CHAPTER 12 OPERATING LEASE ~ LESSOR TECHNICAL KNO WLEDGE To understand lessor accounting in contrast lessee accounting under the new lea standard. To define on operating lease and a finance lease To identify the criteria in determining a finance fase on the part of lessor. To know the recognition of an operating lease on the part of lessor. baintroduction ressor accounting under the new lease standy, Less idard j as usual. ® busin PRS 16 long ceor accounting under IFRS 16 is substangj foe the old lease standard. ally "hang «RS 16, paragraph 61, provides that; IFRS 16, paragraph 61, provi¢ hat a legs TERS Te Rither an operating lease or a finagee Ml asa, re lease Definitions An operating lease is a lease that does no: a ceattially alll the risks and rewards ineigtt@fer se porship of an underlying asset. ental ty A finance lease is a lease that transfers substa: sks and rewards incidental to ownership of et CRITERIA FOR FINANCE LEASE - LESSOR Whether a lease is a finance lease or an operating lease on the part of lessor depends on the substance of the transation rather than the form of the contract. ntially all the an underlying Under IFRS 16, paragraph 63, among others, any of the following situations would normally lead to a lease being classified as a finance lease by the lessor: a. The lease transfers one of the underlying asset to the lessee at the end of the lease term. b. The lessee has an option to purchase the asset at a Pr which is expected to be sufficiently Tower than the far value at the date the option becomes exercisable ‘ t At the inception of the lease, it is reasonably certain th the option will be exercised. economic li c. The lease term i: e je rl he lease term is for the major part of t cnefere of the underlying asset even if title is not tr! amounts © 4. The present value of the lease payments BNC os substantially all of the fair value of the wnd at the inception of the lease. * a reel nature Theve four mujor criteria are determinative 1 Tito meaning, any one of these would nomally TS co, conclusion that the lease contract is a finance oo 3o4Major part what percentage represents Major part? js it 60%, 75% or 80% It is unfortunate that the new lease standard does not provide a clearcut, definition of a major part Under USA GAAP, major Part means at least 75% of the economic life of an asset Of course, right thinking persons can debate part implies a Proportion lower little as 61%, or implies a higher as 90%. whether a major than 75%, for example, as Proportion than 75%, such Substantially all Under USA GAAP, substantially ail means at least 90% of the fair value of the leased asset, There is room for debate over whether substantially ali implies a threshold lower than o1 rv higher than 90%. Other criteria Paragraphs 63 and 64 provide that other situations that individually or in combination could also lead to a lease being classified as finance lease by the lessor ar: & The underlying asset is of such specialized nature that only the lessee can use it without major modification. If the lessee can cancel the lease, the lessor's losse *ssociated with the cancelation are borne by the lessee. “ Gains or losses from the fluctuation in the faiv value of the residual accrue to the lessee. ~ The lessee has the ability to continue the lease for a *condary period ata rent that is substantially lower than market vent, these other criteria are more suggestive in nature, meaning, “S€ could also lead to a finance lease classification 395Land and puilding lease Guidance B55 provides that in classifying ajo, puilding, a lessor normally considers the ents separately. Application ‘on land and and building elem land determining whether the land element is an operating te eee finance lease, an important consideration is ant head normally has an indefinite economic life. Application Guidance B66 provides that the lease payment, are allocated between the land and building elements i, proportion to the relative fair value of the leasehold interests in the land and building elements at the inception of the lease. If the lease payments cannot be allocated reliably between the two elements, the entire lease is classified as a finance lease, unless it is clear that both elements are operating leases. For lease of land and building in which the amount for the land element is immaterial to the lease, a lessor may treat the land and building as single unit for the purpose of lease classification. The single lease is classified as a finance lease or an operating lease applying the lease classification criteria for lessor. In such a case, the economic life of the building is regarded as the economic life of the entire underlying asset. 