Leases Accounting For Lessee Notes

Leases accounting by Lessee

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Definition

Non-Current Liabilities are those obligations of the entity that do not have to be paid within 12 months of a balance sheet date.

A leasing agreement is an agreement whereby one party, the lessee, pays lease rentals to another party, the lessor in order to gain the use of an asset over a period of time.

In other words

A legal document outlining the terms under which one party agrees to rent property from another party.

A lease guarantees the lessee use of an asset and guarantees the lessor regular payments from the lessee for a specified period.

Why is it important?

leasing offers a number of important advantages:

• Leasing increases purchasing power

• Leasing balances usage and cost

• Leasing provides fixed rate financing

• Leasing is convenient

• Leasing is tax-advantaged

• Leasing provides flexible payments

Lecture Notes

There are two types of lease:

1. finance lease

2. operating lease.

A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee.

A finance lease (as its name suggests) is basically a way of financing the use of an asset (by spreading the payment over the life of the asset instead of paying the full amount all at once).

An operating lease is any lease other than a finance lease

An operating lease is similar to a rental agreement. The entity normally rents the asset for only part of its useful life.

Classification of leases

To decide whether a lease is finance or operating, assess whether the risks and rewards of ownership have transferred to the lessee.

SSAP 21 Accounting for leases and hire purchase contracts states that the transfer of risks and rewards of ownership is assumed to have taken place if the present value of the minimum lease payments is 90% or more of the fair value of the leased asset.

• The present value is calculated by using the interest rate implicit in the lease.

• The ‘90% test’ is not always conclusive. SSAP 21 states that even if a lease fails the ‘90% test’, it should be classified as a finance lease if it can be demonstrated that the lease in fact does transfer the risks and rewards of ownership to the lessee.

Accounting by lessees

Finance leases

The accounting treatment to report the substance of the transaction: the lessee controls an asset and has a liability for the outstanding rentals.

1. At the beginning of the lease term, the lessee recognises the leased asset and the obligation to make lease payments as an asset and a liability in the balance sheet.

2. The asset and the liability are measured at the present value of the minimum lease payments (discounted at the interest rate implicit in the...

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