Lessor Accounting PDF

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LESSOR ACCOUNTINGQUESTION 1Explain the accounting for lease on the part of the lessor under the new lease standard.ANSWER 1Lessor accounting under the new lease standard is business as usual.IFRS 16, paragraph 61, provides that a lessor shall classify leases as either an operating lease or a finance...

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LESSOR ACCOUNTING QUESTION 1 Explain the accounting for lease on the part of the lessor under the new lease standard. ANSWER 1 Lessor accounting under the new lease standard is business as usual. IFRS 16, paragraph 61, provides that a lessor shall classify leases as either an operating lease or a finance lease. Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. Under IFRS 16, paragraph 63, any of the following situations would normally lead to a lease being classified as a finance lease: a. The lease transfers ownership of the underlying asset to the lessee at the end of the lease term. b. The lessee has an 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. At the inception of the lease, it is reasonably certain that the option will be exercised. c. The lease term is for the major part of the economic life of the underlying asset even if title is not transferred. Under USA GAAP, “major part” means at least 75% of the economic life of the underlying asset. d. The present vale of the lease payments amounts to substantially all of the fair value of the underlying asset at the inception of the lease. Under USA GAAP, “substantially all” means at least 90% of the fair value of the underlying asset.

QUESTION 2 Explain an operating lease on the part of lessor. ANSWER 2 IFRS 16, paragraph 81, provides that lease income from operating lease on the part of the lessor shall be recognized on a straight line basis over the lease term, unless another systematic basis is more representative of the time pattern in which benefit from the use of the underlying asset is diminished. a. The periodic rental in an operating lease is simply recognized by the lessor as rent income. b. A lessor shall present an asset subject to operating lease in the statement of financial position according to the nature of the asset. c. The underlying asset remains as an asset of the lessor and consequently, the lessor bears all ownership or executory costs such as depreciation of leased property, real property taxes, insurance and maintenance.

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d. The depreciation policy for depreciable underlying asset shall be consistent with the lessor’s normal depreciation for similar asset. e. Any security deposit refundable upon the lease expiration shall be accounted for as liability by the lessor. f. Any lease bonus received by the lessor from the lessee is recognized as unearned rent income to be amortized over the lease term. g. Initial direct costs incurred by lessor in an operating shall be added to the carrying amount of the underlying asset and recognized as an expense over the lease term on the same basis as the lease income.

QUESTION 3 Explain the following in connection with a direct financing lease: 1. 2. 3. 4.

Gross investment Net investment in the lease Unearned interest income Initial direct cost

ANSWER 3 1. Gross investment in the lease The gross investment in the lease is equal to the gross rentals for the entire lease term plus the absolute amount of the residual value, whether guaranteed or unguaranteed. Actually, this is the amount debited to lease receivable. 2. Net investment in the lease The net investment in the lease is equal to the cost of the asset plus ani initial direct cost incurred by the lessor. 3. Unearned interest income The unearned interest income is the total financial revenue of the lessor which is the difference between the gross investment and net investment in the lease. 4. Initial direct cost In a direct financing lease, the initial direct cost incurred by the lessor is added to the cost of the asset to get the net investment in the lease. This would effectively spread the initial direct cost over the lease term and reduce the amount of interest income. Accordingly, the interest rate implicit in the lease is recomputed so as to include the initial direct cost in the measurement of the lease receivable.

QUESTION 4 Explain the following in connection with a sales type lease. 1. Gross investment 2. Net investment in the lease 3. Unearned interest income

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Page |3 4. 5. 6. 7.

Sales Cost of good sold or cost of sales Gross profit Initial direct cost

ANSWER 4 1. Gross investment – This is equal to the gross rentals for the entire lease term plus the absolute amount of the residual value, whether guaranteed or unguaranteed. Recall that this is the same definition of gross investment in a direct finance lease. 2. Net investment in the lease – This is equal to the present value of the gross rentals plus the present value of the residual value, whether guaranteed or unguaranteed. 3. Unearned interest income – this is the total financial revenue of the lessor which is the difference between the gross investment and net investment in the lease. 4. Sales – The amount equal to the net investment in the lease or fair value of the asset, whichever is lower. 5. Cost of goods sold – This is equal to the cost of the asset sold plus the initial direct cost incurred by the lessor. 6. Gross profit – This is the usual formula of sales minus cost of goods sold. 7. Initial direct cost – This amount is expensed immediately in a sales type lease as a component of cost of goods sold.

MULTIPLE CHOICE QUESTION 5 (AICPA Adapted) 1. Rent received in advance by the lessor in an operating lease should be recognized as revenue a. When received b. At the lease inception c. At the lease expiration d. In the period specified by the lease 2. When should a lessor recognize in income a nonrefundable lease bonus paid by a lessee on signing an operating lease? a. When received b. At the inception of the lease c. At the lease expiration d. Over the lease term 3. Lease payments under an operating lease shall be recognized as rent income on a. Straight line basis over the lease term unless another systematic basis is representative of the time pattern of the user’s benefit. b. Diminishing balance basis c. Sum of units basis d. Cash basis 4. As an inducement to enter lease, a lessor granted a lessee twelve months of free rent under a five-year operating lease. The lease was effective at the beginning of the current year and provides

Theory of Accounts

Page |4 for monthly rental payments to begin at the beginning of next year. The lessee made the first rental payment at the end of the current year. In the income statement for the current year, the lessor shall report rent revenue a. Zero b. Cash received during the current year c. One-fourth of the total cash received d. One-fifth of the total cash to be received over the life of the lease 5. Which statement characterizes an operating lease? a. The lessee records depreciation and interest. b. The lessee records the lease obligation related to the underlying asset. c. The lessor transfer title of the underlying asset to the lessee for the duration of the lease term. d. The lessor records depreciation and lease revenue. 6. A ten-year operating lease provide for a 10% increase annual rent every five years. In the sixth year compared to the fifth year, what could be the effect on the on the expense? a. Rent and interest expense will both increase b. Interest expense will increase but not rent expense c. Rent increase will increase but not rent expense d. No increase in both rent and interest expense 7. The lessor should report the underlying asset under an operating lease and income therefrom as which of the following? a. The asset should be kept off the statement of financial position and the lease income should go to other comprehensive income. b. The asset should be kept off the statement of financial position and the lease income should go to the income statement. c. The asset should be reported in the statement of financial position according to its nature and the lease income should go to other comprehensive income. d. The asset should be reported in the statement of financial position according to its nature and the lease income should go to the income statement.

QUESTION 6 (IFRS) 1. The classification of the lease is normally carried out a. At the end of the lease term b. After a “cooling off” period of one year c. At the inception of the lease d. When the entity deems it to be necessary 2. The classification of the lease as either operating lease or finance lease on the part of the lessor is based on a. The length of the lease. b. The transfer of the risks and rewards of ownership. c. The lease payments being at least 50% of fair value. d. The economic life of the underlying asset. 3. All of the following situations would prima facie lead to a lease being classified as a finance lease, except a. Transfer of ownership to the lessee at the end of the lease term. b. Option to purchase at a value below the fair value of the underlying asset. c. The lease term is for major part of the asset’s life.

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