Accounting for Leases in Public Sector (IPSAS 13 Leases)

TRAINING WORKSHOP ON APPLICATION OF IPSASs Accounting for Leases in Public Sector (IPSAS 13 Leases) By Yona Killagane NSSF COMMERCIAL COMPLEX MOROGORO 7thApril 2017

Objectives and Scope Objective: Prescribes accounting policies and disclosures for leases to the lessees and lessors.. Scope: Exclusion: Leases to explore for or use minerals, oil, natural gas, and similar nonregenerative resources; and Licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents, and copyrights Not as a basis for measurement relating to: Property held by lessees that is accounted for as investment property (see IPSAS 16, Investment Property); Investment property provided by lessors under operating leases (see IPSAS 16); Biological assets held by lessees under finance leases (see IPSAS 27, Agriculture); or Biological assets provided by lessors under operating leases 2

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 Lessor Owner Conveys use of asset Makes payments for the use of asset Lessee user

What is a lease? The right to use the asset is passed from the lessor (the legal owner) of the asset to another party (the lessee). Legal ownership is retained by the lessor the person granting the lease. In return for the right to use the asset, the lessee pays a rental to the lessor. Transfers the use OWNER USER Pays a rental

Advantages of the Lease 1) 100% financing at fixed rates without requiring any down payment, lease payments often remain fixed. 2) Protection against obsolescence reduce risk of obsolescence. 3) Flexibility less restrictive provision than other debt agreements. 4) Less costly financing. 5) Off-Balance-Sheet financing specifically on operating lease. 5

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

Definitions The commencement of the lease term : is the date from which the lessee is entitled to exercise its right to use the leased asset. It is the date of initial recognition of the lease (i.e., the recognition of the assets, liabilities, revenue, or expenses resulting from the lease, as appropriate). Contingent rent: is that portion of the lease payments that is not fixed in amount, but is based on the future amount of a factor that changes other than with the passage of time (e.g., percentage of future sales, amount of future use, future price indices, future market rates of interest). Economic life is : (a) The period over which an asset is expected to yield economic benefits or service potential to one or more users; or (b) The number of production or similar units expected to be obtained from the asset by one or more users. A finance lease: is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. Gross investment in the lease is the aggregate of: (a) The minimum lease payments receivable by the lessor under a finance lease; and (b) Any unguaranteed residual value accruing to the lessor. 8

Guaranteed residual value is: 1. (a) For a lessee, that part of the residual value that is guaranteed by the lessee or by a party related to the lessee (the amount of the guarantee being the maximum amount that could, in any event, become payable); and 2. (b) For a lessor, that part of the residual value that is guaranteed by the lessee, or by a third party unrelated to the lessor, that is financially capable of discharging the obligations under the guarantee. Initial direct costs: are incremental costs that are directly attributable to negotiating and arranging a lease, except for such costs incurred by manufacturer or trader lessors. The interest rate implicit in the lease: is the discount rate that, at the inception of the lease, causes the aggregate present value of: (a) The minimum lease payments; and (b) The unguaranteed residual value to be equal to the sum of (i) the fair value of the leased asset, and (ii) any initial direct costs of the lessor. The lessee s incremental borrowing rate of interest : rate of interest the lessee would have to pay on a similar lease or, if that is not determinable, the rate that, at the inception of the lease, the lessee would incur to borrow over a similar term, and with a similar security, the funds necessary to purchase the asset. 9

Implicit discount rate The implicit discount rate is the rate that, at the inception of the lease, causes the present value of the sum of the minimum lease payments + plus the unguaranteed residual value to equal the fair value of the leased asset. The portion of the residual value on which the lessor is at risk its realisation by the lessor is not assured

Calculation of implicit rate FV = p0 + p1 + p2. pn + Unguaranteed (1+r) (1+r)^1 (1+r)^2 (1+r)^n (1+r)^n Use of Excel Try & Error R = implicit rate = Effective rate Effective Decrease in Outstanding Date Payment Interest Balance Balance 01/01/11 479,079 01/01/11 100,000 0 100,000 379,079 31/12/11 100,000 37,908 62,092 316,987 31/12/12 100,000 31,699 68,301 248,686 31/12/13 100,000 24,869 75,131 173,554 31/12/14 100,000 17,355 82,645 90,910 31/12/15 100,000 9,090 * 90,910-600,000 120,921 479,079 *Rounded. Rate = 10% 11

