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Lease In The Financial Statement Of Lessor



I have discussed about definition and classification of lease and lease in the financial statement of lessee. In this post I discuss about lease in the financial statements of lessor. Read on…



Finance Lease In The Financial Statement Of Lessor

Lessors shall recognize assets held under finance leases as a receivable equal to the net investment in the lease. The net investment in the lease is the aggregate of the minimum lease payments and any unguaranteed residual value (the “gross investment”) discounted at the rate implicit in the lease.

Due to the definition of the interest rate implicit in the lease—that rate which discounts the lease payments to the fair value of the asset plus the initial direct costs of the lessor—the initial direct costs of the lessor are automatically included in the receivable. The direct costs of the lessor are those costs directly attributable to negotiating and arranging a lease.

Subsequent to initial recognition, finance income is recognized based on a pattern reflecting a constant rate of return on the net investment in the lease. Receipts under the finance lease are apportioned to the gross investment, as a reduction in the debtor, and to the finance income element.

Lessors who are manufacturers or dealers should recognize profit on the transaction in the same way as for normal sales of the entity. Thus a finance lease will create a profit or loss from the sale of the asset at normal selling prices and a finance income over the lease term. If artificially low rates of interest are quoted, profit is calculated using market interest rates.


Disclosures for Finance Lease In The Financial Statement Of Lessor

In addition to the requirements of the financial instruments standards, these disclosures are required:

A reconciliation between the gross carrying amount of the investment in the lease and the present value of the future minimum lease payments receivable

  • The gross investment in the lease and the future minimum lease payments for each of the following:
  • Not later than one year
  • Later than one year but not later than five years
  • Later than five years
  • Unearned finance income
  • Unguaranteed residual value
  • Doubtful recoverable lease payments
  • Contingent rents recognized as income
  • A general description of the significant leasing arrangements


Operating Lease In The Financial Statement Of Lessor

Lessors shall show assets subject to operating leases in the financial statement in accordance with the nature of the asset—motor vehicles, plant and equipment, and so on.

Lease income from operating leases shall be recognized in the income statement on a straight-line basis over the lease term unless another basis reflects better the nature of the benefit received. As mentioned earlier, any incentives should be considered. Depreciation on the asset subject to a lease is recognized as an expense and should be determined in the same manner as similar assets of the lessor. Additionally, the lessor should apply the principles of IAS 16, 36, and 38 as appropriate.

Initial direct costs of negotiating and arranging the lease shall be added to the cost of the asset and expensed over the lease term in the same pattern as the income is recognized.


Disclosures for Operating Lease In The Financial Statement Of Lessor

In addition to the requirements of the financial instruments standards, these disclosures are required:

  • The future minimum lease payments under noncancelable operating leases for each of the following:
  • Not later than one year
  • Later than one year but not later than five years
  • Later than five years
  • Contingent rents recognized as income
  • A general description of the significant leasing arrangements




  1. R Sathyamurthy

    Apr 20, 2009 at 5:28 am

    Dear Putra,

    I am a regular reader of a forum. I am a Chartered Accountant from India. Right now I have some sort of difference of opinion with our auditors. We are in the business of installment financing. We loan money to our customers to buy vehicles and equipment and also give cash loans for working capital purposes.

    Our auditors want to treat these transactions as Finance leases while I feel that these are not finance leases but simple installment sales.

    Look forward to your views.

    R Sathyamurthy

  2. Putra

    Apr 20, 2009 at 2:56 pm

    Dear Sathyamurthy,

    Glad to know that you a regular reader of this blog.

    For the transaction your company makes to loans monies to its clients are obviously loans, and loan is loan, nothing to do with leasing.

    As for the transaction to loan monies to clients to buy vehicles, equipments, machineries, boats, houses, or other assets, that could be a purely loan or a lease. For better judgment, let’s have a read the following definition provided on IAS 17:

    “Lease; is an agreement whereby the lessor conveys to the lessee in return for payment the right to use an asset for an agreed period of time”.

