Leasing

Prepared by the faculty

 Key points

01 Understand the lease transaction

02 Differentiate amongst the types of leases

Discuss the financial statement effects of leasing

03
 What is lease?
It is a contract between the two people, one who gives the asset on lease (lessor)
and another who takes the asset on lease (lessee) for the ‘use’ of an identified
asset:

 Lessor is owner and supplier of asset

 Lessee is user of asset

Legal Ownership vests with the owner of the asset
 Types of Leases (IAS 17)

Types of
leases

Sale and
Operating Financial
Lease
Lease Lease
back
 Operating Leases

• A lease under which the lessor maintains and finances

the property; also called a service lease.
• Lessor maintains the asset and will also be responsible for
any taxes or insurance.
• Operating leases are often relatively short-term. The
payments received by the lessor are usually not enough to
allow the lessor to fully recover the cost of the asset.
 Financial Lease

• Financial lease is also called capital lease and has the

following properties:
• The lessee (not the lessor) is usually responsible for
insurance, maintenance, and taxes.
• Long-term: The payments made are usually sufficient to
fully cover the lessor’s cost of purchasing the asset and pay
the lessor a return on the investment
 Sale and Leaseback

• An arrangement whereby a firm sells land, buildings, or

equipment and simultaneously leases the property
back for a specified period under specific terms.
1. The lessee receives cash from the sale of the asset.
2. The lessee continues to use the asset
3. The lessee may have the option to repurchase the leased
asset at the end of the lease.
 (FASB 13), “Accounting for Leases.”
Operating Lease Financial Lease
• In this case, neither • The Asset is shown as
the asset nor the a non-current asset
liability (the present and the present value
value of the lease of the lease payments
payments) appears in is shown as a liability
the balance sheet. in the balance sheet.
 Operating or Capital Lease?
If one or more of the four criteria are met, the lease is a capital lease;
otherwise, it is an operating lease for accounting purposes
1. The lease transfers ownership of the property to the lessee by the end
of the term of the lease.
2. The lessee can purchase the asset at a price below fair market value
(bargain purchase price option) when the lease expires.
3. The lease term is 75 percent or more of the estimated economic life of
the asset.
4. The present value of the lease payments is at least 90 percent of the
fair market value of the asset at the start of the lease.
 Practice Question 1
A company leases a machine with a six-year life and a cost of
$10,000 for 4 years with annual payments of $2,500 due at the end
of each year. The lessee can borrow at 4% per annum. Calculate if
the lease should be treated as an operating lease or capital lease.

Reference: Team, T. (2020). December 2020 CFA Level 1: CFA Study Preparation. Retrieved 17 April 2020, from https://analystnotes.com/cfa-
study-notes-distinguish-between-a-finance-lease-and-an-operating-lease-from-the-perspectives-of-the-lessor-and-the-lessee.html
 Solution
1. Does the lease transfer ownership of the property to the lessee at the end of
the lease term?
• No, the asset is only leased for 4 years out of its possible 6-year useful life and the asset
is given back to the lessor. This requirement is not met.
2. Does the lease contain a bargain purchase option?
• Not from the information available in the question. Thus this requirement is not met.
3. Is the lease term equal to 75% or more of the estimated economic life of the
leased property?
• The lease is for 4 of the 6-year useful life, which equates to 66.6% (4/6) of the estimated
economic life. This requirement is not met.
Reference: Team, T. (2020). December 2020 CFA Level 1: CFA Study Preparation. Retrieved 17 April 2020, from https://analystnotes.com/cfa-
study-notes-distinguish-between-a-finance-lease-and-an-operating-lease-from-the-perspectives-of-the-lessor-and-the-lessee.html
 Solution
 4. Does the present value of the minimum lease payments equal or exceed 90%
of the fair value of leased property to the lessor?
Calculate for the PV of the minimum lease payments:
)
PV= 2500)
PV=9074
Therefore, 9074/10,000 = 90.7% 
Conclusion: This is a financing/capital lease 
Reference: Team, T. (2020). December 2020 CFA Level 1: CFA Study Preparation. Retrieved 17 April 2020, from
https://analystnotes.com/cfa-study-notes-distinguish-between-a-finance-lease-and-an-operating-lease-from-the-perspectives-of-
the-lessor-and-the-lessee.html
 Practice Question 2
On January 1, 2017, XYZ Company signed an 8-year lease agreement for
equipment. Annual payments are $28,500, to be made at the beginning
of each year. At the end of the lease, the equipment will revert to the
lessor. The equipment has a useful life of 8 years and has no residual
value. At the time of the lease agreement, the equipment has a fair value
of $166,000. An interest rate of 10.5% and straight-line depreciation are
used
Identify the type of lease?

Reference: Lease Accounting - Operating vs Financing Leases, Examples. (2020). Retrieved 10 April 2020, from
https://corporatefinanceinstitute.com/resources/knowledge/accounting/lease-accounting/
 Solution
 1.There is no bargain purchase option because the
equipment will revert back to the lessor.
2. The life of the lease is 8 years and the economic life of the
asset is 8 years.
= 100%

Reference: Lease Accounting - Operating vs Financing Leases, Examples. (2020). Retrieved 10 April 2020, from
https://corporatefinanceinstitute.com/resources/knowledge/accounting/lease-accounting/
 Solution
 3. Calculate for the PV of the minimum lease payments:
)
PV= 28500)
PV=164995
Therefore, 164,995/166,000 = 99% 
Conclusion: This is a financing/capital lease 
Reference: Lease Accounting - Operating vs Financing Leases, Examples. (2020). Retrieved 10 April 2020, from
https://corporatefinanceinstitute.com/resources/knowledge/accounting/lease-accounting/
 References
Chapter 20: Brigham, E. F., & Houston, J. F.
(2012). Fundamentals of financial management. Cengage
Learning.
Chapter 26: Ross, S. A., Westerfield, R., & Jordan, B. D.
(2008). Fundamentals of corporate finance. Tata McGraw-
Hill Education.
Any Questions??