Definition ( cont.) Minimum lease payments are the payments over the lease term that the lessee is, required to make, excluding contingent rent, costs for services and, where appropriate, taxes to be paid by and reimbursed to the lessor, together with: For a lessee, any amounts guaranteed by the lessee or by a party related to the lessee; or For a lessor, any residual value guaranteed to the lessor by: 1. The lessee; 2. A party related to the lessee; or 3. An independent third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee. 12

Definition (cont.) Net investment in the lease: is the gross investment in the lease discounted at the interest rate implicit in the lease. A non-cancelable lease : is a lease that is cancelable only: (a) Upon the occurrence of some remote contingency; (b) With the permission of the lessor; (c) If the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or (d) Upon payment by the lessee of such an additional amount that, at inception of the lease, continuation of the lease is reasonably certain. An operating lease: is a lease other than a finance lease. Unearned finance revenue: is the difference between: (a) The gross investment in the lease; and (b) The net investment in the lease. Unguaranteed residual value is 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 13 to the lessor.

Hire Purchase Contracts The definition of a lease includes contracts for the hire of an asset that contain a provision giving the hirer an option to acquire title to the asset upon the fulfillment of agreed conditions. 14

Risks and rewards incident to ownership Risks Losses from idle capacity Technological obsolescence Changes in value due to changing economic conditions Etc. Rewards Expectation of service potential or profitable operation over the asset s economic life Gain from appreciation in value Realisation of a residual value Etc.

Balancing Act. Rewards may be represented by the expectation of profitable operation over the asset s economic life and of gain from appreciation in value or realization of a residual value. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return due to changing economic conditions 16

Ownership Transfer Legal form: - Title remains with the lessor for all types of lease. Accounting view: Substance over form A lease that transfers substantially all of the benefits and risks incidental to the ownership of property should be accounted for as acquisition of an asset and the incurrence of an obligation by the lessee. practically how the asset is treated/used vs. legally who own the asset Conclusion: The ownership rights differs according to type of the lease. 17

Classification of Leases LEASE FINANCE LEASE It transfers substantially all the risks and rewards incidental to ownership. OPERATING LEASE It does not transfer substantially all the risks and rewards incidental to ownership 18

Lease Classified as Finance Individually or collective creterias. 1. The lease transfers ownership of the asset to the lessee by the end of the lease term; 2. The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option. Bargain Price; 3. The lease term is for the major part of the economic life of the asset, even if title is not transferred; {US >75%} 4. At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; {US > 90%} 5. The leased assets are of such a specialized nature that only the lessee can use them without major modifications; and 6. The leased assets cannot easily be replaced by another asset. 19

Lease Classified as Finance (cont.) Other indicators that individually or in combination: 1. If the lessee can cancel the lease, the lessor s losses associated with the cancellation are borne by the lessee; 2. Gains or losses from the fluctuation in the fair value of the residual accrue to the lessee; and 3. The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent. Lease classification has to be made at the inception of the lease. If lessee and the lessor agree to change the provisions of the lease, other than by renewing the lease, in a manner that would have resulted in a different classification of the lease under the above criteria if the changed terms had been in effect at the inception of the lease, the revised agreement is regarded as a new agreement over its term. Changes in estimates (for example, changes in estimates of the economic life or the residual value of the leased property) or changes in circumstances (for example, default by the lessee), do not give rise to a new classification of a lease for accounting purposes. 20

Leases Involving Land and Buildings Analyse land and buildings individually Land indefinite life always operating lease (unless title passes at the end of the lease term) Buildings apply IPSAS 13 to decide whether finance or operating lease MLP be allocated on basis of their relative Fair values. Where land element is immaterial, the land and buildings may be treated as a single unit for classification and classified as a finance or operating lease; with building period taken. Separation not necessary when lessee accounts it as investment property under fair value method

