Topic 1

Accounting for
Leases
(MFRS 117)

BKAF3063 A141

Chapter Outline
Nature and classification of leases.
Accounting by lessee:

operating lease

finance lease

Accounting by lessor:

operating lease

direct financing lease

Sales and leaseback transactions.

Disclosure requirement.
2

BKAF3063 A141

Learning outcomes:
Define what is lease & differentiate

between operating & finance lease

Record the leases transactions in the
book of lessor and lessee
Define and record sales and leaseback
transantions

BKAF3063 A141

Definition of Lease
MFRS
MFRS 117
117 (Para
(Para 4):
4):
An
An agreement
agreement whereby
whereby the
the lessor
lessor conveys
conveys to
to
the
the lessee
lessee in
in return
return for
for aa payment
payment or
or series
series of
of
payments
payments the
the right
right to
to use
use an
an asset
asset for
for an
an
agreed
agreed period
period of
of time.
time.

BKAF3063 A141

Advantages of Lease
1) 100% financing at fixed rates without
requiring any down payment, lease
payments often remain fixed.
2) Protection against obsolescence reduce
risk of obsolescence.
3) Flexibility less restrictive provision than
other debt agreements.
4) Less costly financing.
5) Off-Balance-Sheet financing specifically
5

on
operating lease.
BKAF3063 A141

Classification of Lease
Finance Lease

if it transfers
substantially all the risks
and rewards incidental to
ownership.
DMart

BKAF3063 A141

Operating

Lease

if it does not transfer

substantially all the risks
and rewards incidental to
ownership.

Classification of Lease
cont.
Rewards may be
represented by the
expectation of profitable
operation over the assets
economic life and of gain
from appreciation in value
or realization of a residual
value.

7
BKAF3063 A141

Risks include the

possibilities of losses from
idle capacity or
technological obsolescence
and of variations in return
due to changing economic
conditions

Ownership Transfer

Legal form:
- Title remains with the lessor for all
types of lease.
Accounting view:
Substance over form
A lease that transfers substantially all of
the benefits and risks incidental to the
ownership of property should be accounted
for as acquisition of an asset and the
incurrence of an obligation by the lessee.
practically how the asset treated/used
vs. legally who own the asset
Conclusion:
The ownership rights differs according to
BKAF3063
A141
type
of the lease.

Classification of Lease:
Para 10 - depends on the substance of the
transaction rather than the form of the contract.

Ownership transfers at the end of the lease?

YES

Finance Lease

YES

Finance Lease

NO

Bargain Purchase Option?

NO

Lease term is for majority of economic life?75% or

more

YES

Finance Lease

NO

PV of MLP equals at least substantially all of FV of

the leased asset? 90% or more
NO

Leased asset(s) specialised?

NO

Operating Lease
BKAF3063 A141

YES

YES

Finance Lease
Finance Lease

Classification of Lease (Cont.):

Para 11: Indicators of situations which individually or
in combination could also lead to a lease being
classified as a finance lease are:
Cancellation losses borne by lessee?

YES

NO

Changes in FV of residual borne by lessee?

YES

NO

Bargain lease renewal option?

YES

NO

Operating Lease

10

BKAF3063 A141

Finance Lease

Terms
Lease Term
- Non-cancellable period for which lessee has contracted to lease.
- Commencement of lease term = when recognition takes place.
Inception date
- the earlier of the date of the lease agreement and the date of
commitment by the parties to the principle provision of the lease.
- Inception of the lease = when leases are classified.
Bargain purchase option (BPO)
- option to purchase the asset at a price lower than fair value at the date
of the option become exercisable.

