Do You Know Lease in Terms of Accounting?

  • A lease agreement is a contract between the lessor and the lessee. The lessor is the legal owner of the asset, and the lessee obtains the right to use the asset in exchange for rent.
  • Assets that have been used but not owned are not shown in the statement of financial position, so any related liabilities are also excluded from the statements which is the company’s ability to keep debt low.

IAS 17

  • IAS 17 states that there are two types of lease, a finance lease and an operating lease.
  • Finance lease is a lease that transfers almost all risks and rewards related to asset ownership to the lessee.
  • Operating lease is defined as any lease other than finance lease.

Initial accounting

  • The initial accounting treatment is that the lessee capitalizes the financial lease assets and establishes the lease liability according to the value of the assets confirmed.
  • Dr Non-current assets
    Cr Finance lease liability

Subsequent accounting

  • After the initial capitalization of the leased asset, the asset shall be depreciated within the shorter period of the lease term or the useful economic life of the asset. The accounting treatment for this will be:
  • Dr Depreciation expense

Cr Accumulated depreciation

Finance cost

  • In lease agreement, it should be show there are financial costs in the transaction.
  • The company buy an asset with a useful economic life of four years for RM25,000 or lease it for four years paying a rental of RM5,000 per annum.

Consideration

  • Leasing contract is mostly signed for long term.
  • The most common lease term is one year, but as long as the lessor and lessee agree, the lease term can be arbitrarily long.
  • The monthly instalments are paid for the lease.

Change in contract or agreement

A strong, well-worded lease contract helps to ensure the best interests of both parties are protected, because neither party can change the agreement without the other party’s written consent

Offer at expiry

  • Once the term is over, the lessee should decide whether to purchase the asset or property.

The advantage and disadvantage for a lease

Advantage

  • Structured for long term and stable occupancy.
  • Provide more predictable rental income stream.

Disadvantage

  • The monthly instalment remains unchanged until the end of the lease.
  • May lose out on incremental income if market value of property increases.