AC3202 Corporate Accounting I

Weeks 7–9

HKAS 17 Leases
Wiley text: Chapter 21

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5. Accounting for Finance Lease

Lessor

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 5.1 Direct–Finance 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

● 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. 0
 5.1.1 Initial Recognition – Finance Lease Lessor

● To record lease payment receivable,

Dr. Lease payments receivable

Cr. Asset purchased for lease

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 5.1.2 Subsequent Measurement –
Finance Lease : Lessor

● For the lessor, each payment received from the lessee will be recognized
partly as finance income (i.e., interest income), and the remaining
balance will be used to reduce the balance of lease receivable (the
“principal”).

● The lessor’s only source of income from the lease transaction is interest
income 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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 5.1.2 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 * implicit interest rate

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 Example 5
(Finance Lease with Residual Value – Lessor)

A leasing company acquires a specialized packaging machine for

$300,000 cash and leases it for a period of 6 years.
The machine is returned to the company for disposition at the end
of the lease contract.
The expected unguaranteed residual value of the machine is
$20,000.
The lease terms are arranged so that a return of 12% is earned by
the insurance company.
The lease start at 1 Jan. 2016.
Payment is made in advance. The first lease payment is made on 1
January 2016, and subsequent payments are made each December
31 (Balance Sheet date).

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 Example 5
(Finance Lease with Residual Value – Lessor)

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6

1/1/16 31/12/16 31/12/17 31/12/18 31/12/19 31/12/20 31/12/21

Cash price
$300,000
1st 2nd Payment 3rd Payment 4th Payment 5th Payment 6th Payment URV
Payment
$20,000
Lessee makes periodic Lessee returns
payment (MLP) asset
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 Example 5
(Finance Lease with Residual Value – Lessor)

Calculate the annual lease payment by lessee to yield the desired

return.

Prepare entries for the lessor for the first year of the lease assuming
the machine is acquired.

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 Example 5
(Finance Lease with Residual Value - Lessor)

R=?

The present value of the future cash flows from the lease contract
should equal to $300,000.

Let R be the periodic lease payment by the lessee

$300,000 = [R + R x (PVIFA (12%, 5)) + $20,000 x (PVIF (12%, 6))]

$300,000 = R + 3.6048R + $20,000 x 0.5066

R + 3.6048R = 300,000 - 20,000 x 0.5066
R = (300,000 - 20,000 x 0.5066 ) / 4.6048
R = $62,949

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How to calculate present value of future cash flow?

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 Date (a) Periodic (b) Interest (c) Reduction in (d) Lease
Receipts Income 12% lease payment Payments
receivable $
$ $ Receivable $
12% x beginning (a) – (b)
balance of (d)
1-Jan-16 300,000
1-Jan-16 62,949 0 62,949 237,051
31-Dec-16 62,949 28,446 34,503 202,548
31-Dec-17 62,949 ? ? ?
31-Dec-18 62,949 19,669 43,280 120,625
31-Dec-19 62,949 ? ? ?
31-Dec-20 62,949 8,658 54,291 17,860

Balance @ 31-
Dec-20 $377,694 $95,554 282,140 17,860

URV (return
asset at 31-
Dec-2021) 20,000 2,140* 17,860 0
Total $397,694 $97,694 300,000
*Adjusted for $3 rounding difference : $2,140 is the balancing figure = $20,000-17,860 0
 Date (a) Periodic (b) Interest (c) Reduction in (d) Lease
Receipts Income 12% lease payment Payments
receivable $
$ $ Receivable $
12% x beginning (a) – (b)
balance of (d)
1-Jan-16 300,000
1-Jan-16 62,949 0 62,949 237,051
31-Dec-16 62,949 28,446 34,503 202,548
31-Dec-17 62,949 24,306 38,643 163,905
31-Dec-18 62,949 19,669 43,280 120,625
31-Dec-19 62,949 14,475 48,474 72,151
31-Dec-20 62,949 8,658 54,291 17,860