    The definition of a lease includes those contracts for hire of an asset that contain provisions for the hirer to acquire title to the asset upon fulfillment of agreed conditions—these are sometimes called hire purchase contracts.

    What does this means? Let’s assume your company loans monies to client to purchase a vehicle. If the purchase is acquired by your company, and then delivered to your client under lease agreement where agreed that the client will pay your company by installments, and ownership of the vehicle will be transferred when the client settle value of the asset [vehicle], then it is a finance lease. Otherwise it should not be.

  3. Hugo

    Sep 28, 2009 at 9:52 am

    Dear Putra,

    I’m a CPA from Indonesia. We’ve just adopted this IAS 17 to our Indonesia GAAP.

    I want to understand more regarding the lease income recognised by the lessor.

    Quoted from IAS 17: “Lease income from operating leases shall be recognized in the income statement on a straight-line basis over the lease term unless another basis reflects better the nature of the benefit received”.

    Is this straight line basis applies to the lease base or the repayment of lease?

    How shall the lease income be recognised if the lease contains a step up/down rent base? Is it by sum all the rent price and amortise using straight line basis over the lease term?

    Because some lease agreement may contains stepping rent base and also stepping repayment (installment).

    For example, the rent price is 300 for 2 years and the lease repayment is 200 for Y1 and 100 for Y2 then the revenue recognised in Y1 and Y2 is 150 each (I agreed with this).

    But how if the rent price for Y1 is 120 and for Y2 is 180? Is it the revenue recognised also the same as above? which is 150 for Y1 and Y2.

    Or the revenue is recognised by straight line basis on each year, I mean per month in Y1 is 10 and per month in Y2 is 15. Then the revenue Y1 is 120 and Y2 is 180.

    Look forward for your advice.

    Best regards,

  4. Putra

    Sep 28, 2009 at 4:57 pm


    Glad to know that Indonesian GAAP now start adopting IAS 17. Great!

    Unfortunately you don’t mention either it is a sales-type or direct financing or leveraged type of lease.

    Presumably that you’re talking about operating leases; Yes, the payments received by the lessor are recorded as “rent revenues” in the period in which the payment is received or becomes receivable. If either the rentals vary from a straight-line basis, where the lease agreement contains a scheduled rent increase over the lease term [or the lessor grants incentives to the lessee such as a rent holiday or leasehold improvement allowance], the revenue is recorded on a straight-line basis unless an alternative basis of systematic and rational allocation is more representative of the time pattern of physical usage of the leased property.

    If the scheduled increase(s) or decrease(s) is due to the lessee leasing additional/reduction property under a master lease agreement, the increase is allocated proportionally [once again; it is allocated proportionally] to the additional leased property and recognized on a straight-line basis over the years that the lessee has control over the additional leased property.

    ASC [Accounting Standard Codification] 840-20-25 prescribes that, in this case, the total revised rent be allocated between the previously leased property and the additional leased property based on their relative fair values


    Any initial direct costs are amortized over the lease term as the related lease revenue is recognized (i.e., on a straight-line basis unless another method is more representative). However, these costs may be charged to expense as incurred if the effect is not materially different from straight-line amortization.

    Any incentives made by the lessor to the lessee are treated as reductions of rent and recognized on a straight-line basis over the term of the lease.

    In most operating leases, the lessor recognizes rental income over the lease term and does not measure or recognize any gain or loss on any differential between the fair value of the property and its carrying value.

    One exception to this rule is set forth in ASC 840-40. Note that exception applies when an operating lease involving real estate is not classified as a sales-type lease because ownership to the property does not transfer to the lessee at the end of the lease term. In this case, if at the inception of the lease the fair value of the property is less than its carrying amount, the lessor must recognize a loss equal to that difference at the inception of the lease.

    I hope it is a help.

  5. Teresa Dapo

    Nov 1, 2009 at 10:35 pm

    Hi, Putra,

    I am from the Philippines and I am very thankful to have found your site.
    This is very, very informative.

