SUMMARY: ACCOUNTING FOR LEASES

PREPARED BY: ARLENE JALOS

Lease
Agreement

Is PV of MLP
Is there a transfer No No Is Lease term for No Substantially All of
of ownership?
Is there a bargain the major part of FV?
purchase option? Economic Life?
Yes Yes Yes Yes
Finance Lease Finance Lease Finance Lease Finance Lease

Direct Financing
Sales-Type Lease NO Does Asset FV = Lessor's BV? Lease
YES

With residual value GuaranUnguaranteed

Gross investment Rental Rental payments + Residual value Rental payments

Net investment Cost ofCost of asset + Initial direct cost Cost of asset + Initi
Unearned interest income

At the end of the lease term:

FV = RV RecordsRecords asset at its FV No entry
FV < RV Cash (FLoss on finance lease No entry
FV > RV Gain onGain on finance lease No entry
Sales Type Lease
With residual value
Gross investment
Net investment
TFR/ Unearned interest income
The asset reverts to the lessor The ownership transfers to the les
CriteriaCriteria 4 Criteria 1
GuaranUnguaranteed
Rental Rental payments + Residual value Rental payments
PV of rPV of rental payments + PV of RV PV of rental paymen

Sales Net invNet investment or FV of asset, Whichever is lower, d Net investment or F

Cost of sales Cost ofCost of asset + initial direct cost - PV of RV Cost of asset + initi
Gross profit

End of lease term

FV = RV Asset (Asset (at FV) x
Lease receivable x
x
FV < RV Cash Loss on finance lea What if lesse did not exercise the purchase option?
FV < BPO

FV > RV gain ongain on finance lease

FV > BPO

Lessee's point of view

The asset reverts to the lessor The ownership transfers to the les
criteriacriteria 4 criteria 1
with residual value guaranunguaranteed
Leased asset/ Lease liability PV of MLP (rental payments, + GRV, + BPO), or FV of asset wPV of MLP
Depreciable amount Cost - Cost Cost - RV
Term LT LT EUL
End of lease term:
AD AD (leased asset)
FV = RV LL (RV) Asset (leased asset)
Asset

FV < RV Loss onNo additional entry x

Cash
FV > RV No addiNo additional entry x

x
 No Operating Lease

Rental payments + BPO

Cost of asset + Initial direct cost

Cash (BPO)
Lease receivable

What if the lessee did not exercise the purchase option?

FV < BPO Asset at FV
Loss on finance lease (FV - BPO)
 Lease receivable (BPO)

FV > BPO Asset at FV

Lease receivable (BPO)
Gain on finance lease (FV - BPO)

nership transfers to the lessee

Criteria 2 (BPO)

Rental payments + BPO

PV of rental payments + PV of BPO

Net investment or FV of asset, Whichever is lower

Cost of asset + initial direct cost

Cash
Lease receivable (BPO)

Asset (FV)
Loss on finance lease (FV - BPO)
Lease receivable (BPO)

Asset at FV
Lease receivable (BPO)
Gain on finance lease (FV - BPO)

nership transfers to the lessee

criteria 2

PV of MLP + PV of BPO
Cost - RV
EUL

LL
Cash (BPO)
lessee did not exercise:
AD
LL (BPO)
Asset
ACCOUNTING FOR OPERATING LEASE

Lessee's point of view Lessor's point of view

Accounting treatment Pro-forma entry: Accounting treatment Pro-forma entry:
Rent expense (on straight line basis) xxx Cash (collection)

1. Rental payments Recognized as expense on a straight line Prepaid rent (excess of payment/ expense) xxx Recognized as income on a straight line Rent receivable (excess of income/ collectio
basis over the lease term unless another Cash (rental payment) xxx basis over the lease term unless another Rent income (on straight line basis)
systematic basis is more representative of systematic basis is more representative of
the time pattern of the user's benefit. Rent payable (excess of expense/ payment) xxx the time pattern of the user's benefit. Unearned rent income (excess of coll
Prepaid rent xxx Cash
Cash xxx Unearned rent income
Prepaid rent expense to be amortized Deferred income to be amortized over
2. Lease bonus over the lease term the lease term
Rent expense (amortization) xxx Unearned rent income
Prepaid rent xxx Rent income (amortization)
Leasehold improvement xxx
Recognized as asset (part of PPE) to be
depreciated over the life of the Cash/ AP xxx
3. Leasehold improvement or lease term, whichever is Not recognize by the lessor No entry is required.
improvement shorter. The residual value is ignored in
the computation of depreciation
expense. Depreciation expense xxx
Accumulated depreciation xxx
Rent deposit xxx Liability for rent deposit
4. Security deposit Recognized as an asset. Recognized as a liability
Cash xxx Cash
5. Leased asset Not recognize in the books of the lessee No entry is required. Remains as an asset of the lessor.