11

BKAF3063 A141

Terms (cont)
Minimum Lease Payment (MLP)
Payments over the lease term that the lessee is or
can be required to make excluding contingent rent,
cost for services, and taxes, to be paid and
reimbursed to the lessor; together with
(+) Guaranteed residual value:
a) lessee: any amounts guaranteed by the
lessee or related party; or
b) lessor: any residual value guaranteed by
lessee or party related to lessee, or third party.
(+) BPO (bargain purchase option)
12

BKAF3063 A141

Terms (cont.)
Guaranteed Residual Value
-

Lessee: part of the RV guaranteed by the lessee or by a

party related to the lessee (being the max amounts payable
at the end of lease term)

13

Lessor: part of RV guaranteed by the lessee or by a third

party unrelated to the lessor who is capable to pay the
guaranteed amounts.
Initial direct cost
- incremental cost that are directly attributable to
negotiating and
arranging a lease, except for such costs incurred by
manufacturer or
dealer lessors.
- Example: legal fees, lease agreement commission etc.
BKAF3063 A141

Terms (cont.)
Gross Investment
a) the MLP receivable by the lessor under a finance lease, and
b) any unguaranteed residual value accruing to the lessor.
Net Investment
- the gross investment in the lease discounted at the interest rate
implicit in the lease.

14

BKAF3063 A141

Classification of Lease
cont.
Para 15A 18:
When a lease includes both land and buildings elements, an entity

assesses the classification of each element as a finance or an

operating lease separately in accordance with paragraphs 713.
Land
usually operating due to indefinite useful life.
if title passed finance lease.
MLP allocated in the proportion to the relative FV of both
elements.
if cannot reliably allocated: entire lease is considered finance lease,
unless it is clear that both are operating.
15

BKAF3063 A141

Classification
Classification of
of Lease
Lease
Illustration 1:
Pajakan Co. (Lessor) and Trojan Co. (Lessee)
entered into leasing agreement on 1 January 2012.
The term of lease is 15 years. The lease agreement
is non-cancellable and has minimum lease
payments with a present value of RM450,000. The
lease involves the use of machinery that has a 17
years estimated useful life and is valued at
RM460,000. The lease stated that Trojan has an
option to purchase the asset for RM20,000 at the
end of leased period.
16

BKAF3063 A141

Classification
Classification of
of Lease
Lease
Solution to illustration 1:
Criteria

17

Satisfied?
Y/N

Explanation

Transfer of
title

Not transferred.

BPO

BPO = RM20,000

Length of lease
term

useful life = 17 years;

Lease term = 15 years.

PV of MLP

FV = RM460,000;
PV of MLP = RM450,000.

Specialised
assets
BKAF3063 A141

Not specified.

Finance and operating leases:

Differences (Lessee)
Finance Lease

18

Operating Lease

Recognition of PPE and

liabilities on the book

Recognition of rental
expenses/revenue as
incurred/earned

PPE subject to impairment

and test

Not applicable

BKAF3063 A141

Lets take a look at

Operating Lease in
the book of Lessee

19

BKAF3063 A141

Operating Lease:
Accounting by Lessee
Para 33 34:
Lease payments - should be recognised as an expense in the
income statement on a straight-line basis over the lease term.
Lease payments should exclude costs for services such as
insurance and maintenance.
No records on the assets or liability related to the value of
the assets (off balance sheet).

20

BKAF3063 A141

Operating Lease:
Accounting by Lessee
Illustration 2:
Pajakan Company (lessor) leased an equipment costing
RM450,000 to Trojan Company. The economic useful life
of the asset is 20 years. The lease is classified as
operating lease with the lease term of 5 years starting
from 1/1/2011. Payments are made in advance as
follows:
1/1/11
RM18,000
1/1/12
RM16,000
1/1/13
RM14,000
1/1/14
RM12,000
1/1/15
RM10,000
21
Asset
used evenly throughout the lease term. The
BKAF3063is
A141

Operating Lease :
Accounting by Lessee
Solution to Illustration 2:
Total payment for the lease period:
= RM18,000 +RM16,000 + RM14,000 + RM12,000 + RM10,000)
= RM70,000
Expenses recognized per year = RM70,000/5
= RM14,000
Journal entries?

