Corporate Accounting

This essay discusses the accounting for finance lease by lessees, including the disclosures and journal entries involved. It also explores the impact of lease categorization on financial statements and stability measures. Find study material on corporate accounting at Desklib.

Running head: CORPORATE ACCOUNTING
Corporate Accounting
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1CORPORATE ACCOUNTING
Table of Contents
Part A:................................................................................................................................2
Introduction:...................................................................................................................2
Discussion:.....................................................................................................................2
Conclusion:.....................................................................................................................8
Part B:................................................................................................................................9
References:......................................................................................................................11

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Part A:
Introduction:
Lease accounting is deemed to be a significant accounting section owing to the
difference relying on the end-users. The lessees and the lessors disclose and account
for leases in different manner. A lessor is the individual or organisation that owns the
asset and a lessee is involved in using the leased asset through periodic payment to the
lessor (Barone, Birt and Moya 2014). A lease could be defined as the lease agreement
by which the owner of any particular asset allows another party to utilise the asset for a
particular period in lieu of periodic payments to the lessor. A finance lease is deemed to
be identical in buying any asset via external finance. This enables a lessee to own asset
by direct finance from the lessor (Beckman 2016). The lessee has the alternative of
becoming the permanent owner of the asset at the closure of the lease term. The
current essay would aim to analyse accounting for finance lease by lessees.
Discussion:
The finance lease disclosures have to be reported in the accounting books of the
lessor as well as the lessee. In case of the lessees, they have to comply with the
guidelines mentioned in “AASB 7 Financial Instruments”, after which disclosures need
to be made associated with finance leases. In Australia, AASB 117 was used previously
for lease recognition, in which it has been mentioned that the lessees have to report the
net carrying values of each asset group at the closure of the reporting period
(Aasb.gov.au 2019). At present, AASB 16 has been introduced for lease recognition, in

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which no significant changes have been observed in recognition of finance lease
(Aasb.gov.au 2019).
There has to be reconciliation between the total minimum lease payments in
future at the end of the period as well as the present values. After the formation of
reconciliation, it is necessary for any business organisation to undertake relevant
disclosures for three varying timelines. The timelines mainly comprise of less than a
year, between one year and five years and more than five years. During the period of
lease, there needs to be recognition of contingent rents as expense in the same period
(Bragg 2017). It is necessary for the lessees to realise the minimum payments of
sublease estimated to be received under non-cancellable leases at the closure of the
reporting period.
The organisations have to disclose general explanation of the agreements of the
lessees associated with material lease, which need to include various disclosures.
Another disclosure is the development of basis in order to determine the contingent rent
payable. Contingent rent could take the shape of sales, usage amount, rate of interest
in the market or price indices. There is other disclosure related to the existence and
terms of escalation or renewal options as well as purchase options (DiSalvio and Dorata
2014). The last disclosure is related to restrictions of lease agreements like additional
debt, dividends and additional leasing.
In case; the lessee is entitled to all rewards and risks associated with ownership,
the lease is classified in the form of finance lease. It is essential for the lessee to
disclose the leased asset and leased liability on the balance sheet statement. When a
lease does not fulfil any of the above-stated criteria, it would be classified in the form of

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operating lease. The lessee reports the finance lease on the different financial
statements. In the balance sheet statement, the lessee has to report both leased asset
and lease payable (liability). The value to be disclosed has to be the minimum of
present value of future lease payments or the fair market value of the leased assets. In
the income statement, the organisation has to disclose the interest expense on lease
payable (Gordon, Raedy and Sannella 2016). Normally, the interest rate used is the
minimum of the borrowing rate of a lessee and the lessor’s implicit rate. In case; it is
possible to charge depreciation on the leased asset, there is reporting of depreciation
expense to be made coupled with any other asset (Kanodia and Sapra 2016). In the
cash flow statement, the organisations have the option of reporting interest expense as
either operating or financing cash outflow.
Owing to the capitalisation of finance lease, there has been increase in assets as
well as liabilities in the balance sheet statement. As a result, there has been decline in
working capital; however, there would be rise in debt to equity ratio resulting in
additional leverage. Finance lease expenses are assigned between principal amount
and interest expense such as a loan or bond. Hence, in the cash flow statement, there
is recording of lease payments under cash flows from operating activities; however, they
are recognised under cash flows from financing activities (Kieso, Weygandt and
Warfield 2016).
In case; there is substantial transfer of risk and reward of ownership to the
lessee, it is termed as finance lease. If this is not finance lease, they would fall under
operating lease (Paik et al. 2015). The transfer of risk to the lessee might be
represented by lease terms like option for the lessee to purchase the asset at lower