    I sent you a previous email on this but I feel that my question should fall under this article.

    Via Venetto Company leases house and lots on a “rent to own basis”
    after a specified period.

    These house and lots are acquired through mortgages with Banks.
    And, in every property acquired, the company has a partner investor.

    FS are prepared monthly and distribution of earnings are done quarterly
    to partner investors.

    First Question:

    If a tenant defaults on a payment, our dilemna is whether to recognize Revenue on Lease for that particular month or months.

    At present, we recognize revenue on that month but distribute profits based
    on what has been collected.

    For the partner investors, we attach the subsidiary ledger of the tenant to
    show actual payments.

    Now, we are thinking if we can (or is it best for us) to record revenue only whn collected and continue to accrue on expenses?

    Second Question:

    For this particular business, what is the initial lease record ?
    Do we recognize an unearned interest initially?

    What are the accounting entries on:

    1) The initial lease record

    2) Receipt of cash payment

    3) Recognition of Revenue

    Since the merchandise on this partcular business are the properties mortgaged from Banks, is the revenue equal to the monthly rent of the tenant?

    And, is the monthly amortization to Banks the cost of sales?

    I will appreciate your inputs bery much.

    Sincerely and more power,


  6. Putra

    Nov 5, 2009 at 3:10 pm


    Lease accounting is somewhat complex. And your case sound technical. A comprehensive review is needed. But let’s try to simplify these.

    In accounting for a sales-type lease, it is necessary for you as a lessor to determine the following amounts: (1) Gross investment (2) Fair value of the leased asset, and (3) Cost.

    From these amounts, the remainder of the computations necessary to record and account for the lease transaction can be made. The first objective is to determine the numbers necessary to complete the following entry:

    [Debit]. Lease receivable xx
    [Debit]. Cost of goods sold xx
    [Credit]. Sales xx
    [Credit]. Inventory xx
    [Credit]. Unearned interest xx

    The gross investment (lease receivable) of the lessor is equal to the sum of the minimum lease payments (excluding executory costs) plus the unguaranteed residual value. The difference between the gross investment and the present value of the two components of gross investment (minimum lease payments and unguaranteed residual value) is recorded as the unearned interest revenue. The present value is computed using the lease term and implicit interest rate (both of which were discussed earlier). The lease term used in this computation includes any renewal options exercisable at the discretion of the lessor. The resulting unearned interest revenue is to be amortized into income using the effective interest method.

    This will result in a constant periodic rate of return on the net investment (the net investment is the gross investment less the unearned income).

    Worth mentioning here that the fair value (FV) of the leased property is, by definition, equal to the normal selling price of the asset adjusted by any residual amount retained (this amount retained can be exemplified by an unguaranteed residual value, investment credit, etc.). The adjusted selling price used for a sales-type lease is equal to the present value of the minimum lease payments. Thus, I can say that the normal selling price less the residual amount retained is equal to the PV of the minimum lease payments.

    The cost of goods sold to be charged against income in the period of the sale is computed as the historic cost or carrying value of the asset (most likely inventory) plus any initial direct costs, less the present value of the unguaranteed residual value. The difference between the adjusted selling price and the amount computed as the cost of goods sold is the gross profit recognized by the lessor at the inception of the lease (sale). Thus, a sales-type lease generates two types of revenue for the lessor.

    1. The gross profit on the sale
    2. The interest earned on the lease receivable

    The next step in accounting for a sales-type lease is to determine the proper handling of each payment. Both principal and interest are included in each payment. Interest is recognized using the effective interest rate method so that an equal rate of return is earned each period over the term of the lease. This will require setting up an amortization schedule.

    A few of the columns need to be elaborated upon. First, the net investment is the gross in-vestment (lease receivable) less the unearned interest. Note that at the end of the lease term, the net investment is equal to the estimated residual value. Also note that the total interest earned over the lease term is equal to the unearned interest at the beginning of the lease term.

    The entries below illustrate the proper accounting for the receipt of the lease payment and the amortization of the unearned interest in the first year.