22

BKAF3063 A141

Date

Particulars

Debit

1/1/11

Dr. Prepaid rent

Cr. Cash
Dr. Rent expense
Cr. Prepaid rent

18,000

Dr. Prepaid rent

Cr. Cash
Dr. Rent expense
Cr. Prepaid rent

16,000

Dr. Prepaid rent

Cr. Cash
Dr. Rent expense
Cr. Prepaid rent

14,000

Dr. Prepaid rent

Cr. Cash
Dr. Rent expense
Cr. Prepaid rent

12,000

Dr. Prepaid rent

Cr. Cash
Dr. Rent expense
Cr. Prepaid rent

10,000

31/12/11
1/1/12
31/12/12
1/1/13
31/12/13
1/1/14
31/12/14
1/1/15
31/12/15
23

BKAF3063 A141

Credit
18,000

14,000
14,000
16,000
14,000
14,000
14,000
14,000
14,000
12,000
14,000
14,000
10,000
14,000
14,000

Lets take a look at

Operating Lease
in the book of
Lessor

24

BKAF3063 A141

Operating Lease:
Accounting by Lessor
Para 49 55:
Title is not transferred, therefore lessor should
present assets in their balance sheet according to
the nature of the assets.
Payments received from lessee are recorded as
Rent Revenue on a straight-line basis over the
lease term.
Costs including depreciation incurred in earning
the lease income are recognised as an expense.
Initial direct costs incurred by lessor shall be
added to the carrying amount of the leased asset
25
A141
and recognised asBKAF3063
an expense
over the lease term.

Operating
Operating Lease:
Lease:
Accounting
Accounting by
by Lessor
Lessor
Refer to Illustration 2:
Total payment for the lease period:
= RM18,000 +RM16,000 + RM14,000 + RM12,000 + RM10,000
= RM70,000
Expenses recognized per year = RM70,000/5
= RM14,000
Depreciation expense recognized per year = RM450,000/20
= RM22,500
Journal entries?
26

BKAF3063 A141

Operating Lease :
Accounting by Lessor
Date
1/1/11
31/12/11

1/1/12
31/12/12

27

Particulars

Debit

Dr. Cash
Cr. Unearned rent revenue
Dr. Unearned rent revenue
Cr. Rent revenue
Dr. Depreciation expense
Cr. Accumulated depreciation

18,000

Dr. Cash
Cr. Unearned rent revenue
Dr. Unearned rent revenue
Cr. Rent revenue
Dr. Depreciation expense
Cr. Accumulated depreciation

16,000

BKAF3063 A141

Credit
18,000

14,000
14,000
22,500
22,500
16,000
14,000
14,000
22,500
22,500

Lets take a look at

Finance Lease in
the book of Lessee

28

BKAF3063 A141

Finance Lease :
Accounting by Lessee
Para 20 30:
Should be recognized as assets and liabilities (as if the assets
being purchased) at amounts equal to the fair value of leased
asset or if lower, at the PV of MLP [Para 20].
Cost of assets recorded in lessees book:
Fair value at inception date.
The lower of:
Reason: the leased
asset should not be
recorded for more than
its fair value.
29
BKAF3063 A141

OR
PV of MLP at inception date.

Finance
Finance Lease
Lease ::
Accounting
Accounting by
by Lessee
Lessee
The discount rate (to be used in calculating PV of MLP): implicit in the
lease.
IF impracticable to determine, use lessees incremental
borrowing rate.
MFRS 117 requires the lessee to record the obligation arising from
finance lease at then same amount as the leased asset ( para 22)
Journal entries :
Dr. Leased asset
Cr. Lease Liability
* The lower of fair value or PV of MLP
30

BKAF3063 A141

xxx *
xxx *

Finance
Finance Lease
Lease ::
Accounting
Accounting by
by Lessee
Lessee
Interest: MLP Lease Liabilities/FV of asset :
Lease payment should be apportioned between the
finance charge and the reduction of the outstanding
liability.
Finance charge allocated to periods during the lease
term so as to produce a constant periodic rate of
interest on the remaining balance of the liability for
each period [ Para 27].
Contingent rents: charged as expense as incurred.
31

BKAF3063 A141

Finance
Finance Lease
Lease ::
Accounting
Accounting by
by Lessee
Lessee
Depreciation (Para 27):

Depreciation policy should be consistent with that for depreciable

assets which are owned by the lessee (in accordance with
MFRS116).

