Accounting of Financial Lease - Corporate Accounting and Reporting

CORPORATE ACCOUNTING AND REPORTING
Introduction
The Australian Accounting Standard Board recognises concept of leasing u/s AASB 117 in
alignment with Section 334 of the Corporation Acts, 2001.
Under the said standard, lease has been defined as an agreement under which a lessor allows
a lessee to use the asset for a fixed period of time in return of a series of payment.
Further, financial lease has been defined as a lease under which the lessor substantially
transfers all its risk and reward associated with the ownership to Lessee. Further, the same
may or may not be eventually transferred.
Operating lease has been defined as a lease which is other than financial lease.
It is also important to note that under the financial lease, the lessor recognises the sale of asset
and lessee depreciates the same in its books recognising it as purchase. (Australian
Accounting Standard Board, 2015)
Accounting of Financial Lease
Key Terms
(a) Inception of the lease: It is the date at which the lease agreement has been signed or
commitment has been made by the parties to the principal provisions of the lease;
(b) Lease Period: It is a non-cancellable period for which the asset has been leased to lessee
by lessor;
(c) Minimum Lease Payments: It is the payment that is required to be made by the lessor
over the term of lease and shall include guaranteed residual value;
(d) Unguaranteed residual Value: Payment that shall be derived by lessor at the end of
lease tenure which is not guaranteed by lessee or any third party;
(e) Guaranteed Residual Value: Payment that shall be derived by the lessor at the end of
lease tenure which is guaranteed by lessee or any third party;
(f) Gross Investment Value : Net investment value plus finance charge;
(g) Net Investment Value: The value derived by discounting gross investment at a specified
rate of interest.
Sources of Income
For a lessor entering into financial lease, there is generally two source of receipt of income:
(a) Sale value of asset at the inception of lease;
(b) Finance charge realised on net investment over the life of lease.

Initial Recognition
In terms of the Australian Accounting standard board 117, at the initiation of lease term the
lessor shall carry on the following accounting in his books:
(a) Treat the leasing of asset as sales made during the reporting period;
(b) The value of such sale shall be gross value of investment discounted at a discount rate;
(c) The rate of discount shall be the interest rate implicit in the contract;
(d) The profit or loss from such asset disposition shall be recognised in Profit and Loss
Account at the end of reporting period;
(e) Any direct cost associated with leasing of such asset shall not increase the value of net
amount receivable as it happens in case of people other than manufacturer or dealer;
(f) The amount to received shall be recorded as lease receivable on the asset side of the
balance sheet at net investment value;
The journal entries in the book of lessee and lessor have been discussed here-in-below:
Date Particulars LF Amount Amount
In the books of Lessor
Lease Receivable A/c...Dr
To Sales A/c
In the books of Lessee
Leased Asset A/c...Dr
To Lease Liability A/c
(Accounting explained.com, 2013)
SubsequentMeasurement
Post initial recognition of asset the following accounting treatment shall be meted out in the
books of lessor who is a dealer or manufacturer:
(a) Treatment of such sales made by the lessor in Profit and Loss Account;
(b) Reduction of Lease receivable income on receipt of lease payment;
(c) Bifurcation of receipt of such lease income under the head principal investment value
and finance charge;
(d) Treating finance charge under profit and loss account as profit at the end of the
reporting period;
(e) Direct cost which are part of the contract and has been incurred to crystallize the sale
shall be recognised as expense in Profit and Loss Account;
(f) If the rate of interest under the contract is substantially low than the profit under the
sales made shall be allocated to profit and Loss proportionately.
The journal entries for recording the said transactions in books of account have been provided
here-in-below: (AccountingExplained.com, 2013)