NAS 17 Lease

Revision Note
Relevant For CAP-II students

Unit overview:

Objective: to
prescribe
appropriate
accounting
policies and
disclosure to
apply n relation
to leases

sale and
leaseback
transaction Criteria for
where classification of
leaseback is lease-finance
either : finance and operating
lease or lease
operating
lease.

accounting and accounting and

disclosure for disclosure for
operating lease finance lease in
in the books of the books of
lessor and lessor and
lessee. lessee.

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NAS 17 Lease
Revision Note
Relevant For CAP-II students

Relevant Definition

1. Lease: Agreement where lessor conveys to lessee, right to use an asset, for an
agreed period of time, in relation for series of payments.

Transfer right to use the asset

Lessor (a party who Lessee (pays for right to
gives the asset) use an asset)
Payments for right to use the asset
2. Finance lease:
Lease that transfers substantially all risks and rewards incidental to ownership of an
asset. Title may or may not eventually be transferred.
3. Operating Lease:
Lease other than finance lease.
4. Minimum Lease payments:
Payments over lease term that the lessee is or can be required to make excluding
contingent rent, service cost and taxes to be paid by and reimbursed to the lessor.

MLP ( For lessee) = Agreed lease rental excluding contingent rents, costs for service
and taxes + Guaranteed residual value by Lessee or party
related to lessee.
MLP (For lessor) = Agreed lease rental excluding contingent rents, costs for service
and taxes + Guaranteed residual value by Lessee or party related
to lessee, or Independent third party
5. Inception of lease:
Earlier of following:
a. Date of lease agreement.
b. Date of commitment by the parties to the principal provisions of lease.
At this date, lease is classified as either operating or finance lease.
6. Commencement of lease term:
Date from which lessee is entitled to exercise right to use the leased asset. Date of
initial recognition of lease.
7. Unguaranteed Residual value:
That portion of the residual value of the leased asset , the realisation of which by the
Lessor is not assured or is guaranteed solely by a party related to the lessor.
(Total residual value- Guaranteed residual value)
8. Gross investment in lease:
MLP by lessor under a finance lease + Unguaranteed Residual value
9. Net investment in Lease:
Gross investment in lease discounted at interest rate. (Present value of Gross
Investment)
10. Unearned finance income:
Gross investment in lease- Net investment in lease
11. Economic life:
Period over which the asset is expected to be usable by anyone

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NAS 17 Lease
Revision Note
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12. Useful life:

Period over which the economic benefits of the assets are expected to be used by
lessee.

Characteristics of Finance Lease

Meeting only 1 criteria leads to finance lease: (ICAN June 2017)

i. Lease transfers ownership of asset to the lessee by the end of lease term.
ii. Lessee has the option to purchase the asset at a price that is expected to be
sufficiently lower than fair value at the date the option becomes excersiable
for it to be reasonably certain, at the inception of the lease, that the option
will be exercised.
iii. Lease term is for major part of economic life of the asset even if title is not
transferred.
iv. At the inception of lease, Present Value of minimum lease payments amounts
at least substantially all of Fair value of leased assets.
v. Leased assets are of such a specialized nature that only the lessee can use
them without major modifications.
Additional indicators:
i. If lessee can cancel the lease, the lessor’s losses associated with the
cancellation are borne by the lessee.
ii. Lessee has the ability to continue the lease for a secondary period at a rent
that is substantially lower than market rent.
iii. Gain or losses from fluctuation in fair value of residual accrue to the lessee.

A machine having expected useful life of 6 years is leased for 4 years. Both the cost and fair
value of the machinery are Rs. 17,00,000. The amount will be paid in 4 equal installments
and at the termination of lease, lessor will get back the machinery. The unguaranteed residual
value at the end of the 4th year is Rs. 1,70,000. The IRR of investment is 10%. The present
value of annuity factor of Rs. 1 due at the end of 4th year at 10% IRR is 3.169. The present
value of Rs. 1 due at the end of 4th year at 10% rate of interest is 0.683.State with reason
on the basis of your calculation, whether the lease constitutes finance lease or not. (ICAN
Dec 2018)
Answer:
As per NAS 17, meeting any of following condition lease being classified as finance lease:
i. At the inception of lease, Present Value of minimum lease payments amounts at least
substantially all of Fair value of leased assets.
ii. Lease term is for major part of economic life of the asset even if title is not transferred.
Determination of finance lease:
Fair value of leased asset: 1700,000
Unguaranteed Residual value: 170,000
Present value of unguaranteed residual value= 170000*0.683 = 116,110
Present value of lease payment recoverable= 1700000-116110 = 1,583,890
% of PV of lease payments to FV= 1583890/1700000*100= 93.17%
Since the present value of minimum lease payments amounts at least substantially all of
Fair value of leased assets