Use economic useful life, if the lease:

i. transferred rights at the end of lease term;
OR
ii. contains BPO.

Otherwise, use:
The lower of:

Lease term

OR
Economic useful life

32

BKAF3063 A141

Finance
Finance Lease
Lease ::
Accounting
Accounting by
by Lessee
Lessee
Illustration 3:
Assume that Pajakan Company (lessor) and Trojan Company
(lessee) sign a lease agreement dated 1 January 2012. The
terms are as follows:
Term of lease is 5 years, it is non-cancellable, requiring equal
rental payments of RM20,000 at the end of each year.
1. The FV = RM75,816 at the inception date, estimated useful
life of 5 years, and no residual value.
2. The lease contains no renewal options, and the equipment
reverts to Pajakan Co. at the termination of the lease.
3. Discount rate agreed by both parties is 10%.
33

4. Trojan Co. depreciates on a straight line basis, similar

equipment
that it owns.
BKAF3063
A141

Finance
Finance Lease
Lease ::
Accounting
Accounting by
by Lessee
Lessee
Solution to Illustration 3:
Type of lease: Finance lease
MLP = 20,000 x 5 years = RM100,000
PV of MLP

= 20,000 x PVOA(5, 10%)

= 20,000 x 3.7908
= 75,816
FV = 75,816.

Journal entry on 1 Jan 2012

Dr. Leased asset
Cr. Lease Liability
(to recognise the asset leased)
34

BKAF3063 A141

75,816
75,816

Finance
Finance Lease
Lease ::
Accounting
Accounting by
by Lessee
Lessee

Lease amortization schedule: Effective interest me

Date

Annual
lease
payment
(A)

Interest
(10%)
(B)

Principal
payment
(C)

1 Jan 12

75,816

31 Dec 12

20,000

7,582

12,418

63,398

31 Dec 13

20,000

6,340

13,660

49,738

31 Dec 14

20,000

4,974

15,026

34,712

31 Dec 15

20,000

3,471

16,529

18,183

31 Dec 16

20,000

1,818

18,182

(D) X 10%
35

Lease
liability
(D)

BKAF3063 A141

(A) - (B)

Preceeding
- (C)

Finance Lease :
Accounting by Lessee
Journal entries:
Date

Particulars

31/12/
12

Dr.

Lease liability
Interest expense
Cr. Cash

12,41
8
7,582

Depreciation expense
Cr. Accumulated
depreciation

15,16
3

Dr. Lease liability

Interest expense
Cr. Cash

13,66
0
6,340

Dr.

31/12/
13

Dr.

36

Debit

Depreciation expense
BKAF3063 A141
Cr. Accumulated
depreciation

15,16
3

Credit

20,00
0
15,16
3

20,00
0
15,16

Finance Lease :
Accounting by Lessee
Journal entries:
Date

Particulars

31/12/
14

Dr. Lease liability

Interest expense
Cr. Cash
Dr.

31/12/
15

37

Debit
15,02
6
4,974

Depreciation expense
Cr. Accumulated
depreciation

15,16
3

Dr. Lease liability

Interest expense
Cr. Cash

16,52
9
3,471

Dr.

BKAF3063 A141

Depreciation expense
Cr. Accumulated

15,16
3

Credit

20,00
0
15,16
3

20,00
0

Finance Lease :
Accounting by Lessee
Journal entries:
Date

Particulars

31/12/
16

Dr. Lease liability

Interest expense
Cr. Cash
Dr.

