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Implementing the

GOVERNMENT ACCOUNTING MANUAL


(For National Government Agencies)

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 1
SESSION 11

APPLYING ACCOUNTING
STANDARDS AND
POLICIES ON LEASES

Session 11: Applying Accounting Standards and


GAM: Accounting Slide 11 - 2
Policies on Leases
SESSION OVERVIEW

RECOGNITION MEASUREMENT DISCLOSURES

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 3
Learning Objective

At the end of the session, you will be


able to apply accounting standards and
policies on Leases in accordance with
the provisions set out in the GAM.

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 4
What is a Lease?

leased
asset

Lessor Minimum lease Lessee


payments

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 5
Leasing Advantages

Lessor’s Low or no
May avoid Flexibility of borrowing rate downpayment
obsolescence of contracting. may be less than preserves
assets. lessee’s. capital.

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 6
GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 7
Definition of Terms
1. The date from which the lessee is entitled to exercise its right to use the
leased asset is the
a. Inception of the lease
b. Lease Term
c. Commencement of the Lease Term

2. This 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.
a. Inception of the lease
b. Lease Term
c. Commencement of the Lease Term

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 8
Definition of Terms
3. The period over which an asset is expected to yield economic benefits
or service potential to one or more users
a. Useful Life
b. Lease Term
c. Economic Life

4. The non-cancellable period for which the lessee has contracted to


lease the asset
a. Inception of the lease
b. Lease Term
c. Commencement of the Lease Term

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 9
Definition of Terms
5. Refers to an additional payment made by a lessee in property, cash, or
both when a lease terminates
a. Unguaranteed Residual Value
b. Guaranteed Residual Value
c. Minimum Lease Payments

6. That portion of the residual value of the leased asset, the realization of
which by the lessor is not assured or is guaranteed solely by a party
related to the lessor.
a. Unguaranteed Residual Value
b. Guaranteed Residual Value
c. Minimum Lease Payments

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 10
Definition of Terms
7. The aggregate of, the minimum lease payments receivable by the lessor
under a finance lease; and any unguaranteed residual value accruing
to the lessor.
a. Useful Life
b. Net Investment in the Lease
c. Gross Investment in the Lease

8. Payments over the lease term that the lessee is, or can be, required to
make
a. Minimum Lease Payments
b. Initial Direct Costs
c. Contingent Rent

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 11
Definition of Terms
9. This is the discount rate that, at the inception of the lease, causes the
aggregate present value of: the MLP; and the unguaranteed residual
value to be equal to the FV of the leased asset and any initial direct costs
a. Lessee’s incremental borrowing rate of interest
b. Interest Rate Implicit in the Lease
c. Borrowing Rate
10. The gross investment in the lease discounted at the interest rate implicit
in the lease.
a. Inception of the lease
b. Net Investment in the Lease
c. Minimum Lease Payments

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 12
Classification of Leases

Are and transferred to lessee?

REWARDS RISKS

FINANCE LEASE OPERATING LEASE

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 13
Exercise 11-A

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 14
Situation No. 1

On January 1, 2014, an entity entered, as lessee, into a five-year non-


cancellable lease of a machine that has an economic life of five years.
On the same date (the inception of the lease), the fair value of the
machine is P100,000. On December 31 for each of the first four
years of the lease term, the lessee is required to pay the lessor
P23,000. At the end of the lease term, ownership of the machine
passes to the lessee upon payment of the final lease payment of
P23,539. The interest rate implicit in the lease is 5 per cent per year.
This rate approximates the lessee’s incremental borrowing rate.

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 15
Situation No. 2
On January 1, 2014, an entity entered as lessee into a five-year
non-cancellable lease of farmland with a fair value of P100,000.
The lessee is required to pay the lessor P5,000 per year.

