Accounting for Finance Leases by Manufacturer or Dealer Lessors

Running head: CORPORATE ACCOUNTING
Corporate accounting
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1CORPORATE ACCOUNTING
Part A
Accounting for finance leases by manufacturer or dealer lessors
Lease is the legal agreement through which owner of particular asset allows 2 nd
party to use the particular asset for specific period of time in return of the periodic
payment that is to be made to the lessor. Periodic payment made to the lessor is termed
as the lease rental. Finance lease is similar to purchase of asset through the external
finance. It enables the lessee to have ownership on the asset with the assistance of
direct finance from lessor. However, the lessee has option to become permanent owner
of the asset at the closing of the lease term. The lease is regarded as finance lease
where the lessee is entitled for all rewards and risks associated with ownership
(Aasb.gov.au 2019). Further, the lease is regarded as finance lease if it meets any of
the 4 categories including – (i) lessee becomes owner of leased asset while the lease
term is completed (ii) lease enables the lessee in purchasing the leased asset at the
price lower as compared to the fair value of asset in the future period (iii) lease term is
approximately 75% or more than the useful life of the leased asset and (iv) present
value of leased payment is 90% or more than that of asset’s fair market value. However,
in addition to those AASB 16 states that whether lease is the operating lease or the
same is finance lease is solely dependent upon the substance of contract and not on
the form of contract (Aasb.gov.au 2019). Generally the circumstances where the lessor
considers a lease as the finance lease are – (i) ownership for the subjected asset is
transmitted to the lessee at the closing of the lease period (ii) lease period is for the
majority part of economic life of subjected asset even where the title does not get
transferred (iii) at commencement of the lease present value of lease payment is

2CORPORATE ACCOUNTING
considerably equal to fair value of the subjected asset (iv) subjected asset is of special
nature and can only be used by the lessee without major modification (Bohušová 2015).
Further, the indications of circumstances that in combination or individually may result
into classification of lease as finance lease are – (i) if lessee has the option to cancel
the lease and the resultant loss to the lessor in connection with the cancellation of lease
will be borne by lessee (ii) losses or gains arising from variation in fair value of residual
accrue to the lessee, for instance, in form of rent rebate that is equal to the maximum
amount of sales proceed when the lease term is over (iii) lessee is able to carry on the
lease for secondary period at the rent that is considerably lower as compared to the
market rent (Svoboda and Bohušová 2014)
However, the above mentioned indicators are not conclusive at all the times. If it
is clarified from the associated features that lease will not transfer substantial rewards
and risks linked with the ownership of subjected asset, lease will not be classified as the
finance lease rather it will be considered as operating lease. For instance, the same
scenario may arise if ownership of subjected asset is transferred at the closing of the
lease for inconsistent payment that is equal to the asset’s present fair value. However, if
there is variable lease payment owing to which the lesser does not considerably
transfers the risks as well as the rewards to the lessee. Classification of lease is made
while the lease is entered into and is assessed again only in the circumstance while the
lease is modified. Further, are any changes in the estimates including changes in the
projections of residual value or economic life of the subjected asset, or there is any
changes in the circumstances including default by lessee do not result into new
classification of lease for the purpose of accounting (Gross, Huston and Huston 2014)

3CORPORATE ACCOUNTING
At the date of commencement, lessor must report the assets held as per the
finance lease in the balance sheet and shall present the same as receivable with the
amount that is equal to amount of net investment for the lease. Lessor is required to use
the implicit interest rate for lease in measuring the value of net investment in lease.
Direct costs attributable at the initial period except the costs which are incurred by the
dealer or the manufacturer lessor are considered in initial measurement for net
investment of lease and the same reduces the amount of income earned over the term
of lease. However, for sublease, if the implicit interest rate for sublease cannot be
determined readily, intermediate lessor may apply rate of discount that is applied for the
head lease. However, the same amount is adjusted for initial direct cost related to
sublease for measuring net investment made for sublease. Implicit rate of interest in
lease is described in such manner that the direct costs recognised initially are taken into
consideration under net investment of lease automatically and it is not required to add
them distinctively.
In case of dealer or manufacturer lessors at the inception date of lease, the
dealer or manufacturer lessor is required to recognise some facts in context of finance
lease. These facts are – (i) revenue that is the fair value of subjected asset or present
value of lease payment that is accruing to lessor, whichever is lower and is discounted
through using market rate of interest (ii) loss or profit generated from sales where the
loss or profit is the difference among the cost associated with sale and the revenue
generated from sales as per the outright policy of sales applicable under AASB 15. The
dealer or manufacturer lessor is required to report the loss or profit generated from
sales on the finance lease at the date of inception irrespective of the fact whether lessor