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price, which is mainly the residual amount, at the closure of the lease term. The asset’s
nature regardless of whether it would be used by anyone besides the lessee, the lease
term period whether it includes majority of the economic life of the asset and the present
value related to lease payments of whether they cover the asset cost might be
considered as influential dynamics.
After the end of the accounting period, the current and non-current liabilities of an
organisation are associated with lease obligations. The obligations related to finance
lease would constitute of capital balance along with accrued interest to be incurred at
the closure of the reporting period. The current liability would take into consideration the
principal amount to be incurred within the year coupled with the outstanding interest
payment (Paterson 2016). On the contrary, the non-current liability would the principal
amount remaining to be incurred after a certain period. Since the lessor is involved in
transferring risk and reward of ownership of asset to the lessee, it is not possible to
disclose the asset with property, plant and equipment. As a result, the outstanding
amount could be recorded within finance lease as receivable. This would recorded as
the principal amount within net investment in lease and it would be classified as the fair
value of the asset (Pratt 2016).
After the completion of the term of lease, the lessee could return the asset either
to the lessor or the lessee would buy the asset. The situations could be demonstrated
better by passing journal entries. In case; the lessor has obtained the asset after the
end of the lease term, debit would be made to finance lease liability and credit would be
made to the leased asset in order to realise the transfer of the leased asset back to the
lessor. If the lessee buys or decides to purchase the asset, debit would be made to the

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leased asset and credit would be made to the bank account in order to reclassify the
leased asset as purchased asset (Tracy 2016). However; in case, the lessee terminates
the lease within the agreed term, the lessee would be held accountable for any damage
or loss.
AASB does not provide stringent group of rules in order to categorise leases and
there would be borderline cases as well. It is sometimes possible to utilise leases for
making the balance sheet statement look better by taking into consideration the fact that
the lessee could justify the treatment in the form of operating leases. The categorisation
of big transactions like leasebacks and sale of property might have considerable impact
on the accounts as well as on financial stability measures like gearing (Teixeira 2014).
However, it is noteworthy to mention that enhancement in financial gearing might be
offset by the worsening of operational gearing and vice-versa.
For instance, it is assumed that ABC Limited is a rail firm that has leased diesel
generators from XYZ Limited so that backup could be provided to the system of
transportation at times of power outrage. The term of the lease is for five years where
ABC Limited needs to incur payment amounting $500,000 per annum to XYZ Limited.
The question here is to pass the journal of the lease inception and the initial payment
made by ABC Limited in the accounting books of ABC Limited and XYZ Limited; in
case, the minimum lease payments have present value of $1,996,355 and the implicit
interest rate of the lease is 8%.
The start of the lease to be recorded by the lessor could be made through
creation of lease receivable at its net lease investment, which is identical to the
minimum lease payments discounted at the implicit interest rate in the lease

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(Vernimmen et al. 2014). The journal entry to be passed at the inception of the lease
contract is stated as follows:
Lease Receivable Account..................................................Dr $1,996,355
To Asset Account $1,996,355
During the initial payment, the lessor needs to the record the cash receipts,
realisation of finance income and minimisation in lease receivable.
Cash Account..........................................................................Dr $500,000
To Lease Receivable Account ($500,000 - $40,000) $460,000
To Finance Income Account ($500,000 x 8%) $40,000
A finance lease leads to recognition of asset as well as liability in the accounting
books of the lessee at the lease inception at amount identical to the present value of the
minimum lease payments (Wong and Joshi 2015).
Leased Asset Account............................................................Dr $1,996,355
To Lease Liability Account $1,996,355
There is a chance that the leased asset as well as lease liability is recorded at
varying amounts in the books of the lessee and the lessor. During the initial yearly
payment, the lessee has to record the following journal entry:
Lease Liability Account............................................................Dr $1,996,355
Interest Expense Account ($500,000 x 8%)............................Dr $40,000
To Cash Account $500,000

