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INDONESIAN INSTITUTE OF ACCOUNTANTS
ACCOUNTING FOR LEASES
CONTENTS
paragraphs
INTRODUCTION ... 01-11 Background... 01-08 Type of Leases... 09 Execution of Lease Transaction... 10 Syndicated Lease... 11
STATEMENT OF FINANCIAL ACCOUNTING STANDARD NO 30
ACCOUNTING FOR LEASES... 12-46 Basic Considerations... 12-14 Purpose... 15
Criteria for Classifying Lease Transactions... 16-17 Accounting Treatment by Lessor... 18-26 Accounting Treatment by Lessee... 27-33 Reporting and Disclosures of Lease Transactions by the Lessor... 34-43 Reporting and Disclosures of Lease Transactions by the Lessee... 44-46
EFFECTIVE DATE... 47-48
APPENDIX: Problems and Developments of Accounting for Lease Transactions
PREFACE
Rapid economic development in Indonesia, especially after the government program of deregulation and debureaucratization at the beginning of the 1980’s, has resulted in an increased need for investment funds through various financing resources.
Nonetheless, the need for investment funds can be fulfilled by a financing alternative for capital goods which is relatively new in Indonesia, which is leasing.
As this new development emerges, there is a need for a financial accounting standard to be used as a guide for the recording and reporting of lease transactions as one of the financing alternatives other than the conventional financing alternatives of banks and capital markets.
The Indonesian Accounting Principles (PAI)1984 does not entirely fulfill the need for an accounting standard for leasing transactions. Hence, the Indonesian Institute of Accountants (IAI), the Indonesian Leasing Association (ALI), the Directorate General of Monetary Affairs (DJM) and the Directorate General of Tax (DJP) agreed to jointly develop a specific accounting standard for leases, which was stated in a cooperative charter dated November 10, 1989.
Based on the cooperative charter, the following people formed a working committee:
Chairman: Drs. Jusuf Halim (IAI) Vice Chairman: Drs. Karnedi Djairan (DJM) Secretary: Drs. Budi Purwano (ALI)
Members: Drs. Taufieq Herman M.A. (DJP)
Drs. Bambang Heryanto (DJM)
Dr. Wahjudi Prakarsa (IAI)
Drs. Sobo Sitorus (DJP)
Drs. M.V. Adhiprabawa (ALI)
Drs. Muchtar Tumin (DJP)
Drs. Victor Panjaitan (DJM)
The Indonesian Accounting Principles 1984 contain the basic concepts, principles, procedures, methods and accounting techniques which provide the general guidelines for the preparation of financial statements, especially for external users (financial accounting) purposes. To complete and develop the principles, the Indonesian Institute of Accountants issued a series of accounting standards and related interpretations. In addition, as a guide in the preparation of financial statements for specific industries or businesses, the Indonesian Institute of Accountants considered it necessary to issue a specialized accounting standard. After lengthy deliberations, it was unanimously agreed that each PAI statement would be referred to as a specialized accounting standard.
Accordingly, PAI Statement No. 6 is titled Specialized Accounting Standard for Leases. This specialized Accounting Standard for Leases should be used as a guide when recording and reporting lease transactions.
In the framework of developing the Indonesian Accounting Principles (PAI) to become the Statement of Financial Accounting Standard (SFAS), PAI No. 6, Special Accounting Standard for Leases, has been amended as necessary to become SFAS No. 30, Accounting for Leases. This Statement was adopted by a meeting of the Indonesian Accounting Principles Committee on August 24, 1994, and was ratified by a meeting of the Executive Committee of the Indonesian Institute of Accountants on September 7, 1994.
Compliance with the policies in this Statement is not obligatory in the case of immaterial items.
Jakarta, September 7, 1994
Executive Committee Indonesian Institute of Accountants
Indonesian Accounting Principles Committee
Hans Kartikahadi Chairman
Jusuf Halim Secretary
Hein G. Surjaatmadja Member
Katjep K. Abdoelkadir Member
Wahjudi Prakarsa Member
Jan Hoesada Member
M. Ashadi Member
Mirza Mochtar Member
IPG. Ary Suta Member
Sobo Sitorus Member
Timoty Marnandus Member
Mirawati Soedjono Member
INTRODUCTION Background
01 Leasing in Indonesia was first introduced in 1974 by a Joint Decree of the Minister of Finance, Minister of Trade and Minister of Industry No. Kep-122/MK/2/1974, No.