Situation No. 3
On January 1, 2014, an entity entered as lessee into a five-day non-
cancellable lease of a motor vehicle that has an economic life of five years.
On the same date (the inception of the lease), the fair value (cash cost) of
the motor vehicle is P100,000. The lessor charges the lessee P120 per day
for the use of the motor vehicle. At the end of the lease term, the lessee
returns the motor vehicle to the lessor.
GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 16
Situation No. 4

On January 1, 2014, an entity entered as lessee into a five-year non-


cancellable lease of a machine that has an economic life of five years.
On January 1, 2014 (the inception of the lease) the fair value (cash cost)
of the machine is P100,000. On December 31 for each of the first four
years of the lease term the lessee is required to pay the lessor P23,000.
Ownership of the machine does not automatically pass to the lessee at the
end of the lease. Instead, the lease provides the lessee with an option to
acquire the machine from the lessor on January 1, 2019 for P1.

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 17
Situation No. 5

An entity entered, as lessee, into a two-year non-cancellable lease over a


motor vehicle that has an economic life of five years. At the inception of
the lease, the present value of the minimum lease payments approximates
the fair value of the motor vehicle. Ownership of the motor vehicle passes
to the lessee at the end of the lease term

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 18
Ownership transferred at the end of lease term

Option to purchase the asset at a price < FV

Lease term is = > major part of economic life of asset


Present value of MLP = > close to fair value

Leased assets are of such a specialized nature

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 19
Leased assets cannot easily be replaced

Lessor’s losses shall be borne by lessee

Gains/losses from the fluctuation in the FV of the


residual accrue to the lessee
ability to continue the lease for a secondary period at
a rent substantially lower than market rent

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 20
Exercise 11-B
GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 21
Finance Lease: LESSEE

Initial Recognition

DEBIT: CREDIT:
Leased Asset Lease Liability

Fair Value
Lower of current non-current
Present Value of Minimum
Lease payments

+ initial direct costs

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 22
Finance Lease: LESSEE

Subsequent Measurement

PPE: LL: Minimum Lease Payments


Depreciation Expense

Reduction of LL Finance Charge

Debit: Credit: Debit: Lease Liability Credit:


Deprn-Leased Asset-Bldg Accu. Deprn-Leased Asset-Bldg Interest Expense Cash, MDS-Regular

Constant periodic interest rate

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 23
Finance Lease: LESSOR

Initial Recognition

Debit: Credit:
Lease Receivable PPE
Deferred Finance Lease Revenue

Net Investment in the Lease

Minimum Lease Unguaranteed


Payments Residual Value
= fair value + initial direct costs
discounted

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 24
Finance Lease: LESSOR

Subsequent Measurement

LR: Lease Payments

Reduction of LR Finance Income

Debit: Cash, MDS-Regular Credit: Finance Lease Receivable


Deferred FL Revenue Interest Income

Constant periodic rate of return

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 25
Operating Lease

LESSEE LESSOR

Lease Payments Lease Payments

Expense on Straight-line basis Revenue on Straight-line basis

keeps recognizing the asset

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 26
SAMPLE PROBLEM

• Lease Term – 7 years


• Useful Life – 7 years
• FV of Equipment – P100,000
• Annual Payment – P21,912 (due every Dec. 31, 2014 - Dec. 2020)
• Lessee’s incremental borrowing rate – 13%
• Implicit interest rate (known to lessee) – 12%

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 27
Sample Schedule of Amortization

Date Payment/ Interest Decrease in Outstanding


Receipt Balance Balance
1/1/14 100,000
12/31/14 21,912 12,000 9,912 90,088
12/31/15 21,912 10,811 11,101 78,987
12/31/16 21,912 9,478 12,433 66,554
12/31/17 21,912 7,986 13,925 52,628
12/31/18 21,912 6,315 15,596 37,032
12/31/19 21,912 4,444 17,468 19,564
12/31/20 21,912 2,348 19,564 0
Total 153,382
100,000 X 12% = 12,000 53,382 100,000
100,000 - 9,912 = 90,088