Illustration 1 - Type of Lease On January 1, 20x5, ABC signed a 5-year noncancelable lease for a machine. The terms of the lease called for ABC to make annual payments of TZS 9,968 at the beginning of each year, starting January 1, 20x5. The machine has an estimated useful life of 6 years and a TZS 5,000 unguaranteed residual value. ABC uses the straight-line method of depreciation for all of its plant assets. ABC s incremental borrowing rate is 10%, and the lessor s implicit rate is unknown (impracticable to determine). Instructions (a) What type of lease is this? Explain. (b) Compute the present value of the minimum lease payments. (c) Prepare all necessary journal entries for ABC for this lease through January 1, 20x6. LO 2

What type of Lease? Finance Lease Criteria: 1. Transfer of ownership 2. Bargain purchase option 3. Lease term for major part of economic life of leased property 4. Present value of minimum lease payments substantially all of FV of property 5. Specialized nature 6. Not replaceable NO NO Lease term 5 yrs. Economic life 6 yrs. YES 83.3% FV of leased property is unknown. Unknown Unknown Finance Lease, #3

Classification of Lease Illustration 2: ABC(Lessor) and XYZ(Lessee) entered into leasing agreement on 1 January 2012. The term of lease is 15 years. The lease agreement is noncancellable and has minimum lease payments with a present value of TZS450,000. The lease involves the use of machinery that has a 17 years estimated useful life and at inception is fair valued at TZS 460,000. The lease stated that XYZ has an option to purchase the asset for TZS 20,000 at the end of leased period when the market value is TZS 60,000. 24

Classification of Lease Solution to illustration 2: Criteria Satisfied? Explanation Y / N Transfer of title N Not transferred. BPO Bargain Purchase Option Y BPO = TZS 20,000; Vs TZS60,000 Length of lease term Y useful life = 17 years; Lease term = 15 years. PV of MLP Y FV = TZS 460,000; Specialised assets N PV of MLP = TZS 450,000. Not specified. 88% 98%

Finance and operating leases: Differences (Lessee) Finance Lease Recognition of PPE and liabilities in the books PPE subject to depreciation and impairment test Operating Lease Recognition of rental expenses/revenue as incurred/earned Depreciation and Impairment -Not applicable 26

Let s take a look at Finance Lease in the books of Lessee 27

Finance Lease : Accounting by Lessee Para 28-33: Should be recognized as ASSETS and LIABILITIES (as if the assets being purchased) at amounts equal to the fair value of leased asset or if lower, at the PV of MLP [Para 28]. Cost of assets recorded in lessee s book: The lower of: Reason: the leased asset should not be recorded for more than its fair value. Fair value at inception date. OR PV of MLP at inception date. 28

Finance Lease : Accounting by Lessee The discount rate (to be used in calculating PV of MLP): implicit in the lease. IF impracticable to determine, use lessee s incremental borrowing rate. The standard requires the lessee to record the obligation arising from finance lease at then same amount as the leased asset ( para 28) Initial direct costs incurred should be reflected in the cost of the asset Dr. Leased asset xxx * Cr. Lease Liability Cr. Bank initial direct costs paid xxx xxx The lower of fair value or PV of MLP ; Initial direct costs should be added to Leased asset cost 29

MLP: Finance Lease : Accounting by Lessee Lease payment should be apportioned between the finance charge and the reduction of the outstanding liability (principal). Finance charge allocated to periods during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period [ Para 34]. Contingent rents: charged as expense as incurred. 30

Finance Lease : Accounting by Lessee Depreciation (Para 36): Depreciation policy should be consistent with that for depreciable assets which are owned by the lessee (in accordance with IPSAS 17, Property, Plant, and Equipment, and IPSAS 31, Intangible Assets Use economic useful life, if the lease: i. transferred rights at the end of lease term; OR ii. contains BPO. Lease term Otherwise, use: The lower of: OR Economic useful life 31

Finance Lease : Accounting by Lessee Illustration 3: ABC (lessor) and XYZ (lessee) sign a lease agreement dated 1 January 2012. The terms are as follows: Term of lease is 5 years, it is non-cancellable, requiring equal rental payments of TZS20,000 at the end of each year. 1. The Fair Value (FV) = TZS75,816 at the inception date, estimated useful life of 5 years, and no residual value. 2. The lease contains no renewal options, and the equipment reverts to ABC at the termination of the lease. 3. Discount rate agreed by both parties is 10%. 4. XYZ depreciates on a straight line basis, similar equipment that it owns. 5. XYZ paid TZS 5,000 in initial direct cost as legal fees to conclude the lease. 32