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NAS 17 Lease
Revision Note
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Further, the life of asset is 6 years and leased period is 4 years. Lease terms
cover major economic life of asset.
Hence, the lease constitutes finance lease.

In case of finance lease, Accounting Treatment:

Lessor Lessee
At initial recognition At initial Recognition
Receivable Dr. Assets Dr.
Assets Cr. Payable Cr.
(amount at Present value of Gross (amount at lower of PV of minimum Lease
Investment) payment or Fair Value of leased asset)
Subsequent( At year end)
i. Receivable Dr. Finance expenses Dr.
Interest Income Cr. Payable Cr.
(Being interest income recognized) (being interest expenses recognized)
ii. Bank Dr. Liability Dr.
Receivable Cr. Bank Cr.
( being lease amount received from lessee) (being lease amount paid to lessor)
iii. Depreciation Dr.
Asset Cr.
(Being depreciation charged on leased
asset)

Accounting by lessor in case of finance lease

A Ltd leases machinery to B Ltd. The lease is for four years at an annual cost of 2,000
payable annually in arrears. The normal cash price (and fair value) of the asset is 5,900.
The present value of the minimum lease payments is 5,710. The implicit rate of interest is
15%.
Answer:
Accounting by A Ltd (Lessor)
Present value of Gross investment= PV of minimum lease payments+ PV of Unguaranteed
residual value (0)
Present value of Gross investment = PV of minimum lease payments= 5710
At inception of lease
Receivable a/c Dr. 5710
To Assets 5710
( being Assets transfer to B ltd at inception of lease)
At 1st year end
a. Receivable a/c Dr. (5710*15%) 857
To Interest income 857
( Being interest income recognized)
a. Bank a/c Dr. 2000
To Receivable 2000
(Being amount received from B Ltd.)
At 2nd year end:
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NAS 17 Lease
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a. Receivable a/c Dr. ((5710+857-2000)*15%) 685

To interest income 685
( being interest income recognized)
b. Bank a/c Dr. 2000
To Receivable 2000
(Being amount received from B Ltd )

Same continued for 3rd year end and 4th year end

Accounting by lessee in case of finance lease

A Ltd leases machinery to B Ltd. The lease is for four years at an annual cost of 2,000
payable annually in arrears. The normal cash price (and fair value) of the asset is 5,900.
The present value of the minimum lease payments is 5,710. The implicit rate of interest is
15%.
Answer:
Accounting by B Ltd (Lessee)
PV of minimum lease payments = 5,710
Fair value of asset = 5,900
At inception of lease ( Lower of PV of minimum lease payments or Fair value of
asset)
Asset a/c Dr. 5,710
To Payable 5,710
(Being Assets purchase from Altd ltd at inception of lease)
At 1st year end
b. Interest expense Dr. (5710*15%) 857
To Payable 857
( Being interest expenses charged)
b. Payable a/c Dr. 2000
To Bank 2000
(Being amount paid to A Ltd.)
c. Depreciation a/c Dr.(5710/4) 1427.5
To Asset 1427.5)
( Being depreciation charged on leased asset)

At 2nd year end:

a. Interest expenses a/c Dr. ((5710+857-2000)*15%) 685
To Payable 685
( being interest expenses charged)
b. Payable a/c Dr. 2000
To Bank 2000
(Being amount paid to A Ltd )
c. Depreciation a/c Dr. 1,427.5
To Asset 1,427.5
(Being depreciation charged on leased assets.)