Depreciation expense
Cr. Accumulated
depreciation
Dr. Accumulated
depreciation
Cr. Leased assets
(to record the return of
the assets)
38

BKAF3063 A141

Debit
20,00
0
1,818
15,16
3
75,81
6

Credit

20,00
0
15,16
3
75,81
6

Lets take a look

at Finance
Lease in the
book of Lessor

39

BKAF3063 A141

Finance Lease :
Accounting by Lessor
Para 36 40:
The receivable to be presented in the
Balance Sheet at an amount equal to the
net investment in the lease [Para 36],
which is defined in para 4 as the gross
investment in the lease less unearned
finance income
Initial direct cost included in the initial
measurement of finance lease receivable
and reduce the amount of income
40
recognised
over the lease term [para 38].
BKAF3063
A141

Finance
Finance Lease
Lease ::
Accounting
Accounting by
by Lessor
Lessor
Refer to Illustration 3:
Gross investment = 20,000 x 5 years = RM100,000
Net investment = PV of gross investment
= 20,000 x PVOA(5, 10%)
= 20,000 x 3.7908
= 75,816
Unearned finance income = 100,000 75,816 = 24,184
Amortization schedule?
Journal entries?
41

BKAF3063 A141

Finance Lease :
Accounting by Lessor
Journal entries:
Date

Particulars

Debit

01/01/
05

Dr.

Lease receivable
Cr. Fixed assets
Unearned
interest revenue

100,00
0 75,816
24,184

31/12/
05

Dr.

20,000

Cash
Cr. Lease receivable

Dr. Unearned interest

revenue
Cr. Interest revenue
31/12/
06

Dr.

42 BKAF3063 A141
Dr.

Cash
Cr. Lease receivable

Unearned interest
revenue

Credit

20,000
7,582
7,582
20,000
20,000
6,340

Bargain Purchase Option

MLP will be increased by the exercise price
Useful life will be used as basis for depreciation charge.
Example:

On 1/1/2011, ABC Bhd entered into lease agreement with terms:

a) non-cancellable lease term of four years,
b) Lease rental of RM10,000 per year to be paid on 31 Dec,
commencing 31/12/2011.
c) ABC Bhd has an option to buy the equipment at the end of lease term
for RM1,000. On 1/1/2011, it was estimated tha the fair value of the
equipment would be RM5,000 after 4 years usage.
The FV of the equipment on 1/1/2011 was RM42,000 and have
BKAF3063 useful
A141
estimated
life of 5 years. The implicit rate was 5%.
43

Bargain Purchase Option

Solution - Lesse:
MLP

= (10,000 x 4) + 1,000 = 41,000

PV of MLP
= (10,000 x PVAn=4,i=5%) + (1,000 x PV
= 36,282
1/1/11 : Dr. Leased Equipment
Cr. Lease Payable
36,282

36,282

Depreciation exp = 36,282 / 5 = RM7,256.40

31/12/14 - exercise of BPO:
Dr. Lease Payable
1,000
Cr. Cash
1,000

44

BKAF3063 A141

n=4,i=5%

Bargain Purchase Option

Solution - Lessor:
Gross Investment = (10,000 x 4) + 1,000 = 41,000
PV of MLP
= (10,000 x PV OAn=4,i=5%) + (1,000 x PV
= 36,282
1/1/11 : Dr. Leased Receivable
Cr. Equipment 36,282
Unearned interest revenue

41,000
4,718

31/12/14 - exercise of BPO:

Dr. Cash
1,000
Cr. Leased Receivable
45

BKAF3063 A141

1,000

n=4,i=5%

Guaranteed Residual Value

MLP will be increased by GRV
GRV will be deducted from the depreciable

amount of leased asset.

At the end of lease term,
the lease liability will have a balance equal with
GRV
If FV of leased asset < GRV , recognise loss
(lessee)

46

BKAF3063 A141

Guaranteed Residual Value

Example:
On 1/1/2011, ABC Bhd entered into lease agreement with
terms:
a) non-cancellable lease term of four years,
b) Lease rental of RM10,000 per year to be paid on 31 Dec,

commencing 31/12/2011.

c) ABC Bhd guaranteed to lessor that the leased asset would

have a residual value of RM5,000 at the end of lease term.