Solution to Illustration 3: Finance Lease : Accounting by Lessee Type of lease: Finance lease MLP = 20,000 x 5 years = TZS100,000 Year Nominal Discount PV 1 20,000 0.90909 18,182 2 20,000 0.82645 16,529 3 20,000 0.75131 15,026 PV of MLP = 20,000 x PVOA(5, 10%) = 20,000 x 3.7908 = 75,816 FV = 75,816. Journal entry on 1 Jan 2012 4 20,000 0.68301 13,660 5 20,000 0.62092 12,418 75,816 Dr. Leased asset (75,816+5,000) 80,816 Cr. Lease Liability 75,816 Bank/cash 5,000 (to recognise the asset leased) 33

Finance Lease : Accounting by Lessee Lease amortization schedule: Effective interest method Date Annual lease payment (A) Interest (10%) (B) Principal payment (C) Lease liability (D) 1 Jan 12 - - - 75,816 31 Dec 12 20,000 7,582 12,418 63,398 31 Dec 13 20,000 6,340 13,660 49,738 31 Dec 14 20,000 4,974 15,026 34,712 31 Dec 15 20,000 3,471 16,529 18,183 31 Dec 16 20,000 1,818 18,182 0 (D) X 10% (A) - (B) Preceeding - (C) 3 4

Journal entries: Finance Lease : Accounting by Lessee Date Particulars Debit Credit 31/12/12 Dr. Lease liability Interest expense Cr. Cash 12,418 7,582 20,000 Dr. Depreciation expense (80816/5) Cr. Accumulated depreciation 31/12/13 Dr. Lease liability Interest expense Cr. Cash Dr. Depreciation expense Cr. Accumulated depreciation 16,163 13,660 6,340 16,163 16,163 20,000 16,163 3 5

Journal entries: Finance Lease : Accounting by Lessee Date Particulars Debit Credit 31/12/14 Dr. Lease liability Interest expense Cr. Cash 15,026 4,974 20,000 Dr. Depreciation expense Cr. Accumulated depreciation 31/12/15 Dr. Lease liability Interest expense Cr. Cash Dr. Depreciation expense Cr. Accumulated depreciation 16,163 16,529 3,471 16,163 16,163 20,000 16,163 3 6

Journal entries: Finance Lease : Accounting by Lessee Date Particulars Debit Credit 31/12/16 Dr. Lease liability Interest expense Cr. Cash 20,000 1,818 20,000 Dr. Depreciation expense Cr. Accumulated depreciation Dr. Accumulated depreciation Cr. Leased assets (to record the return of the assets) 16,162 75,816 16,162 75,816 37

Disclosures - para 40 For each class of asset, the net carrying amount.; A reconciliation between the total of future minimum lease payments, and their present value; Total of future minimum lease payments at the reporting date, and their present value, for each of the following periods: (i) Not later than one year; (ii) Later than one year and not later than five years; and (iii) Later than five years; Contingent rents recognized as an expense in the period; The total of future minimum sublease payments expected to be received; and A general description of the lessee s material leasing arrangements including: (i) The basis on which contingent rent payable is determined; (ii) The existence and terms of renewal or purchase options and escalation clauses; and (iii) Restrictions imposed by lease arrangements, such as those concerning return of surplus, return of capital contributions, dividends or similar distributions, additional debt, and further leasing. 38

Let s take a look at Operating Lease in the books of Lessee 39

Operating Lease: Accounting by Lessee Para 42 43: Lease payments - should be recognised as an expense in the income statement on a straight-line basis over the lease term. Lease payments should exclude costs for services such as insurance and maintenance. No records on the assets or liability related to the value of the assets (off balance sheet). 40

Operating Lease: Accounting by Lessee Illustration 4: ABC (lessor) leased an equipment costing TZS450,000 to XYZ. The economic useful life of the asset is 20 years. The lease is classified as operating lease with the lease term of 5 years starting from 1/1/2011. Payments are made in advance as follows: 1/1/11 TZS18,000 1/1/12 TZS16,000 1/1/13 TZS14,000 1/1/14 TZS12,000 1/1/15 TZS10,000 Asset is used evenly throughout the lease term. The accounting period of both parties ends on 31 December. 41

