MFRS117

Leases
1
 Learning Objectives
• Explain the nature and economic
substance of lease transactions.
• Describe different types of leases.
• Explain the accounting treatment for
finance lease & operating lease.
• Compare and contrast the finance lease
and operating lease method.
• Explain the accounting treatment for sale
and leaseback.
• List the disclosure requirements for
leases.
2
 Introduction
What is a lease?
• A contractual agreement between a lessor and a
lessee.
• This arrangement gives the lessee the right to use
specific property, owned by the lessor, for a specified
period of time.
• In return for the use of the property, the lessee makes
rental payments over the lease term to the lessor.
MFRS117 defined Lease as:
• A lease is an agreement whereby lessor conveys to
the lessee in return for a payment or series of
payments (minimum lease payments) right to use an
asset for the agreed period of time (lease term). 3
 Leases
• Leases are the great example of “off-balance sheet”
financing if not recorded properly in the
financial statements.
• In the past, many companies used to hide their finance
lease liabilities and they reported all lease payments
directly to profit or loss when paid. So no real picture of
the transaction was shown.
• Therefore, MFRS117 was issued to tackle this problem.
• From 2012 until recently, MFRS 117—Leases was used
for accounting for lease.
– MFRS 16 takes effect from 1 January 2019

4
 Leases
• Advantages of Leases
– For lessor
• a periodic receipt provides interest
revenue.
• ability to retain ownership of the asset
• boost their sales revenue.
– For lessee
• flexibility in using assets.
• less costly financing
 Leases
• Commonly found in information technology,
transportation, construction and agriculture.
– Information technology assets - allows a
company to quickly adapt to changes in
technology.
– Transportation assets - require huge financial
commitments. Leases are a great financing
option.
– For construction and agriculture - minimizes
the possibility that some assets might become
idle at certain periods of time.
 Leases
MFRS 117 is applicable to all leases except the
following;
 property held by lessees that is accounted for as
investment property (see MFRS 140 Investment
Property);
 investment property provided by lessors under
operating leases (see MFRS 140);
 biological assets held by lessees under finance
lease (see MFRS 141 Agriculture); or
 biological assets provided by lessors under
operating leases (see MFRS 141).
7
 Leases
• Although the contract may say that a company leases
an asset from another company, in fact, the contract’s
conditions may be very similar to purchase.
• Eg: The lessee will lease an asset for almost all of its
useful life, will be responsible for maintaining and
repairs, etc.
• MFRS 117 requires to record such a transaction not in
accordance with the strict legal form (legally, the owner
of an asset remains the lessor), but in line with the
“substance over form” principle.

8
 Which leases shall be recorded in line with
“substance over form”?
Economic substance of lease is determined by risks
and rewards incident to the ownership; whether they
are transferred to the Lessee or still with the Lessor.
MFRS117 define risks and rewards as :
 Risks in the asset – possibility of losses incurred due
to the asset becoming idle or technological obsolete
and variations in return due to changing economic
conditions.
 Rewards of beneficial ownership – expectation of
profitable operation from the use of the asset and/or
gain from appreciation in value of asset or a gain on
realization of residual value.
9
 Classification of leases
MFRS117 classifies leases into 2 types:
• Finance lease – a lease that transfers
substantially all the risks and rewards incident to
ownership of an asset to the lessee, while legal
title does not necessarily need to be transferred.
(recorded with substance over form principle).
• Operating lease –a lease that does not transfer
substantially all the risks and rewards incidental to
ownership

10
Lease Classification Criteria

A lease is classified as a finance

lease by the lessee if it is non-
cancelable and meets any one of
the following criteria:

11
 How shall we determine whether the
lease is finance or operating?
5 basic situations that normally lead to a finance lease:
1. The lease transfers the ownership of an asset to the lessee by the
end of the lease term.
2. The lessee has an option to purchase the asset at a price
sufficiently lower than its fair value at the date of purchase .
3. The lease term is for the major part of the economic life of the
asset even if the title is not transferred .
4. At the inception of the lease, present value of the minimum lease
payments comes close to the fair value of the leased asset.
5. Leased assets are of such specialized nature that only the lessee
can use them without major modifications.
So long as one of the factors is satisfied, the lease would be classified
as a finance lease.
12
 Lease Classification Criteria
MFRS 117 further lists indicators of situation which
could leads to a lease being classified as finance lease.
i. If the lessee can cancel the lease, the lessee’s
losses associated with the cancellation are borne
by the lessee.
ii. Gains or losses from the fluctuation in the fair value
of the residual value fall to the lessee,
iii. The lessee has the ability to continue the lease for
a secondary period at a rent which is substantially
lower than market rent.