32/M/SK/2/1974 and No. 30/Kpb/I/74 dated February 7, 1974 on “License for Leasing Companies”. Since then, and especially since 1980, the number of leasing companies and lease transactions have increased from year to year to finance the need for capital goods.
02 The presence of joint venture leasing companies with local private companies have popularized leasing as a capital financing alternative which is essential to Indonesian businesses, in addition to other conventional financing alternatives through banks.
03 The increase in financing alternatives led to the definition of leasing in article 1 of the above mentioned Joint Decree of the Minister of Finance, Minister of Trade and Minister of Industry that states:
"Leasing is any financing activity engaged by a company to provide capital goods for a fixed period based on periodic payments, with an option to purchase such capital goods or to extend the leasing term based on the agreed upon residual value."
04 The definition appears to address only finance leases. However, the Minister of Finance Decree No. 1251/KMK.013/1988 dated December 20, 1988, expanded the definitions of leasing activities in Article 1 of the Decree which includes the following:
(a) a leasing company is a company that provides financing facilities, under finance leases as well as operating leases for capital goods, to be used by the lessee for a fixed period based on periodic payments;
(b) a finance lease is a leasing activity that gives the lessee an option to buy the object of the lease at the end of the lease term, based on a mutually agreed residual value;
(c) an operating lease is a leasing activity that gives the lessee no option to buy the object of the lease; and
(d) a lessee is a person or a company that uses the capital goods which are financed by the lessor.
05 The criteria above does not change the basic meaning of a lease in Indonesia but gives leasing companies an opportunity to engage in operating lease transactions which, in essence, have previously represented regular rental transactions.
06 Concurrent with the increased opportunities for leasing companies to expand the leasing business through either finance leases or operating leases, the need emerged for an accounting standard to record and report lease transactions in accordance with the characteristics and scope stipulated in the Minister of Finance Decree. This need is considered essential because so far there has been no definitive rules on the legal status or the accounting treatment for lease transactions.
07 Even though leasing activities in developed countries are more popular and developed, the accounting treatment for leasing transactions is subject to numerous complicated and contradictory issues which could prove controversial.
08 The development of accounting for leases and its related controversies are summarized in the Appendix of this Statement.
Types of Leases
09 Common types of leases, including the two types of leases stipulated in the Ministry of Finance Decree, are as follows:
Finance Lease: Under this type of lease, a lessor finances the procurement of capital goods. A lessee usually decides on the required capital goods and, on behalf of the lessor as the owner of the capital goods, orders, inspects and maintains the leased asset. During the lease term, the lessee makes periodic payments, the total of which plus the payment of the residual value, if any, will cover the acquisition price of the capital goods and interest, which represents income to the leasing company.
Operating Lease: Under this type of lease, the lessor buys the required capital goods to be leased to the lessee. Unlike the finance lease, the total periodic payments in an operating lease does not cover the amount spent to acquire the capital goods and the interest. The difference is due to the lessor's expectation of earning a profit from the sale of the leased assets or from other lease contracts.
The lessor should possess special skills to maintain and to resell the leased capital goods.
Unlike a finance lease, the lessor in an operating lease usually has the responsibility for lease expenses, such as insurance, tax and maintenance of the related capital goods.
Sales-Type Lease: A sales-type lease is a direct finance lease where the total transaction amount includes the profit determined by manufacturers or distributors who are also the lessors. This type of lease is usually a distribution channel for marketing of a certain company's product.
Leveraged Lease: This lease transaction usually includes at least three parties: the lessee, the lessor and the long-term creditors who finance the major portion of the leasing transaction.
Execution of Lease Transactions
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10 In practice, lease transactions can be executed as follows:
Direct Lease: Under this type of transaction, the lessee does not posses the leased asset until the lessee requests the lessor to acquire the asset. The lessee’s main purpose is to obtain funds through leasing for the acquisition of capital goods for production processes.
Sale and Leaseback: Under this type of transaction, a lessee sells capital goods it owns to a leasing company and subsequently executes a lease contract to lease the same capital goods from the leasing company.