Solution to Illustration 4: Operating Lease : Accounting by Lessee Total payment for the lease period: = TZS18,000 +TZS16,000 + TZS14,000 + TZS12,000 + TZS10,000 = TZS70,000 Expenses recognized per year = TZS70,000/5 = TZS14,000 Journal entries? 42

Date Particulars Debit - TZS 1/1/11 31/12/11 Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent 18,000 14,000 Credit- TZS 18,000 14,000 1/1/12 31/12/12 Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent 16,000 14,000 16,000 14,000 1/1/13 31/12/13 Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent 14,000 14,000 14,000 14,000 1/1/14 31/12/14 Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent 12,000 14,000 12,000 14,000 4 3 1/1/15 31/12/15 Dr. Prepaid rent Cr. Cash Dr. Rent expense Cr. Prepaid rent 10,000 14,000 10,000 14,000

Disclosures Para 44 The total of future minimum lease payments under noncancelable operating leases for each of the following periods: (i) Not later than one year; (ii) Later than one year and not later than five years; and (iii) Later than five years; The total of future minimum sublease payments expected to be received; Lease and sublease payments recognized as an expense showing separately amounts for minimum lease payments, contingent rents, and sublease payments; and A general description of the lessee s significant leasing arrangements including: (i) The basis on which contingent rent payments are determined; (ii) The existence and terms of renewal or purchase options and escalation clauses; and (iii) Restrictions imposed by lease arrangements, such as those concerning return of surplus, return of capital contributions, dividends or similar distributions, additional debt, and further leasing. 44

Let s take a look at Finance Lease in the books of Lessor 45

Para 48 53: Finance Lease : Accounting by Lessor The receivable to be presented in the Statement of Financial Position at an amount equal to the net investment in the lease [Para 48], which is defined as the gross investment in the lease less unearned finance income Initial direct cost include in the initial measurement of finance lease receivable and reduce the amount of income recognised over the lease term [para 50]. Finance revenue be based on a pattern reflecting a constant periodic rate of return on the lessor's net investment in the finance lease.{para 51} Manufacturers or Traders para 54-57 Revenue be based on normal policy of revenue recognition i.e. outright sale and finance revenue. If rate being use is too low then use market rate. Initial direct costs be expensed. 46

Finance Lease : Accounting by Lessor Illustration 4: Refer to Illustration 3: Gross investment = 20,000 x 5 years = TZS100,000 Net investment = PV of gross investment = 20,000 x PVOA(5, 10%) = 20,000 x 3.7908 = 75,816 Year Nominal Discount PV 1 20,000 0.90909 18,182 2 20,000 0.82645 16,529 3 20,000 0.75131 15,026 4 20,000 0.68301 13,660 5 20,000 0.62092 12,418 75,816 Unearned finance income = 100,000 75,816 = TZS24,184 Amortization schedule? Same as in Illustration 3 Journal entries? see next slides for first 2 years only 47

Journal entries: Finance Lease : Accounting by Lessor Date Particulars Debit Credit 01/01/12 Dr. Lease receivable Cr. Fixed assets Unearned interest revenue 31/12/12 Dr. Cash Cr. Lease receivable 100,000 20,000 75,816 24,184 20,000 Dr. Unearned interest revenue Cr. Interest revenue 31/12/13 Dr. Cash Cr. Lease receivable 7,582 20,000 7,582 20,000 48 Dr. Unearned interest revenue Cr. Interest revenue 6,340 6,340

Disclosures para 60-61 A reconciliation between the total gross investment, and the present value of minimum lease payments receivable. Gross investment in the lease and the present value of minimum lease payments receivable at the reporting date, for each of the following periods: (i) Not later than one year; (ii) Later than one year and not later than five years; and (iii) Later than five years; Unearned finance revenue; The unguaranteed residual values accruing to the benefit of the lessor; The accumulated allowance for uncollectible minimum lease payments receivable; Contingent rents recognized in the statement of financial performance; and A general description of the lessor s material leasing arrangements. Gross investment less unearned revenue in new business added during 49 the period, after deducting the relevant amounts for canceled leases.