13
 Finance Lease
Definition according MFRS117 – a finance lease as a
lease that transfers substantially all the risks and
rewards incidental to ownership of an asset.
• The title may or may not eventually be transferred.
• The lessee is the beneficial owner.
• The lessee may make a payment or a series of
payments.
• The lessee may guarantee the residual value for the
leased assets at the end of lease term.
• Total amount payable is called minimum lease
payment.
14
 Example for Finance Lease
On 1.1.x1, YYY Bhd entered into lease agreement with ZZZ
Bhd for the use of a plant. The agreement was that YYY Bhd
would make five yearly instalments of RM25,000 in advance
i.e 1st instalment being on 1.1.x1. The machine can be
bought for cash at RM100,000. YYY incremental borrowing
rate is 13% per annum.

Solution:
The present value of the five installments is
RM25,000 + (25,000 x 2.96) = RM99,000

As the present value of the minimum lease payment is 99%

of the fair value of the assets ($99,000/$100,000), the lease
qualifies as a finance lease.
15
 Operating Lease
 Risks and rewards associated with the
asset are not transferred to the lessee.
 The legal and beneficial owner is the
lessor.
 Accounted for as if it is a rental agreement.
 The leased asset will continue to be
accounted for in the lessor’s books, and
the periodic lease payments will be
recorded as income by the lessor AND as
expenses by lessee. 16
 Accounting for Finance Lease
by Lessee
 MFRS 117 requires the asset under a finance
lease to be recorded as a Fixed Asset in the
lessee’s book.
 The lessee will record the lease asset as if the
asset were purchased with financing facility.
 The related financing facility will be recorded as a
liability (lease payable) in the lessee’s book and
as an asset (lease receivable) in lessor’s book.
 MFRS 117 requires lessee to record the obligation
(liability) arising from the finance lease at the
same amount of the leased asset.
17
 Accounting for Finance Lease by Lessee
Initial Recognition
MFRS117 stated that:
• At the commencement of the lease term, lessee should
recognize an asset and a lease liability at the lower of :
– the fair value of the asset; and
– the present value of the minimum lease payments.
• The accounting entry is as follows:

• Any initial direct costs of the lessee are added to the

amount recognised as an asset.
18
 Accounting for Finance Lease
by Lessee
Example:
If the fair value of a plant was RM100,000 and
present value of the minimum lease payment
was RM96,000, then the lease asset is recorded
at RM96,000.

Dr. Plant RM96,000

Cr. Lease Liability RM96,000

19
 Interest Rates for discounting
Minimum Lease Payments
Minimum lease payment (MLP) is the payments over the
lease payment excluding contingent rent, cost of services
and taxes.
MFRS117 : In calculating the present value of the minimum
lease payments – the discount factor is the interest rate
implicit in the lease. If implicit rate is not practical to
determine, the lessee’s incremental borrowing rate is used
 Implicit Interest Rate:
Rate that would be used to discount the minimum lease
payments to the fair market value of the leased asset at
the inception of the lease.
 Incremental Borrowing Rate:
Rate at which lessee would have to pay on similar lease
or would incur to borrow the amount of money
necessary to purchase the leased asset. 20
 Accounting for Finance Lease by Lessee
Subsequent Measurement
There are 2 things to take care about after
initial recognition:
1. Minimum lease payments
MFRS117 stated that MLP should be apportioned
between the finance charge (interest) and the
reduction of the outstanding lease liability.
The basic accounting entry of minimum lease payment
paid to the lessor is as follows:

21
 Accounting for Finance Lease
by Lessee
Each lease payment contains the interest, as the finance
lease is in fact a loan. Therefore:

The finance charge is allocated to the periods over the lease

term to arrive at a constant periodic rate of interest on the
remaining balance of the liability using 2 methods which are:
a) the actuarial method
b) the sum-of-digits
In practice, actuarial method is used a lot to work out
the allocation.
Actuarial method – uses the interest rate implicit in the lease
(internal rate of return of the lease) to calculate the finance
charge for the period based on the amount of outstanding
finance lease liability. 22
 Accounting for Finance Lease
by Lessee
2. Depreciation
As the lessee acquires the non-current asset, it must be
depreciated over the shorter of the lease term and asset’s
useful life. Depreciation entry is as follows:

MFRS117 stated that :

 Leased asset should be depreciated over its
economic/useful life if there is reasonably certain that
the lessee will obtain the ownership by the end of lease
term or the bargain purchase option will be exercised
by lessee.
 Otherwise (if both the terms are not met), the leased
asset should be depreciated over the lease term. 23
 Illustration 117.5
On 1 Jan 20x1, ABC Trading Bhd entered into a lease
agreement to lease a piece of equipment from DEF
Leasing Bhd. The terms of the agreement included:
a. non-cancellable lease term of four years, with no
renewal or purchase option;
b. Lease rental of RM10,000 per year to be paid by ABC
Trading Bhd on 31 Dec each year of the four years
commencing 31 Dec 20x1.
The leased rental was calculated and mutually agreed
upon based on 5% rate of return to DEF Leasing Bhd. The
equipment was new on 1 Jan 20x1, had a fair market value
of RM42,000, and was expected to have an estimated
useful life of five years.
24
 Illustration 117.5

At the end of the lease term, the equipment was to be

returned to DEF Leasing Bhd. There was no mention of
residual value.

As part of the accounting policies, ABC Trading Bhd

used the ‘straight-line’ method to depreciate all its fixed
assets (assuming no salvage value unless stated
otherwise) and the “effective interest” method to allocate
the finance charge.

25
 Illustration 117.5 - Solution
In this case, the lease would be classified as finance
lease because the lease term of four years was the
major part (> 75%) of the useful life of five years of the
equipment.
ABC Trading Bhd (lessee) would have to capitalise
the leased asset, record the related liability, provide
depreciation, and allocate the interest expense over
the lease term. Thus, three initial calculations would
have to be performed:
a. present value of the minimum lease payment
b. depreciation charge
c. amortisation for interest expenses.
26
 Illustration 117.5 - Solution

a. Calculation of PV of the minimum lease payments:

Minimum lease payments:
Ordinary annuity of RM10,000 for four periods =
RM10,000 x 4 = RM40,000
Discount rate: 5% (PV of ordinary annuity)
PV = RM10,000 x 3.5459 = RM35,459

Since the PV of the minimum leased payments

(RM35,459) was less than the fair market value of the
equipment (RM42,000), the leased equipment would
be capitalised, and related liability recorded in
lessee’s book at RM35,459
27
 Illustration 117.5 - Solution

b. Depreciation charge on leased equipment for

each of the four years from 20x1 to 20x4
= RM35,459 / 4 years
= RM8,865

c. Amortisation for finance charges

RM40,000 - RM35,459 = RM4,541

28
 Illustration 117.5 - Solution
Date Lease Interest Principal Lease
Payment Liability
RM RM RM RM
1.1.x1 35,459
31.12.x1 10,000 1,773 8,227 27,232
(35,459 x 5%) (10,000–1,773) (35,459 – 8,227)
31.12.x2 10,000 1,362 8,638 18,594
31.12.x3 10,000 930 9,070 9,524
31.12.x4 10,000 476 9,524 Nil
40,000 4,541 35,459

29
 Illustration 117.5 - Solution
Journal entries to record the lease for each of the four
years (assuming 31 Dec year-end) as follows:
Debit Credit
RM RM
1.1.x1 DR : Leased Equipment 35,459
CR : Lease payable 35,459
(To record the finance lease)
31.12.x1 DR : Lease payable 8,227
DR : Interest expense 1,773
CR : Bank 10,000
(To record lease payment)
DR : Depreciation expense 8,865
CR : Acc. Depreciation 8,865
(To record depreciation expense)
30
 Illustration 117.5 - Solution
Journal entries to record the lease for each of the four
years (assuming 31 Dec year-end) as follows:
Debit Credit
RM RM
31.12.x2 DR : Lease payable 8,638
DR : Interest expense 1,362
CR : Bank 10,000
(To record lease payment)
DR : Depreciation expense 8,865
CR : Acc. Depreciation 8,865
(To record depreciation expense)

