Accounting Treatment of Financial Lease for Dealers and Manufacturers

This article discusses the accounting treatment of financial lease for dealers and manufacturers under AASB 117. It covers the initial recognition, subsequent measurement, and disclosures required for financial leases. The article explains the difference between financial and operating leases, and key terms such as economic life, guaranteed residual value, unguaranteed residual value, gross investment, and net investment. The journal entries for lessor and lessee are also provided.

CORPORATE ACCOUNTING AND REPORTING
Introduction
In term of Australian Accounting Standard Board, the concept of leases has been
recognisedunder AASB 117 which is covered under Section 334 of the Corporation Acts,
2001.
In terms of the definition provided in the aforesaid standard lease means an agreement under
which a person who is letting his asset i.e. lessor shall allowthe other person who is taking
asset on hire i.e. lessee to utilise the asset for a given period of time in return of rent or a
series of payment known as lease liability or rent.
Generally there are two types of lease (a) Financial Lease and (b) Operating Lease. The term
financial lease means a lease under which the lessor substantially transfers all the risk and
reward which are incidental to ownership to lessee. In other words, lessee is treated as the
owner of the asset.
While operating lease means any lease other than financial lease.
Under Financial lease for a lessor (dealer or manufacturer) there are generally two sources of
income:
(a) Income from sale of asset;
(b) Income from interest or finance charge.
Further, it is important to understand some key terms before understanding the accounting
treatment in the books of lessor.
Economic life: It is the time period over which it is expected to be economically useable;
Guaranteed Residual value: It is the value which the lessor shall be entitled to receive at the
end of the lease tenure either from lessee or from third party by disposing the same;
Unguaranteed Residual Value: It is that portion of gross investment over which there is not
guaranteed of receipt from the lessee or by third party;(Australian Accounting Standard
Board, 2015)
Gross Investment: It is the summation of minimum lease payment that is attributable to lessor
and any unguaranteed residual value;
Net Investment: It is the value computed by discounting the gross investment at an
appropriate rate of return.
Accounting of Financial Lease for dealers and manufacturers
Initial Recognition
Lessor is a person who sublets the asset to a lessee for a series of fixed payment to receive
over the term of the lease.

Under the AASB 117, at the initiation of lease term the lessor shall recognise as if the asset
has been disposed by the lessor. Thus, he shall record a sale in his book and shall make a
corresponding asset in the book in the form of lease receivable which shall be equal to net
investment value made by the lessor under the contract. Thus, under initial recognition, the
asset under financial leases is treated as if the same has been sold by the lessor and the same
has been purchased by the lessee. Further, the asset leased under such an arrangement has
economic life equal to the tenure of lease.
In addition, the lessor shall be entitled to guarantee residual value which shall be received
from lessee or third party.
Further, for manufacturer and dealer initial direct cost associated with lease contract are not
included in the initial measurement of financial lease receivable and thereby by does not
reduce the same over the recognition period. These are directly expensed and a net impact is
shown in Profit and Loss A/c.
Further, the discount rate to be used by the lessor for purpose of accounting of minimum
lease payment shall be the rate of interest which shall encompass direct cost associated with
such contract.
The journal entries that shall be passed in the book of lessee and lessor have been shown
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
SubsequentMeasurement
Under Financial lease, post initial recognition of contract in the books of account, the
recognition of finance income shall be computed in such a manner that it shall reflect a
constant periodic rate of return over the net investment that has been made by the lessor
under the financial lease. Further, the payment received under the contract shall be reduced
against such finance income and the principal component, thereby resulting in decrease
finance income on year on year basis.(Maxxia, 2017)
Further, unguaranteed residual value which has been used for the purpose of computation of
gross investment shall be reviewed regularly.
Gross Investment= Net Investment + Finance Income.

Further, manufacturer and dealer shall recognise the profit or loss on such at the end of the
relevant reporting period. If the rate of interest charged by lessor is significantly low, then
profit to be booked shall be apportioned accordingly assuming that profit includes the balance
interest component.
Further, the initial selling expense that has been associated for making the present sale shall
be recognised in Profit and Loss A/c as an expense since the same has been incurred to make
profits. The journal entries for recognising the same in books of accounts have been provided
here-in-below:
Date Particulars LF Amount Amount
In the books of Lessor
Bank A/c…Dr
To Lease Receivable A/c
To Finance Charge A/c
Finance Charge A/c…Dr
To Profit and Loss A/c
Profit and Loss A/c..
To Direct costs A/c.
Sales A/c…
To Profit and Loss A/c.
( Assuming high rates)
In the books of Lessee
Lease Liability A/c…Dr
Interest expense A/c..Dr
To Bank A/c
Profit and Loss A/c..Dr
To Interest expense A/c
Disclosures
Further, the lessor shall be required to make the following disclosures in addition to
disclosures made under AASB 7. The following disclosures shall be made:
(a) Finance income which is unearned;
(b) Any unguaranteed residual value that shall be accrued to the lessor;
(c) The minimum lease payment receivable which has been uncollected and
correspondingly allowance made for the same.
(d) The rent of contingent nature recognised in Profit and loss A/c during the year;
(e) A general description of material arrangements of the lessor;
(f) A reconciliation statement of the gross investment of the lease at the end of the year
and the value of present value of minimum lease payment that shall be receivable by

the assessee at the end of reporting period. Further, the disclosure shall be made with
respect to receipt pending:
(i) Payment due to be received not later than 1 year;
(ii) Payment which are due to be received later than 1 year but not later than 5 years;
(iii) Payments which are due to be received later than 5 years
References:
Australian Accounting Standard Board, 2015, Lease,. [Online]
Available at: https://www.aasb.gov.au/admin/file/content105/c9/AASB117_08-15.pdf
[Accessed 16 September 2018].
Maxxia, 2017, Finance Lease Explained, [Online]
Available at: https://maxxia.co.uk/business-finance/finance-lease/
[Accessed 16 September 2018].