Let s take a look at Operating Lease in the books of Lessor 50

Operating Lease: Accounting by Lessor Para 63 68: Title is not transferred, therefore lessor should present assets in their Statement of Financial Position according to the nature of the assets. Carry out normal impairment testing. Payments received from lessee are recorded as Rent Revenue on a straight-line basis over the lease term. Costs including depreciation incurred in earning the lease income are recognised as an expense. Initial direct costs incurred by lessor shall be added to the carrying amount of the leased asset and recognised as an expense over the lease term. A manufacturer or trader lessor should not recognize any gain on sale on 51 entering into an operating lease because it is not the equivalent of a sale.

Refer to Illustration 4: Operating Lease: Accounting by Lessor Total payment for the lease period: = TZS18,000 +TZS16,000 + TZS14,000 + TZS12,000 + TZS10,000 = TZS70,000 Expenses recognized per year = TZS70,000/5 = TZS14,000 Depreciation expense recognized per year = TZS450,000/20 = TZS22,500 Journal entries? 52

Operating Lease : Accounting by Lessor 5 3 Date Particulars Debit-TZS Credit-TZS 1/1/11 Dr. Cash 18,000 Cr. Unearned rent revenue 18,000 31/12/11 Dr. Unearned rent revenue 14,000 Cr. Rent revenue 14,000 Dr. Depreciation expense 22,500 Cr. Accumulated depreciation 22,500 1/1/12 Dr. Cash 16,000 Cr. Unearned rent revenue 16,000 31/12/12 Dr. Unearned rent revenue 14,000 Cr. Rent revenue 14,000 Dr. Depreciation expense 22,500 Cr. Accumulated depreciation 22,500

Disclosures Para 69 The future minimum lease payments under noncancelable operating leases in the aggregate and for each of the following periods: (i) Not later than one year; (ii) Later than one year and not later than five years; and (iii) Later than five years; Total contingent rents recognized; and A general description of the lessor s leasing arrangements. 54

Let s take a look at Bargain Purchase Option (GPO) and Gross Residual Value (GRV) in the books of Lessee and Lessor

When Bargain Purchase Option exists MLP will be increased by the exercise price Useful life will be used as basis for depreciation charge. Illustration 5: On 1/1/2011, ABC entered into lease agreement with terms: a) non-cancellable lease term of four years, b) Lease rental of TZS10,000 per year to be paid on 31 Dec, commencing 31/12/2011. c) ABC has an option to buy the equipment at the end of lease term for TZS1,000. On 1/1/2011, it was estimated that the fair value of the equipment would be TZS5,000 after 4 years usage. The FV of the equipment on 1/1/2011 was TZS42,000 and have estimated useful life of 5 years. The implicit rate was 5%.

When Bargain Purchase Option exists (cont.) Solution - Lessee: MLP = (10,000 x 4) + 1,000 = 41,000 PV of MLP = (10,000 x PVA n=4,i=5% ) + (1,000 x PV n=4,i=5% ) = 36,282 1/1/11 : Dr. Leased Equipment 36,282 Cr. Lease Payable 36,282 Depreciation exp = 36,282 / 5 = TZS 7,256.40 31/12/14 - exercise of BPO: Dr. Lease Payable 1,000 Cr. Cash 1,000

When Bargain Purchase Option exists (cont.) Solution - Lessor: Gross Investment = (10,000 x 4) + 1,000 = 41,000 PV of MLP = (10,000 x PV OA n=4,i=5% ) + (1,000 x PV n=4,i=5% ) = 36,282 1/1/11 : Dr. Leased Receivable 41,000 Cr. Equipment 36,282 Unearned interest revenue 4,718 31/12/14 - exercise of BPO: Dr. Cash 1,000 Cr. Leased Receivable 1,000

When Guaranteed Residual Value (GRV) exists o MLP will be increased by GRV o GRV will be deducted from the depreciable amount of leased asset. o At the end of lease term, the lease liability will have a balance equal with GRV If FV of leased asset < GRV, recognise loss (in lessee books)

When Guaranteed Residual Value (GRV) exists (cont.) Illustration 6: On 1/1/2011, ABC entered into lease agreement with terms: a) non-cancellable lease term of four years, b) Lease rental of TZS 10,000 per year to be paid on 31 Dec, commencing 31/12/2011. c) ABC guaranteed to lessor that the leased asset would have a residual value of TZS 5,000 at the end of lease term. The FV of the equipment on 1/1/2011 was TZS 42,000 and have estimated useful life of 5 years. The implicit rate was 5%. The estimated residual value at the end of lease term was TZS 7,000.

