr10,000 –I/S

• B) Dr. Cash 75,000 Cr. NBV80,000 Dr5,000 –I/S
• C) Dr. Cash 50,000 Cr. NBV80,000
• Dr Deferred expenses 30,000
• D) Dr. Cash 110,000 Cr. NBV80,000 Cr10,000 –I/S
• Cr. Deferred income20,000
 Q11 - Past exam paper
(HKICPA September 2008)
• On 1 January 20X7, lessor, entered into a non-cancellable lease
agreement for equipment with SRC, the lessee.
• Annual lease payment due at the beginning of each year, beginning on
1 January 20X7 $53,069 Option to purchase at the end of lease term
$10,000
• Lease term 5 years, economic useful life of leased equipment 8 years
• Lessor's manufacturing cost $200,000
• Fair value of leased equipment at 1 January 20X7 $227,500 estimated
unguaranteed residual value of leased equipment at the end of lease
term $30,000
• Lessor's implicit rate 12.93%,Lessee's incremental borrowing rate 10%

• (a) Discuss how the purchase option at the end of the lease term
offered by TMI to SRC will affect the classification of this lease by
SRC.
• (b) Prepare an amortisation schedule that would be suitable for TMI for
the lease term.
• (c) Prepare all the journal entries that company should make for each
of the years ended31 December 20X7 and 20X8.
 Q11 - Past exam paper
answer
• Date Amount Interest Principal lease
• Expenses Obligation
$227,500
• 1/1/20X7 $53069 $22,554 $196,985
• 1/1/20X8 $53069 $18,608 $162,524
• 1/1/20X9 $ 53069 $14,153 $123,608
• 1/1/2010 $53069 $9,121 $79,660
• 1/1/2011 $53069 $3,438 $30,029
• Dr. F.L. Receivable 227,500
• Cr. Revenue 227,500

• Dr. cost of sales 200,000

• Cr. Inventory 200,000

• Dr Cash 53,069
• Cr. F.L. Receivable 53,069

• Dr. F.L. Receivable 22,554

• Cr. Interest income 22,554