Lease classification in Business

[Yakub02]

If it cannot be done with the entire lease, it must be classified as a finance lease unless it is clear that both elements are operating leases, in which case the entire lease is classified as an operating lease.

If the land element is immaterial, the land and buildings may be treated as a single unit for the purpose of lease classification. In such a case, the economic life of the building is regarded as the economic life of the entire leased asset.

The lessor does not record the leased asset in his own financial statements because he has transferred the risks and rewards of ownership of the leased asset to the lessee. Instead, he records the amount due to him under the terms of the finance lease as a receivable. The receivable is described as the net investment in the lease.

Net investment in the lease is the gross investment in the lease discounted at the interest rate implicit in the lease. Gross investment in the lease is the aggregate of: (a) the lease payments receivable by the lessor under a finance lease, and (b) any unguaranteed residual value accruing to the lessor.

the aggregate present value of the lease payments and the unguaranteed residual value; to be equal to;  the sum of the fair value of the leased asset and any initial direct costs of the lessor.

 

[Yakub02]

Therefore the net investment in the lease is the sum of the fair value of the asset plus the initial direct costs.

The lessor records a receivable for the capital amount owed by the lessee. This should be stated at the amount of the ‘net investment in the lease’.

For finance leases other than those involving manufacturer or dealer lessors, initial direct costs are included in the initial measurement of the finance lease receivable thus reducing the amount of income recognised over the lease term to below what it would have been had the costs not been treated in this way.

result of this is that the initial direct costs are recognised over the lease term as part of the income recognition process

 

[Yakub02]

Initial direct costs of manufacturer or dealer lessors in connection with negotiating and arranging a lease are excluded from the definition of initial direct costs. As a result, they are excluded from the net investment in the lease.

The treatment of similar costs incurred by manufacturers and dealers is explained later. Subsequent measurement of the receivable During each year, the lessor receives payments from the lessor

A finance lease receivable (net investment in the lease) is measured in the same way as any other financial asset

The finance charge is recognised as income in profit or loss for the period. The partial repayment of the lease receivable reduces the amount owed to the lessor