Year-end lease liability
At the end of the accounting period, there will be a current and non-current liability associated with the company’s lease obligations.
The finance lease obligations will be made up of the capital balance outstanding plus any interest accrued but not yet paid at the end of the reporting period.
The current liability will be:
- The amount of the principal repayable in the next twelve months, and
- Any interest accrued but not yet paid at the end of the reporting period
The non-current liability will be:
- The remaining principal balance, which will be paid in a period greater than twelve months.
Lessor’s financial statements
We’ll just take a quick look at how to account for finance leases in the financial statements of the lessor.
At the commencement of a finance lease, the lessor transfers the risks and rewards of ownership of the asset to a lessee.
Therefore, it would be inappropriate to record is as a piece of property, plant and equipment, as the lessor no longer has the use of the asset.
Instead, the lessor should record the amount due under the terms of the finance lease as a receivable.
This will be the principal amount and will be recorded as a ‘net investment in lease’, which should be the fair value of the asset.
During the term of the lease, the rental payments received by the lessor will be made up of two elements:
- Repayment of principal, and
- Interest income (finance income) on the principal outstanding.
The repayment of principal will reduce the amount of the principal due from the lessee in respect of the lease, and the interest income will be treated as income in the profit or loss for the period.
End of the lease
Two things may happen at the end of a lease term, either the asset will return to the lessor or the lessee will buy the asset.
Let’s look at the journal entries for these:
1. Return to lessor
To recognise the transfer of a leased asset back to the lessor:
| DR | Finance lease liability | XX | ||
| CR | Asset (leased asset) | XX |
2. Lessee purchases the asset
To reclassify a leased asset as a purchased asset:
| DR | Asset | XX | ||
| CR | Lease | XX | ||
| CR | Bank | XX |
Finance lease disclosures
A lessee must split the finance lease liabilities between the current liability and non-current liability.
- The current liability is the amount of principal payable in the next twelve months, plus any accrued interest, and
- The non-current liability is the amount of the principal payable in a period greater than twelve months.
The disclosure requirements of IAS 16 – Property, Plant and Equipment apply to leased assets, as they are treated as tangible non-current assets in the financial statements of the lessee.
IAS 17 also requires the following disclosures in the financial statements of the lessee:
- For each class of asset, the net carrying amount of assets held under finance leases at the end of the reporting period.
- A reconciliation (analysis) of the total future minimum lease payments at the end of the reporting period, and the present value of future minimum lease payments (i.e. discounted to present day values), divided into amounts falling due
− within 1 year
− later than 1 year and not later than 5 years
− later than 5 years.
- A general description of the lessee’s material leasing arrangements, including details of contingent rent payable, any renewal, purchase of escalation clauses, plus any lease restrictions in place (e.g. dividends, debt and further leasing restrictions)
- Contingent rents recognised as an expense in the period. Contingent rents amounts above the minimum lease payments and are not fixed in amount. They are based on factors other than the passage of time, for example they can be linked to factors such as sales (for a retail unit), or based on usage, interest rates, or price indices.