Syndicated Lease
11 In a syndicated lease, several leasing companies, in consortium, enter into a lease transaction with a lessee. This type of lease is executed because the value of the transaction is too significant or because of other factors. One leasing company will be appointed as the coordinator, to whom the lessee communicates all activities related to the lease contract. This transaction can be performed through a direct lease as well as sale and leaseback.
STATEMENT OF FINANCIAL ACCOUNTING STANDARD NUMBER 30 ACCOUNTING FOR LEASES
Basic Considerations
12 In accordance with Article 3 paragraph 3 of the Minister of Finance Decree No.
1251/KMK.013/1988 dated December 20, 1988, it is stipulated that as long as the lease contract is valid, the legal title to leased assets remains with the lessor. Therefore, during the lease term, the legal title to the leased assets stays with the lessor, even though the lease contract transfers the responsibility for the usage of the capital goods to the lessee.
13 Regardless of the above rule, from an accounting point of view, paragraph 35 of the Framework for the Preparation and Presentation of Financial Statements states that financial reporting emphasizes the economic substance of an event or a transaction, rather than its legal form. Therefore, a lease transaction that, based on the economic substance represents a transfer of benefits and risks attached to the ownership of the asset, should be treated as an asset acquisition and incurrence of a capital lease by the lessee and as sales or finance lease by the lessor.
14 On the other hand, a lease transaction that, based on the economic substance, does not represent a transfer of benefits and risks attached to the ownership of the asset, should be treated as an operating lease between the lessee and the lessor.
Purpose
15 This Statement was prepared for the following reasons:
(a) the need for clarity in the accounting treatment and reporting for lease transactions to disclose the status of leased capital goods for both the lessor and the lessee;
(b) the need for guidance on uniform accounting treatment for lease transactions so that the financial data presented in financial statements can be easily analyzed and interpreted by all interested parties; and
(c) the popularity of lease transactions in Indonesia after the deregulation and debureaucratization increased the need for an accounting standard to clarify the required disclosures necessary to fulfill the requirements of the users of financial statements.
Criteria for Classifying Lease Transactions
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16 Since economic substance is the basic principle considered, a lease transaction is classified as a capital lease by the lessee or as a finance lease by the lessor if it satisfies all of the following criteria:
(a) the lessee has the option to purchase the leased asset at the end of the lease period at an agreed upon price at the inception of the lease agreement;
(b) the sum of periodic lease payments made by the lessee, plus the residual value will cover the acquisition price of the leased capital goods and the related interest, which represents the leasing company's profit (full payout lease); and
(c) a minimum lease period of 2 years.
17 If any of the above criteria is not satisfied, the lease transaction should be classified as an operating lease.
Accounting Treatment by the Lessor Finance Lease
18 Net investment in the leased assets should be treated and recorded as a net investment in finance lease. This amount consists of lease payments receivable plus the residual value (option price) that will be received by the lessor at the end of the lease period, less the unearned lease income and security deposit.
19 The difference between lease payments receivable plus residual value (option price) and the acquisition price of the leased assets is treated as unearned lease income.
20 Unearned lease income should be allocated consistently to the current period’s income based on a constant periodic rate of return lessor’s net investment in the leased assets.
21 If the lessor sells the leased assets to the lessee before the end of the lease term, the difference between the selling price and the net investment in the leased assets at the time of sale should be recognized and recorded as a current year gain or loss.
22 Other income received in connection with the lease transaction should be recognized and recorded as current year’s income.
Operating Lease
23 Capital goods leased should be treated and recorded as leased assets based on the acquisition cost.
24 Current year lease payments from the lessee should be recognized and recorded as lease income. Lease income should be recognized and recorded on a straight-line basis
over the lease term, even though the lease payments may be in different amounts for each period.
25 Depreciation of assets should be recorded based on its estimated useful life.
26 If the leased asset is sold, the difference between the book value and the selling price should be recognized and recorded as a current year gain or loss.
Accounting Treatment by the Lessee Capital Lease
27 A lease transaction is treated and recorded as a fixed asset and lease obligation at the inception of the lease term, at the present value of all lease payments plus residual value (option price) which must be paid by the lessee at the end of the lease term. During the lease term, each lease payment is allocated and recorded as repayment of the lease obligation and interest expense based on an interest rate applied to the carrying amount of the lease obligation.