Balance @ 31-
Dec-20 $377,694 $95,554 282,140 17,860

URV (return
asset at 31-
Dec-2021) 20,000 2,140* 17,860 0
Total $397,694 $97,694 300,000
*Adjusted for $3 rounding difference : $2,140 is the balancing figure = $20,000-17,860 0
 Example 5
(Finance Lease with Residual Value - Lessor)
(b)
2016 $ $
1 Jan Dr. Machine Purchased for Lease 300,000
Cr. Cash 300,000

1 Jan Dr. Lease Payments Receivable 300,000

Cr. Machine Purchased for Lease 300,000

1 Jan Dr. Cash 62,949

Cr. Lease Payments Receivable 62,949

31 Dec Dr. Cash 62,949

Cr. Interest Revenue 28,446*
Cr. Lease Payments Receivable 34,503

*($300,000– $62,949) x 12% = $28,446

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 Example 5
(Finance Lease with Residual Value - Lessor)

(b)
2017
31 Dec Dr. Cash 62,949
Cr. Interest Revenue 24,306
Cr. Lease Payments Receivable 38,643
2018
31 Dec Dr. Cash 62,949
Cr. Interest Revenue 19,669
Cr. Lease Payments Receivable 43,280

2019
31 Dec Dr. Cash 62,949
Cr. Interest Revenue 14,475
Cr. Lease Payments Receivable 48,474

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 Example 5
(Finance Lease with Residual Value - Lessor)

(b)
2020
31 Dec Dr. Cash 62,949
Cr. Interest Revenue 8,658
Cr. Lease Payments Receivable 54,291

2021
31 Dec Dr. Machine 20,000
Cr. Interest Revenue 2,140
Cr. Lease Payments Receivable 17,860

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 Example 5
(Finance Lease with Residual Value - Lessor)
(c) At the end of the 6 years , rather than returning the machine to the lessor, the
packaging machine is sold by the leasing company to the lessee for $32,000.

How will the journal entry at the end of the lease change?

JEs from 2016-2020 remain the same as in (b).

2021 $ $
31 Dec Dr. Cash 32,000
Cr. Lease Payments Receivable 17,860
Cr. Interest Revenue 2,140
Cr. Gain on Sale of Machine (plug-in) 12,000

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 Initial Recognition – Finance Lease Lessor
Initial Direct Costs
● Initial direct costs are often incurred by lessors and include amounts such
as commissions and legal fees.

● Initial direct costs are included in the initial measurement of the finance
lease receivable (i.e., capitalized)
● IDC will be amortized over the course of the lease.
● No interests income will accrue from the initially capitalized IDC.

➢ To record initial direct cost:

Dr. Lease payments receivable
Cr. Cash

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 Lessor versus Lessee

● Lease receivable for Lessor may not be the same as Lease liability
by lessee.

● The amount to be capitalized is different:

● Lease receivable: PV(MLP from lessee + Expected RV + any additional RV
accruing to the lessor)
● Lease liability: PV(MLP)
● The interest rate used in discounting may be different:
● Lessor: implicit interest rate
● Lessee: lessor’s implicit interest rate if known, if not, use lessee’s own
incremental borrowing rate

● For the same reasons, the lease interest expense (lessee) and lease
interest revenue (lessor) may not be the same.

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 5.2 Manufacturer or Dealer Lessor

● If lessor is manufacturer or dealer, a finance lease can give rise to two sources
of income: [if amt. of lease receivable is different from the lessor’s cost]

● Selling profit or loss resulting from an outright sale of the asset being leased
at the lease inception date
● Manufacturer or dealer lessor's profit = lease payment receivable - cost of leased
asset
● Interest revenue over the lease term

● To record the lease at its commencement

Dr. Lease Payments Receivable

Cr. Sales

Dr. Cost of Goods Sold (lessor’s cost) Cr. Finished Goods or Asset
purchased for lease

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 5.2 Manufacturer or Dealer Lessor

● If artificially low discount rates are quoted, selling profit should be restricted
to that would apply if a market rate of interest were charged.

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6. Disclosures

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 6.1 Statement of Financial Position
(Balance Sheet)

● 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).

● 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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 6.2 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.

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Thank you!