21,912 – 12,000 = 9,912 21,912 X 4.56376 = 100,000


Slide 11 - 28
ACCOUNTING FOR FINANCE LEASE
ACCOUNTS LESSEE LESSOR
Leased Assets – Machinery & Equipment 100,000
Finance Lease Receivable 153,382
Other Machinery and Equipment 100,000
Finance Lease Payable 100,000
Deferred Finance Lease Unearned Revenue 53,382
To recognize lease
payable (Jan. 2, 2014) To recognize lease
computed as follows: receivable and Other
(PV of MLP = P21,912 x Unearned Revenue
4.56376 = P100,000)

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 29
ACCOUNTING FOR FINANCE LEASE
ACCOUNTS LESSEE LESSOR
Cash - MDS, Regular 21,912
Cash-Collecting Officer 21,912
Finance Lease Receivable 21,912
Finance Lease Payable 9,912
Interest Expense 12,000
To record 1st To record collection of 1st
lease payment – Dec. 31, lease payment – Dec. 31,
2014 2014

ACCOUNTS LESSEE LESSOR


Deferred Finance Lease Revenue 12,000
Interest Income 12,000
To recognize interest income
– Dec. 31, 2014

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 30
ACCOUNTING FOR FINANCE LEASE

ACCOUNTS LESSEE LESSOR

Depreciation - Leased Assets 13,571.43


Accumulated Depreciation-Leased
Assets, Machinery and Equipment 13,571.43 none
To record depreciation
(P100,000 – 5000) / 7 = 13,571.43 for Dec. 31, 2014

Note: For the 2nd to the 7th year, the illustrative entries shall be the same using
the amount of interest expense and the reduction of lease liability shall be based
on per amortization table while the annual depreciation expense shall be uniform
up to the 7th year.
GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 31
ACCOUNTING FOR OPERATING LEASE
A 5-year operating lease is initiated on January 1st, 2015. Payments are P10,000.00 per
year, payable on December 31st each year. Cost of Equipment is P50,000 with a useful
life of 8 years. Give journal entries for the 1st year.

ACCOUNTS LESSEE LESSOR


Cash-Collecting Officer 10,000
Cash-MDS Regular 10,000
Rent/Lease Expense 10,000
Rent/Lease Income 10,000
To record rent/lease
expense for the year To record receipt of collection for
(Dec. 31) the year (Dec. 31)

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 32
ACCOUNTING FOR OPERATING LEASE
Accounts LESSEE LESSOR
Cash – Treasury/Agency
none
Deposits, Regular 10,000
Cash-Collecting Officer 10,000
To record remittance
to BTr (Dec. 31)

Depreciation-Machinery and
Equipment 5,937.50
none
Accumulated Depreciation -
Other Machinery and Equipment 5,937.50
To record depreciation
for the year (Dec. 31)
GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 33
Disclosures (Lessor)

Finance Lease Operating Lease


 reconciliation between  future minimum lease
gross investment in the payments under
lease and the present contingent rents
value of minimum lease  general description of
payments receivable at the lessor’s leasing
the reporting date. arrangements
 Unearned finance
revenue
 Contingent rents
GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 34
Disclosures (Lessee)
Finance Lease Operating Lease
 net carrying amount  future minimum lease payments
 reconciliation between  future minimum sublease
the total of future payments expected to be
minimum lease received
payments at the  Lease and sublease payments
reporting date, and their recognized as an expense in
present value the period
 future minimum lease  general description of the
payments and present lessee’s significant leasing
value arrangements
 Contingent rents
GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 35
FINANCE OPERATING

Transfer of Risks and Risks and Rewards


Rewards not transferred

LESSOR LESSEE LESSEE


LESSOR

Recognize: Recognize:

Rental Income Asset RENTAL RENTAL


Finance Lease Receivable Depreciation INCOME EXPENSE
Finance Revenue Rental Payments
Derecognize Asset Finance Charge

GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 36
GAM: Accounting Session 11: Applying Accounting Standards and Policies on Leases Slide 11 - 37