28 The discount rate used to determine the present value of lease payments is the interest rate charged by the lessor or the prevailing market interest rate at the inception of lease term.
29 Leased capital goods should be amortized based on its estimated useful life.
30 If the leased asset is purchased before the end of the lease term, the difference between the amount paid and the carrying amount of the lease obligation is charged or credited to current year’s income.
31 Leases should be presented as current and long-term liabilities in accordance with common practices in the lessee's type of business.
32 When a sales and leaseback transaction is involved, the transaction should be treated as two separate transactions, that is, a sales transaction and a lease transaction.
The difference between the selling price and the book value of the asset sold should be recognized and recorded as deferred gain or loss. Amortization of deferred gain or loss should be treated in proportion to the amortization of the leased assets if the leaseback is a capital lease, or in proportion to the rent expense if the leaseback is an operating lease.
Operating Lease
33 Lease payments during the current year should be recognized and recorded as lease expense. However, lease expense, should be recorded on a straight-line basis over the lease term even though the lease payments may be in different amounts for each period.
Reporting and Disclosure of Lease Transactions by the Lessor
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Finance Lease
34 Assets are classified based on their liquidity, and liabilities are classified based on their maturity dates, without grouping them into current or long-term items in an unclassified balance sheet.
35 Net investment in leased assets should be reported in the balance sheet as follows:
Lease receivables Rp XXXXX Guaranteed residual value XXXXX Unearned lease income (XXXXX) Security deposit (XXXXX)
Net investment in finance lease Rp XXXXX Allowance for doubtful lease receivables (XXXXX)
Net Investment Rp XXXXX
36 The income statement should be presented in a manner that all income is reported separately from expenses (single step). Lease income should be reported as a major component of income.
37 The sum of the net investment and lease income from syndicated and leveraged leases should be reported by each party in the proportion of their investment.
38 Adequate disclosure should be made in the notes to the financial statements for the following:
(a) significant accounting policies adopted with respect to lease transactions;
(b) total lease payments for at least the next two years;
(c) the nature of security deposits that represent the lessor's liability to the lessee;
(d) lease receivables pledged to a third party; and
(e) syndicated and leveraged leases.
Operating Lease
39 Leased assets are reported at the acquisition cost less accumulated depreciation.
40 Leased assets are reported separately from fixed assets that are not used for leasing purposes.
41 The income should be presented in a manner that all income is reported separately from expenses (single step). Lease income should be reported as a major component of income.
42 Depreciation of leased assets should be reported separately from depreciation of fixed assets that are not used for leasing purposes.
43 Adequate disclosure should be made in the notes to the financial statements for the following:
(a) significant accounting policies adopted with respect to lease transactions;
(b) total lease payments for at least the next two years;
(c) the nature of security deposits, if any;
(d) leased assets pledged to a third party; and
(e) syndicated and leveraged leases.
Reporting and Disclosure of Lease Transactions by the Lessee Capital Lease
44 Leased assets should be reported separately as a part of fixed assets. The related lease obligation should be presented separately from other liabilities.
45 Adequate disclosure should be made in the notes to the financial statements for the following:
(a) total lease payments for at least the next two years;
(b) current year depreciation expense on leased assets;
(c) guarantees given in connection with the lease transaction;
(d) deferred gain or loss and its related amortization in connection with sale and leaseback transactions; and
(e) major covenants stipulated in the lease agreement.
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Operating Lease
46 Adequate disclosure should be made in the notes to the financial statement for the following:
(a) payments charged to lease expense in the current year;
(b) total lease payments for at least the next two years;
(c) guarantees given in connection with the lease transaction;
(e) deferred gain or loss and its related amortization in connection with sale and leaseback transactions; and
(f) major covenants stipulated in the lease agreement.
EFFECTIVE DATE
47 This Statement becomes effective for any lease transactions entered into since January 1, 1991. Earlier application is encouraged.
48 Lease transactions entered into before January 1, 1991, should be accounted for in accordance with this Statement starting from January 1, 1991. The restatement of previous financial statements is not required.
