Cost of Asset in lease term business

[Yakub02]

The lessor knows that it needs to make sure to recover the cost of the asset together with any related interest during the lease term. The rentals are set at a level which allows it to do this. Therefore, the lessee will pay the full cash price of the asset together with related finance expense over the lease term.

 The lessee would only do this if it had access to the risks and benefits of ownership.

 In substance, this is just like borrowing the cash and buying the asset. Therefore, the lease is a finance lease.

Specialised nature of the asset If the lessor includes this term in the lease the lessor knows that when the lease comes to an end it will be unable to lease the asset on to another party.

Therefore the lessor knows that it needs to make sure to recover the cost of the asset together with any related interest during the lease term. The rentals are set at a level which allows it to do this.

Therefore, the lessee will pay the full cash price of the asset together with related finance expense over the lease term

 The lessee would only do this if it had access to the risks and benefits of ownership.  In substance, this is just like borrowing the cash and buying the asset.

 

[Yakub02]

The total rental receipts over the life of the lease will be more than the amount initially recognised as a receivable. The difference is finance income. The total finance income that arises over the life of the lease is the difference between the amount invested in the lease (the amount loaned plus the initial direct costs) and the sum of all receipts.

Manufacturers or dealers often offer to customers the choice of either buying or leasing an asset. A finance lease of an asset by a manufacturer or dealer lessor gives rise to two types of income:

 profit or loss equivalent to the profit or loss resulting from an outright sale of the asset being leased, at normal selling prices, reflecting any applicable volume or trade discounts;

 

[Yakub02]

The sales revenue recognised at the commencement of the lease term is the lower of:  the fair value of the asset; and  the present value of the lessor’s lease payments at a market rate of interest.

Cost of sale The cost of sale recognised at the commencement of the lease term is the carrying amount of the leased asset less the present value of the unguaranteed residual value.

The deduction of the present value of the unguaranteed residual value recognises that this part of the asset is not being sold. This amount is transferred to the lease receivable.

The balance on the lease receivable is then the present value of the amounts which the lessor will collect off the lessee plus the present value of the unguaranteed residual value. This is the net investment in the lease as defined earlier.

 

[Yakub02]

Costs incurred by manufacturer or dealer lessors in connection with negotiating and arranging a lease must be recognised as an expense when the selling profit is recognised.

Profit or loss on the sale The difference between the sales revenue and the cost of sale is the selling profit or loss. Profit or loss on these transactions is recognised in accordance with the policy followed for recognising profit on outright sales.

The manufacturer or dealer might offer artificially low rates of interest on the finance transaction. In such cases the selling profit is restricted to that which would apply if a market rate of interest were charged.