31
 Illustration 117.5 - Solution
Journal entries to record the lease for each of the four
years (assuming 31 Dec year-end) as follows:
Debit Credit
RM RM
31.12.x3 DR : Lease payable 9,070
DR : Interest expense 930
CR : Bank 10,000
(To record lease payment)
DR : Depreciation expense 8,865
CR : Acc. Depreciation 8,865
(To record depreciation expense)

32
 Illustration 117.5 - Solution
Journal entries to record the lease for each of the four
years (assuming 31 Dec year-end) as follows:
Debit Credit
RM RM
31.12.x4 DR : Lease payable 9,524
DR : Interest expense 476
CR : Bank 10,000
(To record lease payment)
DR : Depreciation expense 8,865
CR : Acc. Depreciation 8,865
(To record depreciation expense)

By the end of the lease on 31 December 20x4, all the

accounts relating to the lease would have been written
off, the lease liability fully settled and the leased asset
fully depreciated. 33
 Bargain Purchase Option
The effect of the existence of a bargain
purchase option are:
 the lease will be classified as finance lease.
 Minimum lease payments will be increased
by the exercise price, and
 The useful life, instead of the lease term will
be used as the basis over which the
depreciable amount for the leased asset is
allocated to determine the annual
depreciation charged for the leased asset.
34
 Illustration 117.6
Assuming that the lease agreement between ABC
Trading Bhd and DEF Leasing Bhd in illustration 117.5
above included a provision to give ABC Trading Bhd
an option to buy over the equipment at the end of the
four year lease term for RM1,000 and that at the
inception date of the lease on 1 Jan 20x1, it was
estimated that the fair market value of the equipment
would be about RM5,000 after four years’ usage.
Given the bargain purchase option, the lease would be
classified as a finance lease (the lease would also
qualify as a finance lease under the economic life
test).
35
 Illustration 117.6 - Solution
The minimum lease payments would be increased by the
exercise price to RM41,000 (RM40,000 + RM1,000). Also,
the leased equipment would be depreciated over five years
instead of four years.
The related calculations would be as follows:
a. Calculation of the PV of the minimum lease payments:
Ordinary annuity of RM10,000 for four periods
+ RM1,000 at the end of the 4th period
= PV : RM10,000 x 3.5459 + PV : RM1,000 x 0.8227
= RM35,459 + RM823 = RM36,282
The leased equipment would be capitalised and the related
liability recorded in ABC Trading Bhd’s book at RM36,282
(the PV of minimum lease payments of RM36,282 being
lower than the fair value of RM42,000).
36
 Illustration 117.6 - Solution
b. Depreciation charge for the leased equipment for each of the
five years from 20x1 to 20x5.
RM36,282 / 5 years = RM7,256.40
c. Amortisation for finance charges
RM41,000 - RM36,282 = RM4,718

37
 Illustration 117.6 - Solution
 The journal entries to record the lease would be the
same as those under the original lease in illustration
117.5 except changes in figures.
 In addition, in the amortisation schedule there would be
a balance of RM1,000 in the lease liability account at the
end of the lease. This is the amount the lessee would
have to pay to exercise the purchase option.
 The journal entry to record the exercise of the purchase
option on 31 Dec 20x4 would be as follows:
DR : Lease payable 1,000
CR : Bank 1,000
(To record exercise of purchase option)
38
 Illustration 117.6 - Solution
 At the end of the lease on 31 Dec 20x4,
while the lease liability would be fully
settled, the leased asset would still carry
a balance because it would be
depreciated over five years.
 Also on this date, the leased asset should
preferably be transferred to an ordinary
fixed asset account.