APPENDIX: ISSUES AND DEVELOPMENTS RELATED TO ACCOUNTING FOR LEASE TRANSACTIONS
As mentioned in the Introduction, even though lease activity in developed countries is substantially more developed than Indonesia, the accounting treatment for leasing transactions is subject to numerous, complicated and contradictory issues which could be controversial.
For example, Leaseurope (an organization of leasing associations from 16 West European nations) has objected to lease capitalization by the lessee because of the controversy over the right to the capitalized asset and the inherent complication in its application. This objection indicates that the application of International Accounting Standard (IAS) No. 17 in Europe has not been as smooth as expected, because there is no agreement among accounting professionals and practitioners on the accounting treatment for lease transactions.
The same situation arose in the United States where application of the Statement of Financial Accounting Standards (SFAS) No. 13 has proven to experienced several difficulties. As a result, follow-up efforts were made through the issuance of several additional SFAS and Financial Accounting Standards Board (FASB) Interpretations1.
Although leasing is still in an early stage of development, the situation in Indonesia is not much different. So far, the development of accounting standards for lease transactions has only referred to the following sources and regulations:
1. Director General of Monetary Affairs Circular Letter No. SE-499/MD/1984
Dated January 24, 1984 on Rules and Procedures for Submission of Reports of Leasing Companies. Item 5 of this Circular Letter states that:
"The Company's Balance Sheet and Income Statement should be presented based on the finance method with a minimum requirement of clearly reflecting its investment position in leasing, current assets, fixed assets, current/short-term liabilities, long-term liabilities and equity at each reporting period."
1SFAS 22, "Changes in the Provision of Lease Agreements Resulting from Refundings of Tax-Exempt Debt"; SFAS 23, "Inception of the Lease"; SFAS 26, "Profit Recognition on Sales-type Leases of Real Estate"; SFAS 27, "Classification of Renewals or Extensions of Existing Sales-Type or Direct Financing Leases"; SFAS 29, "Determining Contingent Rentals"; FASB Interpretation 19, "Lessee Guarantee of the Residual Value of Leased Property"; FASB Interpretation 23, "Leases of Certain Property Owned by a Governmental Unit or Authority"; FASB Interpretation 24, "Leases Involving Only Part of a Building"; FASB Interpretation 26, "Accounting for Purchase of a Leased Assets by the Lessee During the Term of the Lease"; and FASB Interpretation 27, "Accounting for a Loss on a Sublease".
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This Circular Letter was superseded by Presidential Decree No. 61/1988 and Minister of Finance Decree No. 1251/KMK.013/1988 dated December 20, 1988.
2. Exposure Draft of Indonesian Accounting Principles (PAI) 1983 Article 13 chapter 3 relating to leasing states that:
2.1 Leasing is any financing activity engaged in by a company to provide capital goods for a fixed period based on periodic payments, with an option to purchase such capital goods or to extend the lease term based on the agreed upon residual value.
2.2 Accounting for leases is based on the economic concept of "substance over form".
It considers the substance of the related transactions and whether there is any substantial transfer of inherent benefits and risks in the ownership of the leased asset.
If there is a transfer of substantial benefits and risks from the lessor to the lessee, the lease is classified as a capital lease by the lessee, and a direct financing lease or a sales-type lease by the lessor. Otherwise, the lessor and the lessee will account this lease as an operating lease.
2.3 The accounting treatment for leases in the financial statements of the lessee can be summarized as follows:
Capital Lease
A capital lease is reflected in the balance sheet by recording an asset and a corresponding liability at the lower of the present value of minimum lease payments over the lease term or fair value of the leased assets at the inception of the lease term.
Any payments during the lease period will be allocated as a reduction of lease obligation and interest expense. Assets recorded under capital leases and its accumulated depreciation should be presented separately in the lessee’s balance sheets or adequately disclosed in the notes to the financial statements. The same applies to lease obligations which should also be presented and classified as short-term or long-term liability in the balance sheet in accordance with common industry practice. The amount of depreciation on leased assets which has been charged to income should also be disclosed.
Operating Lease
Lease payments under an operating lease are expensed during the lease period when they are accrued. However, when the lease payments are not based on a straight- line method, the lease expense should be recognized based on the straight-line method, unless there is a more systematic basis to reflect the pattern of benefit obtained from the leased asset.