Taxes/ Insurance/ Maintenance cost xxx Taxes/ Insurance/ Maintenance cost

The lease agreement may include a
6. Executory costs provision that executory costs shall be Cash xxx The lessor normally bears all ownership Cash
shouldered by the lessee. costs, however, the lessor may pass on to
in case the lessee shoulders the costs, otherwise no entry is the lessee the payment for taxes, in case the lessor shoulders the costs, oth
required. insurance and maintenance costs. required.
7. Depreciation of Not recognize in the books of the lessee No entry is required. Recognize as an expense in the books of Depreciation expense
leased asset the lessor. Accumulated depreciation
 Deferred initial direct costs

Includes commissions, legal fees and Cash

internal costs. Added to the carrying
8. Initial direct costs Not recognize in the books of the lessee. No entry is required. amount of the leased asset and
recognized as an expense over the lease
term on straight line basis. The balance of
the deferred intial direct costs shall be Amortization of initial direct costs
presented as an addition to the carrying
amount of leased asset. Deferred initial direct costs

Sale and leaseback transaction

9. Sale of asset by seller-lessee to purchaser - lessor
If FV or SP > CV entry to record the acquisition of asset:
Selling price = Fair Value of asset
Cash (at SP or FV since SP = FV) xxx Asset
Asset at CV xxx Cash
Gain on sale and leaseback (SP or FV - CV) xxx
CASE 1
G/L on sale (FV or SP - CV) is recognized If FV or SP < CV:
immediately Cash (at SP or FV since SP = FV) xxx entry to record the depreciation of leased as
Loss on sale and leaseback (FV or SP - CV) xxx Depreciation expense
Asset at CV xxx Accumulated depreciation
If SP > CV:
Selling price < Fair Value of asset
Cash (at SP) xxx
Asset at CV xxx
Gain on sale and leaseback (SP - CV) xxx
G/L on sale (SP - CV) is recognized If SP < CV:
immediately Cash at SP xxx
Loss on sale and leaseback (SP - CV) xxx
Asset at CV xxx
The purchaser - lessor shall recognize the
CASE 2 However, if the loss is compensated by asset at its fair value and depreciate the
future lease rental at below market value If loss is compenasated by rental payments at below market
value: asset over its remaining useful life.
(lower rental payments)

Cash at SP xxx

Accounting treatment:
The loss is deferred and amortized in
proportion to the lease payments over
the period for which the asset is expected
CASE 2 asset at its fair value and depreciate the
asset over its remaining useful life.

Deferred loss on sale and leaseback (SP - CV) xxx

Accounting treatment:
The loss is deferred and amortized in Asset at CV xxx
proportion to the lease payments over
the period for which the asset is expected
to be used. Amortization of deferred loss on sale and leaseback:
Loss on sale and leaseback xxx
Deferred loss on sale and leaseback xxx
Cash at SP xxx
Selling price > Fair Value of asset
Asset at CV xxx
Gain from sale and leaseback (FV - CV)
xxx
CASE 3
The excess over fair value is deferred and Deferred gain from sale and leaseback (SP
amortized over the period for which the - FV)
xxx
asset is expected to be used. While the
excess of fair value over the carrying
amount is an outright gain.
view
Pro-forma entry:
xxx
excess of income/ collection) xxx
me (on straight line basis) xxx
rent income (excess of collection/ incom xxx
xxx
rent income xxx

xxx
me (amortization) xxx

red.

xxx
xxx

/ Maintenance cost xxx

xxx
sor shoulders the costs, otherwise no entry is
required.
xxx
ted depreciation xxx
 xxx

xxx

nitial direct costs xxx

nitial direct costs xxx

he acquisition of asset:
xxx
xxx

he depreciation of leased asset:

xxx
ted depreciation xxx
Summary of Accounting for Finance Lease
Lessor's Point of View
1. Direct Financing Lease - If Asset FV = Lessor's BV

The asset reverts to the lessor The ownership transfers to the les
Criteria 3 and 4 Criteria 1
Case 1. Without Residual Value
Gross Investment (GI) Dr. Rental payments Rental payments Rental payments
Lease Receivable