    [Debit]. Cash xxx
    [Credit]. Lease receivable xxx
    [Debit]. Unearned interest xxx
    [Credit]. Interest revenue xxx

    Note that there is no entry to recognize the principal reduction. This is done automatically when the net investment is reduced by decreasing the lease receivable (gross investment) and the unearned interest. These entries are to be made over the life of the lease.

    At the end of the lease term the asset is returned to the lessor and the following entry is required:

    [Debit]. Asset xxx
    [Credit]. Lease receivable xxx

  7. Teresa Dapo

    Nov 6, 2009 at 4:27 pm

    Thank you very much for the precious time you gave to this scenario.

    Yes, this is complicated and seems difficult.
    I am studying again!

    Is it allright, if I ask questions as I learn it?

    Very, very respectfully,

  8. ashish

    Dec 2, 2009 at 8:08 am

    Dear mr. Putra

    I have gone through your blog and am sure that you can help me.

    We are in the business of car rental and full service operative lease of passenger cars and I have a debate with my auditors on how cost of dep should be accounted.

    If we buy a car at 10000 and lease it for three years then assuming a RV of 6000 at the end of three year we charge the customer 4000 ( 10000-6000) 0ver three years. For our P&L we take 4000 as a dep cost . My auditors say that you should depreciate the car flat by 20% per year considering 5 years as a useful life of the car which I do not think is correct as our revenues will be based on 4000 dep charged to the customer and we will take costs of 6000 in three years as per the auditors.

    look forward to yoru direction in this .


  9. Elen

    Nov 6, 2010 at 8:54 am

    Dear Sir.

    My company had entered into a contract for purchase of new plant equipments. I have now been approached by an agent of a bank to enter into a sale and lease back transaction;

    • I will sell the plant to an SPV, at the purchase price, that will be owned by the bank.
    • SPV will receive funds from the bank to pay the builder.
    • SPV will lease the assets back to me for ten years with an option to purchase it ( I think at the given price I will purchase it since the price they are offering is very cheap)
    • I will have to pay lease rentals that they have fixed (believe this cover their cost of borrowing for ten years)
    • I will have to take an insurance for these ten years so that it will protect them in case of any accidents.
    • I will also have to give some assets as collateral to the SPV.

    In another option they have given, I am also given an option to own 50% of the SPV.

    How should I account for this in my accounts. Should I account this as a sale and lease back or as financing transaction since in essence what I am doing is paying for acquiring the plant.

    Thanks in advance for your help.

  10. Ann

    Feb 9, 2012 at 1:04 pm

    Dear Mr Putra,

    We are in the business of selling fax/copiers. We sell these machines to customers, customer will get financing from finance companies, we will receive full amount upfront from the finance company. At the end of the leasing period, the customer will have the option to purchase the machine. I would like to clarify the accounting entries for these. For machines that are transferred to customer’s premise during the leasing period, how do we record these machines? as stock? or as our fixed assets and provide depreciation etc? Please advise the relevant accounting entries.
    In near future, we will sell these machines to customer and provide financing to them directly. We will then get financing from finance companies. How should the accounting entries go? For your kind advices.

    Many thanks and have a great day!

    with regards,

  11. Hamdan

    Mar 21, 2012 at 5:37 am


    i liked this forum. i am studing CPA. And appreciate if somebody can reply to one point which is taken a lot of debate and discussion in my company. actually we have a huge fleet of vehicles and are leasing them through leasing contracts vary from a day to more than five years. And still we have not considered capital lease but operating lease. What I know that since we do not have goods to sell but only let assets(vehicles) and get periodic rentals. The form of P&L should be revenues mines all expenses(depreciation +G&A +S&M+…) but not revenues minus cost of sales(which equals vehicles depreciation+ maintenance+ registration +insurance) =gross profit minus operating expenses(like G&A +S&M+ …).

    Which style should I use to present the P&L statement.

    Hamdan MBA, CMA

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