2.4 For the lessor, the accounting treatment is as follows:
Direct Financing Lease
Lease payments receivable are recorded in the balance sheet in the amount of the total minimum lease payments plus unguaranteed residual value. The difference between the lease payments receivable and the book value of leased assets is recorded as unearned income.
Sales-Type Lease
The accounting treatment for sales-type leases is similar to direct financing leases.
The only difference between the sales-type lease and direct financing lease is the existence of a manufacturer's or dealer's profit at the inception of the lease.
Operating Lease
The lessor records the leased assets as fixed assets and depreciates them in accordance with the normal depreciation policy. Rent income should be reported in the income statement during the lease period.
A decision was made that this exposure draft should be deferred, and excluded from the Financial Accounting Standard with a note that this issue will be addressed in a separate Statement.
3. International Accounting Standard (IAS) No. 17 Classification of Leases
The classification of leases under the International Accounting Standard (IAS) is based on the economic concept, where the risks and benefits associated with the ownership of leased assets lies with the lessor or the lessee and not based on the lease contract.
A lease is classified as finance lease if all risks and benefits associated with the ownership is transferred to the lessee. Such a lease is normally noncancelable and assures the recovery of lessor's capital outlay as well as the return on the lease investment.
Any lease that does not meet the above criteria is classified as an operating lease.
Accounting for Leases in the Lessor's Financial Statements
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Paragraph 48 states that an asset recorded under a finance lease should be recorded in the balance sheet as a receivable at an amount equal to net investment in the lease and not as a fixed asset.
Paragraph 49 states that the recognition of the lease income in finance leases should be based on a pattern reflecting a constant periodic rate of return and applied on a consistent basis.
In an operating lease, lease income should be recognized on a straight-line basis over the lease term or any other systematic and rational basis based on the pattern of the earnings process.
The amount of depreciation on leased assets should be determined on a consistent basis with the lessor's normal depreciation policy for their fixed assets.
Adequate disclosure of the gross investment in the lease, unearned lease income and unguaranteed residual value of the leased assets should be made at each balance sheet date for lease transactions reported as finance leases. The basis for recognizing lease income should also be disclosed. If a significant portion of the lessor's business consists of operating leases, the lessor should disclose total assets based on lease classifications and the related accumulated depreciation.
Accounting for Leases in the Lessee's Financial Statements
Paragraph 44 states that a finance lease should be reflected in the lessee's balance sheet by recording the asset and lease obligation at an amount equal to the fair market value of the leased asset or the present value of the minimum lease payments at the inception of the lease term.
Paragraph 47 states that the charge to income under an operating lease should be the rent expense for the accounting period. The expense should be recognized on a systematic basis reflecting the pattern of benefits obtained by the lessee.
Under finance leases, lease payments should be allocated between reduction of the lease obligation and payment of interest based on a constant interest rate applied to the balance of the lease obligation. A finance lease will result in depreciation of the leased asset by the lessee. The depreciation policy for leased assets should be consistent with the depreciation policy for other fixed assets.
If there is no certainty that the lessee will obtain ownership at the end of the lease term, the cost of the leased asset should be depreciated over a shorter term than the lease term or its economic useful life.
In a sale-leaseback transaction treated as a financing lease, the excess of the selling price over the book value should not be recognized immediately as income in the seller's
(lessee's) financial statements. The profit should be deferred and allocated over the lease term.
If the sale-leaseback transaction is treated as an operating lease based on fair value, the profit or loss should be recognized immediately. On the other hand, if the sale- leaseback transaction is consummated at an amount higher than the fair value, then the excess above the fair value should be deferred and allocated over the lease term.
At each balance sheet date, total assets acquired through finance leases should be adequately disclosed. The related lease obligations should be disclosed separately from other liabilities, and the current and long-term portions should also be presented separately.
A noncancelable commitment to pay minimum lease payments under either a finance lease or an operating lease that covers a more than one year should be disclosed in a summary form, covering the amounts and payment dates.
Important information, such as financial restrictions, renewal rights, and purchase options, remaining lease payments and other commitments related to the lease, should also be disclosed.