Net Investment (NI) Asset

Cr. Asset Cost of asset + Cost of asset + Cost of asset +
Initial direct costs Initial direct costs Initial direct costs
Cr. Unearned Interest Income GI - NI GI - NI GI - NI

The asset reverts to the lessor The ownership transfers to the les
Criteria 3 and 4 Criteria 1
RV is not considered since the ow
will be transferred to the lessee a
With residual value Guaranteed Unguaranteed of the lease term

Gross investment
Dr. Lease Receivable
Net investment
Asset
Cr. Unearned interest income
Rental payments + Rental payments + Rental payments
Residual value Residual value
Cr. Cost of asset + Cost of asset + Cost of asset +
Initial direct cost Initial direct cost Initial direct cost
=GI - NI =GI - NI =GI - NI
 The asset reverts to the lessor The ownership transfers to the les
Criteria 3 and 4 will Criteria 1
be transferred to the lessee a
With residual value Guaranteed Unguaranteed of the lease term

At the end of the lease term:

FV = RV Asset at FV Asset at FV No entry
Lease Receivable (RV) Lease Receivable (RV)

FV < RV Asset at FV Asset at FV No entry

Cash (RV - FV) Loss on finance lease
Lease Receivable (RV) Lease Receivable (RV)

FV > RV Asset at FV Asset at FV No entry

Lease Receivable (RV) Lease Receivable (RV)
Gain on finance lease Gain on FL
1. Sales Type Lease - If Asset FV Lessor's BV
The asset reverts to the lessor The ownership transfers to the les
Criteria 3 and 4 Criteria 1
Case 1. Without Residual Value
Gross Investment (GI) Dr. Rental payments Rental payments Rental payments
Lease Receivable

Net Investment (NI) Asset PV of rental PV of rental PV of rental

Cr. Sales (if higher than FV) payments payments payments

Cr. Unearned Interest Income GI - NI GI - NI GI - NI

Net investment or Net investment or Net investment or

Cr. Sales FV of asset, FV of asset, FV of asset,
Whichever is Whichever is Whichever is
lower lower. lower.

Dr. Cost of sales/ Cr. Inventory/

Cr. Cash for initial direct cost Cost of asset + Cost of asset + Cost of asset +
initial direct cost initial direct cost initial direct cost
Gross profit Sales - COS Sales - COS Sales - COS

The asset reverts to the lessor The ownership transfers to the les
Criteria 3 and 4 will Criteria 1
be transferred to the lessee a
Case 2. With residual value Guaranteed Unguaranteed of the lease term

Gross investment Dr. Rental payments + Rental payments + Rental payments

Lease receivable Residual value Residual value
Net investment PV of rental PV of rental PV of rental
Cr. Sales (if higher payments + PV payments + PV payments
than FV) of RV of RV
Cr. Unearned interest income GI - NI GI - NI GI - NI
1. Sales Type Lease - If Asset FV Lessor's BV
The asset reverts to the lessor The ownership transfers to the les
Case 2. With residual value Criteria 3 and 4 Criteria 1

Guaranteed Unguaranteed RV is not considered since the ow

will be transferred to the lessee a
of the lease term

Net investment or
Cr. Sales Net investment or FV of asset, Net investment or
FV of asset, Whichever is FV of asset,
Whichever is lower, deduct the Whichever is
lower PV of RV lower

Dr. Cost of sales/ Cr. Inventory/ Cost of asset +

Cr. Cash for initial direct cost Cost of asset + initial direct cost - Cost of asset +
initial direct cost PV of RV initial direct cost
Gross profit Sales - COS Sales - COS Sales - COS

End of lease term

FV = RV Asset (at FV) Asset (at FV) No entry
Lease receivable (RV) Lease receivable (RV)

FV < RV Asset at FV Asset at FV

Cash (FV - RV) Loss on finance lease No entry
Lease receivable (RV) Lease receivable (RV)

FV > RV Asset at FV Asset at FV

Lease receivable (RV) Lease receivable (RV) No entry
Gain on finance lease Gain on finance lease

Lessee's point of view (whether DFL or STL)