Same continued for 3rd year end and 4th year end

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NAS 17 Lease
Revision Note
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In case of Operating lease, Accounting Treatment:

The substance of the transaction is that the lessee uses an asset, but does not own or control
it:
• The lessee does not recognise the leased asset in its statement of financial position.
• Rentals are charged as an expense on a straight line basis over the term of the lease unless
another systematic and rational basis is more appropriate.
• Any difference between the amount charged to profit or loss and the cash payments should
be recognised as a prepayment or an accrual.

Accounting treatment:

In case of lessor In case of lessee

a. Receivable Dr Lease expenses Dr.
To Lease income To Payable
(Being lease income booked) ( Being lease expenses charged)
b. Bank Dr Payable Dr.
To Receivable To Bank
(Being amount received from lessee) ( being amount paid to lessor)

A company hires a machine under an operating lease for three years. Payments are due
annually in arrears, as follows:

Year 1: 5,000
Year 2: 10,000
Year 3: 6000

Required:
Prepare extracts from the statement of profit and loss and the statement of financial
position for each of the three years
Ans:

Lease expenses to be charged= (5000+10000+6000)/3 = 7,000

Accounting Year 1 Year 2 Year 3

Treatment
a. Operating lease 7000 7000 7000
expenses Dr
To Payable 7000 7000 7000
(being lease
expenses booked)
b. Payable Dr 5000 10000 6000
To Bank 5000 10000 6000
( being lease liability
paid)

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NAS 17 Lease
Revision Note
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Extract:
Statement of profit or loss

Year 1 Year 2 Year 3

Operating lease 7,000 7,000 7,000
expenses

Statement of Financial Position:

Year 1 Year 2 Year 3
Lease liability (7000-5000) (2000+7000- (-1000+7000-6000)
=2000 10000)= (1000) = 0
Sale and Leaseback Transaction

A sale and leaseback transaction involves the sale of an asset and leasing back of the same
asset. The lease payments and sale price are usually interdependent because they are
negotiated as a package. The accounting treatment of sale and leaseback transac tion depends
upon the type of lease involved

Sale

Seller/ Lessee Buyer/Lessor

Leaseback:

Finance leaseback

Operating leaseback

a. Sale and finance leaseback:

The transaction is merely a means by which the lessor (buyer) provides finance to the lessee (seller),
with the asset as security. The substance of arrangement is that the asset has been used as security
for a loan.
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NAS 17 Lease
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Accounting treatment:
a. Lessee (Seller) defers any gain on the disposal of the asset and amortises this to profit or
loss over the lease term.
b. The lessee recognizes both a finance lease asset and a finance lease obligation.
c. The finance lease asset is depreciated over the lease term.
d. A finance cost is charged based on the outstanding lease liability.
e. The finance lease repayments reduce the outstanding lease liability.

A Ltd. owned a machine with a carrying amount of 750,000. On 1 January 2018, this was
sold to a bank for its fair value of 1,000,000 and then leased back for five years. The
remaining useful life of the machine is 5 years. Lease payments of 277,409 are to be made
annually in arrears. The implicit rate of interest is 12%.
Required:
Prepare extracts of Statement of profit or loss and Statement of financial position
for year ended 31 December, 2018.
Ans:

Sale of asset:
Sale proceeds: 1000,000
Less: carrying amount: (750,000)
Gain 250,000

The gain on sale is credited as deferred income and amortised to the statement of profit
or loss over the lease term.

Income of (250,000/5) 50,000 will be recorded in the current year.

The balance of 200,000 will be recognised as differed income at the year end.

Recording and depreciating the asset:

The asset and finance lease obligation are recognised at the fa ir value of 1000,000.

The asset is depreciated over the shorter of the lease term.

Depreciation of (1,000,000/5) 200,000 will be charged to statement of profit or loss and

asset will have a carrying amount at the year end of 800,000.

