Finance

Lease-Lessee

Finance Lease

In substance, a purchase of property by the

lessee from the lessor

Actually a lease purchase

A capital lease (under USA GAAP)

Finance Lease

Finance lease is a lease that transfers

substantially all the risks and rewards
incident to ownership of an asset.
Lessees part

Lessors part

Purchase of asset

Transfer of property

Recognize asset

Recognize receivable

Recognize lease liability

Revenue

Whether a lease is a finance lease is a finance

lease or an operating lease depends on the
substance of the transaction rather than the
form of the contract

When is a lease a
Finance Lease?

Transfer of ownership of the leased asset at the end of

the leased term

Option to purchase the asset at price lower than Fair

Value (Bargain Purchase Option)

The lease terms is for the major part of the economic

life of the asset even if the title is not transferred

Major part: 75% (USA GAAP)

PV of the Minimum Lease Payment amount to

substantially all of the FV of the leased asset @ the
inception of the lease.

Substantially all: 90% (USA GAAP)

Other Criteria

Leased asset is of such specialized in nature that only

the lessee can use it without major modification.

Lessee can cancel the lease but bear all the lessors
losses

Gain or losses from the fluctuation in the fair value of

the residual accrue to the lessee

The lessee has the ability to continue the lease for

secondary at a rent that is substantially lower than
market rent

Sale and
Leaseback

Sale and Leaseback

A sale and leaseback is an arrangement whereby

one party sells a property to another party and then
immediately leases that property back from its
owner.
Sells the asset

Seller

lessee

Purchaser

Leases it back

lessor

Sale and Leaseback

Reasons for sale and leaseback:

The seller-lessee may experiencing cash flow or

financing problem

There is tax-advantage in such arrangement in

lessees jurisdiction

Avoid the burden of paying the executory costs such

as repairs, insurance and taxes.

Leaseback as an
operating lease
Rules if the leaseback is an operating lease:
1.

If the sale price is established @ Fair Value, the gain or

loss is recognized immediately

2.

If the sale price is below fair value, any gain or loss

shall also be recognized immediately

3.

If the sale price is above fair value, the excess over

fair value should be deferred and amortized and the
excess of fair value over the carrying amount is an
outright gain

Illustration Leaseback
as an operating lease
At the beginning of the current year an entity sold a machinery with
a remaining useful life of 10 years for P2,000,000 which is equal to
the fair value of the machinery. The entity immediately leased the
machinery back for 4 years at the prevailing annual rent of
P100,000.
The machinery has a carrying amount of P1,800,000, net of
accumulated depreciation of P1,200,000.
Books of seller-lessee
1.

To record the sale

Cash2,000,000
Accumulated Depn
Machinery

1,200,000

3,000,000

Gain on sale and leaseback

2.

To record annual rent

Rent expense
Cash

100,000

100,000

200,000

Books of purchaser-lessor

1.

To record the purchase

Machinery

2,000,000

Cash

2.

2,000,000

To record the annual rent

Cash

100,000
Rent income

3.

100,000

To record the depreciation of the machinery

Depreciation

200,000

Accumulated Depreciation

200,000

Leaseback as a finance
lease

Any gain on sale and leaseback is deferred

and amortized over the lease term.

Any loss on sale and leaseback is recognized

immediately

Illustration- Leaseback as
a finance lease

On January 1, 2014 an entity sold an equipment with a

remaining life of 15 years. At the same time, the entity
leased back the equipment for 10 years.

Cost of equipment
Accumulated Depreciation
Sale price (equals to PV of rentals)
Annual rental payable at year end

5,000,000
1,250,000
4,520,000
800,000

Interest rate implicit in the lease

12%

PVOA of 1 @ 12%, 10 periods

5.65

Assume that this is a finance lease because of BPO and its

reasonably certain that it would be exercise at the end of the lease
term.

Books of seller lessee

To record the sale

To record the depreciation

Cash4,520,000
Accumulated Dep
Equipment

Depreciation
Acc.Dep

1,250,000

5,000,000

Deferred gain on s&lb

770,000

301,333
301.333

4,520,000 / 15
Based on the remaining useful life
*

To record the leaseback as finance lease

Equipment

4,520,000

Lease Liability (800k x 5.65)

4,520,000

To record the first rental payment

Interest Expense(12% x 4,520,000) 542,400

Lease Liability

257,600

To amortize the deferred gain as

earned over the lease term of 10
years
Deferred gain

77,000
Gain on s&lb
(770,000/10)

77,000

Books of purchaser-lessor
To record the purchase
Equipment
Cash

4,520,000

4,520,000

To record the lease as a finance lease

Lease Receivable (800,000) 8,000,000
Equipment

4,520,000

Unearned interest income

3,480,000

To record the first rental payment

Cash

800,000

Lease Receivable

800,000

To record the interest income for the first year

Unearned interest income
Interest Income

542,400

542,400