The asset reverts to the lessor The ownership transfers to the les
Criteria 3 and 4 Criteria 1
Case 1. Without Residual Value
 PV of MLP PV of MLP PV of MLP
(excluding (excluding (excluding
executory costs) executory costs) executory costs)
Capitalizable cost of asset: or FV of the leased or FV of the leased or FV of the leased
Leased asset/ Lease liability asset at the asset at the asset at the
inception of the inception of the inception of the
lease, whichever is lease, whichever is lease, whichever is
lower1 lower1 lower1

Depreciable amount Cost Cost Cost

Term of depreciation LT or EUL LT or EUL EUL

whichever is lower whichever is lower

End of lease term:

Accumulated depreciation xxx No entry
Leased asset xxx
Case 2 With residual value
The asset reverts to the lessor The ownership transfers to the les
Criteria 3 and 4 Criteria 1

RV is not considered since the ow

Guaranteed Unguaranteed will be transferred to the lessee a
of the lease term

Leased asset/ Lease liability

PV of MLP (rental PV of MLP (rental PV of MLP (rental
payments + RV) payments only) payments only)
Depreciable amount Cost - RV Cost Cost - RV

Term LT or EUL LT or EUL EUL

whichever is lower whichever is lower

End of lease term:

FV = RV Accum. dep. Accum. Dep. No entry
Lease liability (RV) Leased asset
Leased Asset

FV < RV Accum. dep. Accum. Dep. No entry

Lease liability (RV) Leased asset
Leased Asset

Additional entry to
make-up for the No additional
difference: entry is
required.The
lessee has no
financial
obligation on the
Loss on finance value of asset at
lease (FV - RV) the end of lease
Cash term

FV > RV Accum. dep. Accum. Dep. No entry

Lease liability (RV) Leased asset
Leased Asset

No additional No additional
entry is required.It entry is required.It
is the lessor who is the lessor who
will benefit for the will benefit for the
remaining value of remaining value of
asset. asset.
nership transfers to the lessee
Criteria 2 (BPO)

Rental payments +
BPO

Cost of asset +
Initial direct costs
GI - NI

nership transfers to the lessee

Criteria 2 (BPO)
not considered since the ownership
transferred to the lessee at the end
of the lease term

Rental payments +
BPO

Cost of asset +
Initial direct cost
=GI - NI
nership transfers to the lessee
Criteria
transferred to the lessee at2the
(BPO)
end
of the lease term

Lessee exercise the BPO:

Cash (BPO)
Lease receivable (BPO)

Lessee did not exercise the BPO:

FV = BPO
Asset at FV
Lease receivable at BPO

FV > BPO
Asset at FV
Lease receivable (BPO)
Gain on finance lease (FV - BPO)

FV < BPO
Asset at FV
Loss on finance lease (FV - BPO)
Lease receivable (BPO)
nership transfers to the lessee
Criteria 2 (BPO)

Rental payments +
BPO

PV of rental
payments + PV of
BPO
GI - NI

Net investment or
FV of asset,
Whichever is
lower.

Cost of asset +
initial direct cost
Sales - COS

nership transfers to the lessee

Criteria
transferred to the lessee at2the
(BPO)
end
of the lease term

Rental payments +
BPO

PV of rental
payments + PV
of BPO
GI - NI
nership transfers to the lessee
Criteria 2 (BPO)

not considered since the ownership

transferred to the lessee at the end
of the lease term

Net investment or
FV of asset,
Whichever is
lower

Cost of asset +
initial direct cost
Sales - COS

If the lessee exercise the BPO;

Cash (BPO)
Lease receivable (BPO)

If the lessee did not exercise the BPO;

FV = BPO
Asset at FV
Lease receivable at BPO

FV > BPO
Asset at FV
Lease receivable at BPO
Gain on finance lease

FV < BPO
Asset at FV
Loss on finance lease
Lease receivable at BPO

nership transfers to the lessee

Criteria 2 (BPO)
PV of MLP
(excluding
executory costs)
or FV of the leased
asset at the
inception of the
lease, whichever is
lower1

Cost

EUL

If the lessee exercise the BPO

Lease liability xxx
Cash (BPO)

If the lessee did not exercise the BPO

FV = BPO
Lease liability (at BPO)
Accumulated depreciation
Leased asset
nership transfers to the lessee
Criteria 2 (BPO)

not considered since the ownership

transferred to the lessee at the end
of the lease term

PV of MLP (rental
payments + BPO)
Cost - RV

EUL

The lessee exercise the BPO:

Lease liability
Cash (BPO)

The lessee did not exercise the BPO:

Lease liability (BPO)
Accum. Dep.
Leased asset