Accounting of lease liability( in the books of A Ltd)

Leased asset (On 1s t jan 2018) 1,000,000

To Lease obligation 1,000,000
( being leased asset has been purchased)
At reporting date( 31s t Dec, 2018)
Interest expenses Dr. (1000000*12%) 120000
To lease obligation 120000
( being interest expenses charged)
Lease obligation Dr. 277,409
To Bank 277409
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NAS 17 Lease
Revision Note
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(being lease payment made)

b. Sale and operating leaseback:

A sale and operating leaseback transfers the risk and rewards incidental to the ownership
to the buyer/ lessor. The accounting treatment is as follows:

a. Operating lease rental are recognised as expenses in profit or loss.

b. The asset is removed from seller’s statement of financial position.
c. Any gain on disposal is recognised in accordance with guidance provided in NAS 17. This
is summarized in the following diagram:

Selling Price (SP)

Fair value

Carrying value

Case Treatment of gain or loss

a. If SP= Fair value Recognised profit or loss immediately
b. If SP< Fair value
i. Deferred and amortised (loss
compensated by future lease
payment below Market price)
ii. Recognised immediately ( If loss not
compensated by future lease
payment)
c. If SP> FV
i. Recognised deferred (SP- FV) Amortise
excess profit over lease period.
ii. Recognised profit or loss (FV- CV)
immediately.

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NAS 17 Lease
Revision Note
Relevant For CAP-II students

Additional Topics:

Lease of Land and Buildings

When lease included both land and building, entity assess the classification of each element
as a finance or an operating lease separately.

 Land element is often classified as operating lease because it normally has an

indefinite economic life.
 Building element may be classified as either a finance or an operating lease
depending upon the nature of lease contract.
 The minimum lease payments are allocated between the land and buildings elements
in proportion to their relative fair values.

On 1 April 2017, ALtd began to lease a property on a 20-year lease. Altd paid a lease
premium of 3,000,000 on 1 April 2017. The terms of the lease required Altd to make
annual payments of 500,000 in arrears, the first of which was made on 31 March 2018.
On 1 April 2017 the fair values of the leasehold interests in the leased property were as
follows:
– Land 3,000,000.
– Buildings 4,500,000.
There is no opportunity to extend the lease term beyond 31 March 2037. On 1 April 2017,
the estimated useful economic life of the buildings was 20 years.
The annual rate of interest implicit in finance leases can be taken to be 9·2%. The present
value of 20 payments of Rs.1 in arrears at a discount rate of 9·2% is 9.
Required:
Explain the accounting treatment for the above property lease and produce appropriate
extracts from the financial statements of A td for the year ended 31 March 2018.
Answer:
Given:

Particulars Amount NRs. Ratio

FV of Land 3,000,000 0.4
FV of Building 4,500,000 0.6
7,500,000 1

For land (Lease rental treated as operating lease)

Upfront lease premium= 3000000*40%= 1200,000
Annual lease rental= 500000*40%= 200,000
Annual lease rent to be charged in statement of profit and loss=
(1200000+200000*20)/20= 260,000
For Building ( Lease rental treated as finance lease)
Lease premium= 3000000*60%= 1,800,000
Annual lease rental= 500000*60%= 300,000
PV of minimum lease rental= 1800,000+ 300000*9 = 4,500,000
1-apr- Building a/c Dr.
4,500,000
2017
To Lease obligation 4,500,000
(being building taken on lease)
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NAS 17 Lease
Revision Note
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1-apr- Lease obligation a/c Dr. 1,800,000

2017
To Bank 1,800,000
(being lease premium paid)
31-Mar- Finance expenses (4500000*9.2%) 248,400
2018
To lease obligation 248400
Being interest expenses booked
31-Mar- Lease obligation Dr.
300,000
2018
To Bank 300,000
(being lease obligation paid)
31-mar- Depreciation Dr.
225,000
2018
To Building 225,000
(being depreciation charged)

Initial Direct Cost

Initial direct costs are costs that are directly attributable to negotiation and arranging a lease,
for example, commissions, legal fees and premiums. Both lessees and lessors may incur these
costs. The treatment is summarised below:

Cost incurred by lessee Cost incurred by lessor

Finance Lease Add to amount recognised as Include in initial
an asset; depreciate over measurement of receivable;
asset’s useful life. reduce income receivable
over lease term
Operating Lease Treat as part of lease Add to carrying amount of
rentals; expense over lease leased asset; expense over
term on SLM lease term on same basis as
lease income.

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