396erating lease ~ Lessor op’ ps 16, paragraph 81, provides that a lessor shall recognize jease payments from operating lease as income either on a raight line basis or another systematie basis. he lessor shall apply another systematic basis if this ia more representative of the pattern in which benefit from the wee of the underlying asset is diminished. otherwise stated, the periodic rental received by the less in an operating lease is simply recognized as rent income ‘A lessor shall present an underlying asset subject to operating lease in the statement of financial positic | gccording to the nature of the asset. The underlying asset remains as an asset of the lessor Consequently, the lessor bears all ownership or executory costs such as depreciation of leased property, real property taxes, insurance and maintenance. However, the lessor may pass on to the lessee the payment for taxes, insurance and maintenance cost. The depreciation policy for depreciable leased asset shall be consistent with the lessor's normal depreciation for Similar asset. | hitial direct cost incurred by lessor in an operating le shall be added to the carrying amount of the underlying as *nd recognized as an expense over the lease term on the ‘ame basis as the lease income Any security deposit refundable upon the lease expiration ‘ll be accounted for as liability by the lessor Any lease bonus received by the lessor from the lessee is {KoBnized as unearned rent income to be amortized over lease term. 397Illustration L ont year, Simple Comp, ginning of current y Bany At the pete machinery for P3,000,000 1 for th, eervose of leasing it. The machine ie expected Ys hay, Vo-year life and no reeidual value Machinery 3,000,000 lachiner : 5,00) Cash 00,00 Simple Company leased the machine yy ril 1, On Apri ears ata monthly rental of P50,oy¢, another entity for 3 yee payable at the beginning of every month Cash (50,000 x 9 months) 450,000 Rent income 450,00 On April 1, Simple Company received a security deposit of P600,000 to be refunded upon the lease expiration. Cash 600,000 Liability for rent deposit. 600,000 . In addition to the rental, Simple Company received from the lessee a lease bonus of P120,000 on January 1. Cash 120,000 Unearned rent income 120,000 On April 1, Simple Company paid initial direct cost of P300,000. Such costs are directly attributable to negotiating and arranging the operating lease. Deferred initial direct cost 300,000 Cash 300,000 During the current year, Simple Co: i alr and maintenance of P20,000. 7 meas, Pa iP Repair and maintenance 20,000 Cash , 20,000 The lease bonus is amortized s ov 0,000 annually or P30,000 for 9 months. years or PA Unearned rent income Rent income (40,000 x 9/12) 0,000 30,000 398g, The machinery is depreciate annually. d over 10 years or P300,000 Depreciation Accumulated depreciation 300,000 300,000 Note that the depreciation ia f, rom the date of acquisition January 1 and not from April 1, date of lease The reason is that the machinery is acquired for | purposes and already available for the int meaning for rental from January 1 ended use Idle property is subject to depre available for the intended use tion as long as it 9. The initial direct cost is recognized as expense over lease term. Amortization of initial direct cost 75,000 Deferred initial direct cost Annual amortization (300,000 /3) Amortization for 9 months (9/12 x 100,000) The balance of the deferred initial direct cost shal presented as an addition to the carrying am machinery. Presentation of leased machinery Machinery 3,000 000 mulated depreciation (300,000 ‘ying amount. ferred initial direct cost 2.925,000 carrying amount 000 300,000 erred initial direct cost. oes ‘ortization for first year 225.000 amortized balance = 399Unequal rental payments lease requires une : IFRS, where the operating Nequal ne the total cash payments for the lease lorm Shall be amortized uniformly on the straight line hasig /” rent income over the lease term. Illustration On January 1, 2021, Aye Company leased office space to another entity for a three-year period. J : the terms of the operating lease, rent for the firs, yar P1,000,000 and rent for the next two years, P1,250,069 annually. However, as an. inducement to enter the lease, Aye Company granted the lessee the first six months of the lease rent-free 2021 (1,000,000 x 6/12) 500,000 2022 1,250,000 2023 1,250,000 Total rental for 3 years 3,000,000 Average annual rental (3,000,000 / 3) 1,000,000 Books of Aye Company - Lessor 2021 Cash 500,000 Rent receivable 500,000 Rent income 1,000,000 2022 Cash 1,250,000 Rent income 1,000,000 Rent receivable 250,000 Rent income for 2021 and 2022 2,000,000 Rent collected (500,000 + 1,250,000) 1,750.00 Rent receivable 2023. Cash 1,250.0 Rent income — Rent receivable noe het ane rent receivable had a zero balance 0” jecember 31, 2023 and the recorded ren iron eat youria Poole recorded rent income 400