From the lessees perspective sale and leaseback

Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are:
(a) the lease transfers ownership of the asset to the lessee by the end of the lease term;

(b) the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised;

Now turning our attention to part (a) of the question, given the guidance in paragraph 10 above, the lease would not be deemed to be a finance lease. The lease term is five years and the asset has a useful life of eight years. As such, the lease would not be considered to cover ‘the major part of the economic life of the asset’ (as a rule of thumb, a major part should constitute at least 75 per cent of the useful life of the asset). The period covered by the option would not be included in the lease term as the lease rental is not low enough to give reasonable assurance of renewal (that is, it is not below normal commercial rates). We cannot anticipate the market rentals in five years’ time with any accuracy.

The present value of minimum lease payments is 80 per cent of the fair value of the leased property. Eighty per cent would not be construed as ‘at least substantially all of the fair value of the leased asset’ (a rule of thumb might be that the present value of the minimum lease payments should constitute at least 90 per cent of the fair value of the leased asset at the inception of the lease). Hence, given the lease term and the present value of the minimum lease payments do not satisfy the guidelines provided in paragraph 10 above, the lease is not considered to transfer the risks and rewards of ownership. From the perspective of the lessee, the term ‘guaranteed residual’ does not include amounts guaranteed by a third party unrelated to the lessee (although it can include amounts guaranteed by related entities). Hence, from the perspective of the lessee, the lease would be an operating lease.

However, the existence of the put option is probably sufficient to suggest classification as a finance lease by both the lessee and the lessor. Assume that the residual value equals the estimated market value at the end of the lease term. In this case, one could argue that the lessee bears substantially all the risks and rewards of ownership. In particular, the low market value that could result from obsolescence and wear and tear.

2

3

[13 122 = (140 000 – 8 784) x 0.10]

a revenue item, some organisations might treat this as an offset against the amortisation

expense. The net effect on profits will be the same.

Dr Cash 22 784
Cr Lease receivable 22 874 Dr Unearned interest
14 000 Cr Interest revenue 14 000

11.19 (a) The seller does not lose control of the asset (if the lease is a finance lease), but is able to ‘free-up’ funds for other activities which might generate higher returns that might be yielded from the property market. The sale might also enable the entity to diversify into other activities. At the time of the sale, the seller is also able to lock in any capital gains that might have occurred (although from an accounting perspective, if the subsequent lease is a finance lease, any gains must be recognised over the lease term).

If the lease is an operating lease, paragraph 61 of AASB 117 requires:

If a sale and leaseback transaction results in an operating lease, and it is clear that the transaction is established at fair value, any profit or loss shall be recognised immediately. If the sale price is below fair value, any profit or loss shall be recognised immediately except that, if the loss is compensated for by future lease payments at below market price, it shall be deferred and amortised in proportion to the lease payments over the period for which the asset is expected to be used. If the sale price is above fair value, the excess over fair value shall be deferred and amortised over theperiod for which the asset is expected to be used.

Firstly, although not required by the question, we can prove that the interest rate implicit in the lease is 10 per cent:

$300 000 x 1.0 = $300 000
$250 000 x 8.5136 = $2 128 400
$2 428 400

To determine the entry for the final lease payment we must determine the present value of one payment of $250 000 in one year discounted at 10 per cent. The present value is $250 000 x 0.9091 = $227 275.

Payment 06/19 includes residual