The FV of the equipment on 1/1/2011 was RM42,000 and

have estimated useful life of 5 years. The implicit rate was
5%. The estimated residual value at the end of lease term
was RM7,000.
47

BKAF3063 A141

Guaranteed Residual Value

Solution Lessee:
MLP
= (10,000 x 4) + 5,000 = 45,000
PV of MLP = (10,000 x PV OAn=4,i=5%) + (5,000 x PV
n=4,i=5%)
= 39,572
1/1/11 : Dr. Leased Equipment
Cr. Lease Payable

39,572
39,572

Depreciation exp = (39,572- 5,000) / 4 = RM8,643

48

31/12/14, if FV of leased asset is RM3,000,

Dr. Lease Payable
5,000
Accumulated depreciation
34,572
Cr. Leased Equipment
39,572
Dr.Loss
2,000
BKAF3063
A141 on finance lease
Cr. Cash
2,000

Guaranteed Residual Value

Solution Lessor:
GI
= (10,000 x 4) + 7,000 = 47,000
PV of GI = (10,000 x PVOA n=4,i=5%) + (7,000 x PV
= 41,218
1/1/11 : Dr. Leased Receivable
Cr. Equipment
Unearned interest revenue
5,782

n=4,i=5%

47,000
41,218

31/12/14, if FV of leased asset is RM3,000,

Dr. Equipment
3,000
Cash
2,000
Loss on finance lease
2,000
Cr. Leased Receivable
7,000
49

BKAF3063 A141

Sales and Leaseback

Transaction

in which the owner of the asset

(seller, lessee) sells the asset to another and
simultaneously leases it back from the new
owner.

?
50

In the book of Buyer/lessor:

- Same as lessor as discuss before.
In the book of
seller/lessee:
-To recognize gain from
sales of asset:
immediate or defer.

BKAF3063 A141

Sales and Leaseback

Para 59: for Finance lease

Profit = Sales proceed Carrying

amount
Should not be recognized immediately,
instead, should be deferred and amortized
over the lease term.

51

BKAF3063 A141

Sales and Leaseback

Para 61: for Operating lease.
(a) If Selling price = FV

Profit = Sales proceed Carrying amou

Should be recognized immediately.

52

BKAF3063 A141

Sales and Leaseback

Para 61: for Operating lease
(b) If

Selling price

<

FV

Profit = Sales proceed Carrying amo

Should be recognized immediately EXCEPT
THAT if the loss is compensated by future
lease payments at below market price, it
should be deferred and amortized.
53

BKAF3063 A141

Sales and Leaseback

Para 61: for Operating lease
Selling price
carrying amount)
(c) If

>

FV

(FV >

Profit = Sales proceed Carrying amo

Profit = Sales proceed

FV
deferred and
amortized.
54
BKAF3063 A141

Profit = FV - Carrying
amount
recognized immediately.

Sales and Leaseback

Illustration 5:
Chocolate Company sold an equipment to Chips
Company and lease back the asset. The carrying
amount (book value) of the asset is RM60,000.
The asset has a fair value of RM70,000.
How to recognize profit/loss if the selling price:
1. RM70,000
2. RM55,000
3. RM50,000 (with lower lease payment)
4. RM90,000
55

BKAF3063 A141

Sales and Leaseback

Solution to Illustration 11:
1. SP = FV (SP > CA) =
Profit = 70,000 - 60,000 = 10,000

recognize immediately

2. SP < FV (SP < CA)

Loss = 55,000 60,000 = 5,000 loss

recognize immediately

3. SP < FV (SP < CA with lower lease payment)

Loss = 50,000 60,000 = 10,000 loss
56

BKAF3063 A141

defer & amortize

Sales and Leaseback

Solution to Illustration 11:
4. SP > FV =
Profit = 90,000 60,000 = 30,000

FV CA
= 70,000 60,000
= 10,000 recognize immediately
SP FV
= 90,000 70,000
= 20,000 defer & amortize

57

BKAF3063 A141

Disclosure
Requirements
For Lessee:
Para 31: Finance lease.
Para 35: Operating lease.
For Lessor:
Para 47: Finance lease.
Para 56: Operating lease.

58

BKAF3063 A141

End of Topic 1

References:
MFRS 117 Lease
Ng Eng Juan 2012
Lazar & Huang 2012
Zaimah et al. 2009
59

BKAF3063 A141