When Guaranteed Residual Value (GRV) exists (cont.) Solution Lessee: MLP = (10,000 x 4) + 5,000 = 45,000 PV of MLP = (10,000 x PV OA n=4,i=5% ) + (5,000 x PV n=4,i=5% ) = 39,572 1/1/11 : Dr. Leased Equipment 39,572 Cr. Lease Payable 39,572 Depreciation expense = (39,572-5,000) / 4 = TZS 8,643 31/12/14, if FV of leased asset is TZS 3,000 at the end of lease, Dr. Lease Payable 5,000 Accumulated depreciation 34,572 Cr. Leased Equipment 39,572 Dr. Loss on finance lease 2,000 Cr. Cash 2,000

When Guaranteed Residual Value (GRV) exists (cont.) Solution Lessor: GI = (10,000 x 4) + 7,000 = 47,000 PV of GI = (10,000 x PVOA n=4,i=5% ) + (7,000 x PV n=4,i=5% ) = 41,218 1/1/11 : Dr. Leased Receivable 47,000 Cr. Equipment 41,218 Unearned interest revenue 5,782 31/12/14, if FV of leased asset is TZS 3,000 at the end of the lease, Dr. Equipment 3,000 Cash 2,000 Compensation from lessee Loss on finance lease 2,000 Cr. Leased Receivable 7,000

Let s take a look at Sales and Leaseback in the books of Lessee and Lessor

Sales and Leaseback Transaction in which the owner of the asset (seller, lessee) sells the asset to another and simultaneously leases it back from the new owner.? In the book of Buyer/lessor: - Same as lessor as discussed before. In the book of seller/lessee: - To recognize gain from sales of asset: immediate or defer. Any excess of sales proceeds over the carrying amount shall not be immediately 64 recognized as revenue by a seller-lessee but deferred and amortized over the lease term.

Sales and Leaseback Para 71: for Finance lease (Seller/Lessee) Excess = Sales proceed Carrying amount Should not be recognized immediately, instead, should be deferred and amortized over the lease term. 65

Sales and Leaseback Para 73: for Operating lease.(seller/lessee) (a) If Selling price = FV Excess = Sales proceed Carrying amount Should be recognized immediately. 66

Sales and Leaseback Para 61: for Operating lease (b) If Selling price < FV Exccess = Sales proceed Carrying amount Should be recognized immediately EXCEPT THAT if the loss is compensated by future lease payments at below market price, it should be deferred and amortized. 67

Sales and Leaseback Para 73: for Operating lease (c) If Selling price > FV (FV > carrying amount) Excess = Sales proceed Carrying amount Excess = Sales proceed FV Excess = FV - Carrying amount deferred and amortized. recognized immediately. 68

Sales and Leaseback Illustration 7: YNO sold an equipment to WYZ and leased back the asset. The carrying amount (book value) of the asset is TZS 60,000. The asset has a fair value of TZS 70,000. How to recognize profit/loss if the selling price: 1. TZS 70,000 2. TZS 55,000 3. TZS 50,000 (with lower lease payment) 4. TZS 90,000 69

Sales and Leaseback Solution to Illustration 7: 1. SP = FV (SP > CA) = Profit = 70,000-60,000 = 10,000 Key: SP Selling Price FV Fair value CA Carrying Amount recognize immediately 2. SP < FV (SP < CA) Loss = 55,000 60,000 = 5,000 loss recognize immediately 3. SP < FV (SP < CA with lower lease payment) Loss = 50,000 60,000 = 10,000 loss defer & amortize 70

Sales and Leaseback Solution to Illustration 7: 4. SP > FV = Profit = 90,000 60,000 = 30,000 FV CA = 70,000 60,000 = 10,000 recognize immediately SP FV = 90,000 70,000 = 20,000 defer & amortize 71