4. Statement of Financial Accounting Standards (SFAS) No. 13 Criteria for Classifying Leases
SFAS No. 13 states that the criteria for classifying leases should be based on the economic concept, that is if a lease transfers all the benefits and risks associated with ownership of the asset then the lease should be regarded as acquisition of an asset and incurrence of an obligation by the lessee, and as a sale or financing by the lessor.
If, at its inception, a lease meets one or more of the following criteria at its inception, then the lease shall be classified as a capital lease by the lessee, otherwise it shall be classified as an operating lease.
The criteria are as follows:
(a) there is a transfer of ownership of the leased asset to the lessee at the end of the lease term;
(b) there is an option for the lessee to purchase the leased assets at the end of the lease term at a price lower than the estimated fair value at the time the option is exercised;
(c) the lease term is equal to or greater than 75 percent of the estimated economic life of the leased asset; and
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(d) the present value of minimum lease payments at the beginning of the lease term, excluding the executory costs, equals or exceeds 90 percent of the fair value of the leased asset.
Other than any one of the criteria above, two other criteria must be met in order for the lessor to classify the lease as a direct financing lease.
The two additional criteria are:
(a) the ability to collect the minimum lease payments is reasonably assured; and
(b) no significant uncertainties relating to the amount of costs incurred by the lessor in connection with the lease.
Accounting for Leases in the Lessor's Financial Statements
Paragraph 18 states that in a direct financing lease, the minimum lease payments plus the unguaranteed residual value accruing to the benefit of the lessor should be recorded as the gross investment in the lease.
The difference between the gross investment in the lease and the acquisition cost of leased property should be recorded as unearned income, which will be allocated over the lease term so as to produce to a certain periodic rate of return on the net investment in the lease. Gross investment in the lease less unearned income equals net investment.
Classification of the net investment in the lease as current or long-term assets in the balance sheet is subject to current rules for other assets.
Paragraph 19 states that for an operating lease, the leased property should be recorded as a lease asset and presented before or right after fixed assets in the lessor's balance sheet. The leased property should be depreciated following the lessor's depreciation policy for other fixed assets and accumulated depreciation should be deducted from the investment in the leased property.
Lease payments under an operating lease will be reported as income over the lease term as they become receivable from the lessee according to the provisions of the lease.
Even though lease payments vary from a straight-line basis, the income should be recognized on a straight-line basis, unless there is another more systematic basis that better reflects the pattern of diminishing benefit from the leased property.
For a direct financing lease, the minimum lease payments to be received annually for the five succeeding years, the unguaranteed residual value accruing to the benefit of the lessor, and the unearned income should be adequately disclosed at each balance sheet date. The asset's acquisition cost or its carrying amount, if it is different from the acquisition cost, in an operating lease should be disclosed by asset groups according to the nature and function of the leased asset, together with the accumulated depreciation.
The amount of noncancelable minimum lease payments should be disclosed for the year and for each of the five succeeding years.
Accounting for Leases in the Lessee's Financial Statements
Paragraph 10 states that under a capital lease, the lessee should record the leased property as an asset and an obligation at an amount equal to the present value of the minimum lease payments at the beginning of the lease term. If the amount exceeds the leased property's fair value at the inception of the lease, then the amount recorded as an asset and an obligation should be the fair value. During the lease period, each lease payment should be allocated as a reduction of the obligation and interest expense.
Fixed assets under capital leases and its related accumulated depreciation should be presented separately in a lessee's balance sheet or disclosed adequately in the notes to the financial statements. The related obligation for capital leases should be presented and classified as current or noncurrent liabilities in the balance sheet consistent with industry practice.
The depreciation on leased assets that is charged to income should also be disclosed. Meanwhile, paragraph 15 states that lease payments under an operating lease shall be charged to expense over the lease term as it becomes payable.
When lease payments are not made on the straight-line method, lease expense should still be recognized based on a straight-line method, unless there is a more systematic and representative basis to reflect the pattern of benefits derived from the use of the asset.
Under a direct financing lease, adequate disclosure should be made on the gross amount of the leased assets based on the nature and function of the assets and the minimum lease payments for the year and for each of the five succeeding years.
Under an operating lease, adequate disclosure should be made on noncancelable minimum lease payments for the year and for each of the five succeeding years.
Lease payments charged to expense in the income statement should also be disclosed.
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