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After the initial year, the lessee is required to pass one additional entry so that
depreciation expense could be realised on the leased asset. The leased asset is
depreciated like self-owned asset.
Conclusion:
Based on the above analysis, it is apparent that the finance lease disclosures
have to be reported in the accounting books of the lessor as well as the lessee. In case
of the lessees, they have to comply with the guidelines mentioned in “AASB 7
Financial Instruments”, after which disclosures need to be made associated with
finance leases. In Australia, AASB 117 was used previously for lease recognition, in
which it has been mentioned that the lessees have to report the net carrying values of
each asset group at the closure of the reporting period.
After the completion of the term of lease, the lessee could return the asset either
to the lessor or the lessee would buy the asset. The situations could be demonstrated
better by passing journal entries. In case; the lessor has obtained the asset after the
end of the lease term, debit would be made to finance lease liability and credit would be
made to the leased asset in order to realise the transfer of the leased asset back to the
lessor. If the lessee buys or decides to purchase the asset, debit would be made to the
leased asset and credit would be made to the bank account in order to reclassify the
leased asset as purchased asset.
AASB does not provide stringent group of rules in order to categorise leases and
there would be borderline cases as well. It is sometimes possible to utilise leases for
making the balance sheet statement look better by taking into consideration the fact that
the lessee could justify the treatment in the form of operating leases. The categorisation

9CORPORATE ACCOUNTING
of big transactions like leasebacks and sale of property might have considerable impact
on the accounts as well as on financial stability measures like gearing.
Part B:

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11CORPORATE ACCOUNTING
References:
Aasb.gov.au., 2019. [online] Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB117_08-15.pdf [Accessed 29
May 2019].
Aasb.gov.au., 2019. [online] Available at:
https://www.aasb.gov.au/admin/file/content105/c9/AASB16_02-16.pdf [Accessed 29
May 2019].
Barone, E., Birt, J. and Moya, S., 2014. Lease accounting: A review of recent
literature. Accounting in Europe, 11(1), pp.35-54.
Beckman, J.K., 2016. FASB and IASB diverging perspectives on the new lessee
accounting: Implications for international managerial decision-making. International
Journal of Managerial Finance, 12(2), pp.161-176.
Bragg, S.M., 2017. Fixed Asset Accounting. AccountingTools LLC.
DiSalvio, J. and Dorata, N.T., 2014. Lease accounting change: it's not over yet. Review
of Business, 35(1), p.16.
Gordon, E.A., Raedy, J.S. and Sannella, A.J., 2016. Intermediate accounting. Boston,
MA: Pearson.
Kanodia, C. and Sapra, H., 2016. A real effects perspective to accounting measurement
and disclosure: Implications and insights for future research. Journal of Accounting
Research, 54(2), pp.623-676.

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Kieso, D.E., Weygandt, J.J. and Warfield, T.D., 2016. Intermediate Accounting, Binder
Ready Version. John Wiley & Sons.
Paik, D.G.H., Van Der Laan Smith, J.A., Lee, B.B. and Yoon, S.W., 2015. The relation
between accounting information in debt covenants and operating leases. Accounting
Horizons, 29(4), pp.969-996.
Paterson, R., 2016. Off balance sheet finance. Springer.
Pratt, J., 2016. Financial accounting in an economic context. John Wiley & Sons.
Teixeira, A., 2014. The international accounting standards board and evidence-informed
standard-setting. Accounting in Europe, 11(1), pp.5-12.
Tracy, J.A., 2016. Accounting for dummies. John Wiley & Sons.
Vernimmen, P., Quiry, P., Dallocchio, M., Le Fur, Y. and Salvi, A., 2014. Corporate
finance: theory and practice. John Wiley & Sons.
Wong, K. and Joshi, M., 2015. The impact of lease capitalisation on financial statements
and key ratios: Evidence from Australia. Australasian Accounting, Business and
Finance Journal, 9(3), pp.27-44.