This article explains the accounting treatment for finance lease by lessees, including the recognition of lease liability and right of using the asset, categorization of lease as finance or operating lease, reporting of finance lease in financial statements, and disclosure requirements for lessees.
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Running head: CORPORATE ACCOUNTING AND REPORTING Corporate accounting and reporting Name of the student Name of the university Student ID Author note
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1CORPORATE ACCOUNTING AND REPORTING Accounting for finance lease by lessees At the inception of any contract the company must analyse whether the contract is a lease contract or the contract includes the lease. It is considered that the contract is a lease contract or the contract includes the lease if it is clear from the contract that right of control for using the asset is in exchange for any consideration. Under lease contract the lessee is the person who takes out lease on the capital asset. At the date of commencement the lessee must recognize the lease liability and right of using the asset (Barone, Birt and Moya 2014). Any lease is categorized as finance lease or as operating lease. A lease is determined as the finance lease when the lease shifts entire rewards and risks linked with the asset. Whether the lease will be operating lease or it will be finance lease that depends on substance of transaction and not on the contract form (Morais 2013). The situations where the lease contract is determined as the finance lease are – (i) entire rewards and risks and ownership for the asset is transferred to lessee at the closing of the lease term (ii) term of lease is for the major portion of the assets economic life even if the asset’s title is not reassigned (iii) lessee has choice to purchase the asset at considerably lower value as on the date when the choice can be exercised (iv) the asset under consideration has special characteristic that can only be used by the lessee without any major alteration (v) at the date of inception, present value of lease payment is matches with total fair values of the asset (Schelle and Baltussen 2013). Further, the situation where the lease individually or in combination with other the indications can be segregated as the financial asset are – (i) in case of cancellation of lease the loss of the lessor will be owing to cancellation will be paid by the lessee (ii) losses or gains, if any from fluctuation of the fair value will be accumulated to
2CORPORATE ACCOUNTING AND REPORTING lessee (iii) lessee is able to carry on the term of lease for additional period for payment of rent that is considerably low as against the market value. The lessee reports the finance lease in various financial statements as follows – (i) Income statement – under the income statement the interest expenses on lease payment is recognized as expense. It is computed on the lease payment at the opening period through the applicable rate of interest in lease. Normally, rate of interest used is lower among the borrowing rate for lease and implicit rate for the lessor. However, if the leased asset can be depreciated, the depreciation expense is recognized with the asset (ii) balance sheet – lease amount payable and leased asset both are reported as liability. The recorded amount is lower between the fair value of leased asset and PV of leased payments (iii) cash flow statement – interest on lease payment shall be recognised as cash outflow from operation and the principle amount that is used for reducing the payable amount of lease is recognized ascashoutflowfromfinancingactivities(SvobodaandBohušová2014).Any modification to the finance lease is accounted as separate lease if – (i) modification enhances the lease scope through adding the usage rights for the asset or assets and (ii) lease consideration enhances by the commensurate amount with stand alone price of the increase in the scope for reflecting the specific contract’s circumstances. The main objective of disclosure requirement for the lessee is assessing the impact of lease on the financial performance as well as the financial position and cash flow statement of lessee. The lessee is required to disclose the information regarding lease for which the lessee shall disclose it through the single note or the separate section in the financial statement. However, the lessee shall not duplicate the information as the information is incorporated through cross reference in single note or the distinct section for lease (Krische, Sanders and Smith 2013). The amount
3CORPORATE ACCOUNTING AND REPORTING required to be disclosed by the lessee shall are – (i) interest charges on the lease liability (ii) depreciation on right of using the asset (iii) losses or gains generated from leaseback and sales transactions (iv) income arising from subleasing the right for using the asset (v) expenses related to variable lease amount that is not included in measuring the lease liabilities (v) entire cash outflow for the leases (vi) expenses associated with the short-term lease (vii) carrying amount of right for using the asset attheclosingofreportingperiod(Song2016).Further,allthesementioned disclosure shall be presented in tabular format unless any other format is seemed to be more appropriate. The disclosure amount must include the carrying amount of other asset under the period of reporting. Lessee shall further disclose the maturity analysis for the lease liability and the disclosures for financial instruments shall be made separately (Rapoport 2013). Apart from that, the lessee shall disclose – (i) nature of the leasing activities (ii) expected future cash outflow that includes the variable payments for lease, lessee’s committed leases those are not started yet, residual value of the guarantee and termination and extension options (iii) covenants or restrictions, if any imposed by the leases and (iv) leaseback as well as sales transactions. The lessee who accounts for leases of the low value assets or short term leases shall disclose the fact thereof (Wong and Joshi 2015).
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4CORPORATE ACCOUNTING AND REPORTING Reference Barone, E., Birt, J. and Moya, S., 2014. Lease accounting: A review of recent literature.Accounting in Europe,11(1), pp.35-54. Krische, S.D., Sanders, P.R. and Smith, S.D., 2013. Management credibility and investmentrisk:Anexperimentalinvestigationofleaseaccounting alternatives.Behavioral Research in Accounting,26(1), pp.109-130. Morais, A.I., 2013. Why companies choose to lease instead of buy? Insights from academic literature.Academia Revista Latinoamericana de Administración,26(3), pp.432-446. Rapoport,M.,2013.Leaseaccountingmayshift—Companiesmighthaveto increase amount of debt they report under change.Wall Street Journal, (May 17), p.C2. Schelle, T.G.F. and Baltussen, S., 2013. IFRS lease accounting impact on Corporate Real Estate Management.Eindhoven: masterthesis aan de faculteit Bouwkunde van de Technische Universiteit Eindhoven. Song,X.,2016.Changesinleasefinancingpracticeduringleaseaccounting standard overhaul (2005-2014).American Journal of Finance and Accounting,4(3- 4), pp.309-326. Svoboda, P. and Bohušová, H., 2014, June. The Uncertainty Associated with the EstimatedLeaseTermanditsImpactontheFinancialAnalysisRatios. InProceedings of the 11th International Scientific Conference on European financial systems(pp. 621-628).
5CORPORATE ACCOUNTING AND REPORTING Wong, K. and Joshi, M., 2015. The impact of lease capitalisationon financial statementsandkeyratios:EvidencefromAustralia.AustralasianAccounting, Business and Finance Journal,9(3), pp.27-44.