39
 Residual Value

Three possible scenarios for residual value of

leased asset
a. Lessee may required to guarantee the
residual value of the leased asset at the
end of the lease,
b. Lessee may enjoy wholly or share with
the lessor the sale proceeds of the leased
asset when it is disposed of at the end of
the lease.
c. Lessee may have nothing to do with the
residual value. 40
 Residual Value
a. Guaranteed residual value
If the leased agreement requires the lessee (or any party
related to the lessee e.g parent/holding Co.) to guarantee the
residual value of the lease asset.
 The guaranteed residual value will form part of the
minimum lease payment.
 Depreciable amount of the leased asset will be equal to
be capitalised amount less the guaranteed residual
value.
 Lease liability will also have a balance equal to the
amount of the guaranteed residual value at the end of
the lease.
 A gain or loss will arise due to the difference between the
guaranteed residual value and the fair value of the
leased asset at the end of the lease. 41
 Illustration 117.8
Assuming that in the lease transaction between ABC Trading
Bhd and DEF Leasing Bhd in illustration 117.5 above ABC
Trading Bhd guaranteed to DEF Leasing Bhd that the leased
asset would have a residual value of RM5,000 when the
leased asset reverted back to the lessor at the end of the
lase on 31 Dec 20x4.
The above lease would be classified as a finance lease
because the lease term (4 years) was for the major part
(>75%) of the useful life (5 years).
In this case, the minimum lease payments would be
increased by the guaranteed residual value of RM5,000 to
RM45,000.
The depreciable amount of the leased equipment would be
reduced by the guaranteed residual value.
42
Illustration 117.8
a. Calculation of the present value of the minimum lease
payments:
Minimum lease payment
Ordinary annuity of RM10,000 for 4 periods + RM5,000
at the end of 4th period
= (10,000 x 4) + 5,000 = $45,000
Discount rate:5%
PV = 10,000 x 3.54595 + 5,000 x 0.8227
= 35,459 + 4,113 = $39,572
The leased equipment would be capitalised and related
liability recorded in lessee book at $39,572 (PV of
minimum lease payment of $39,572 is lower than FV of
$42,000)
43
Illustration 117.8
b. Depreciable amount of the leased equipment
would be :
($39,572 - $5,000) = $34,572.
Depreciation expenses for the leased asset
$34,572/4 years = $8,643 for each of the 4
years from 20x1 to 20x4
c. Amortisation for finance charges
$45,000 - $39,572 = $5,428

44
 Illustration 117.8
Date Lease Interest Principal Lease Liability
Payment RM
RM RM RM
1.1.x1 39,572
31.12.x1 10,000 1,979 8,021 31,551
39,572 x 5% 10k – 1,979 39,572 – 8,021
31.12.x2 10,000 1,578 8,422 23,129
31.12.x3 10,000 1,157 8,843 14,286
31.12.x4 10,000 714 9,286 5,000

The journal entries to record the lease would be the same as those under the
original lease in illustration 117.5 except for changes in figures.
In addition, there would be a balance of RM5,000 in the lease liability account at
the end of the lease. This is the amount the lessee guaranteed to pay the residual
value of the leased asset.
The leased equipment account would be carried at BV of RM5,000 [Capitalised
amount $39,572 less accumulated depreciated $34,572 ($8,643 x 4 years)].
45
Illustration 117.8
Assuming the FV of the equipment @ 31.12.20x4 was
RM5,000.

Journal entry to close the account.

Dr: Lease Payable 5,000
Dr: Accumulated depreciation 34,572
Cr: Leased equipment 39,572
(To close the lease account)

If the FV of the leased equipment was less than the

guaranteed amount when it was returned to lessor, the lessee
would have to pay to the lessor the difference.
Additional payment would be recorded as loss in lessee’s
books 46
Illustration 117.8
Example – assuming the leased equipment had a
FV of $3,000 at the end of lease on 31.12.20x4,
the lessee would have to pay to lessor the
difference of $2,000. Closing entry & journal entry
to record the loss.
Dr: Lease payable 5,000
Dr: Accumulated depreciation 34,572
Cr: Leased equipment 39,572
(To close the leased accounts)
Dr: Loss on finance lease 2,000
Cr: Cash 2,000
(To record loss on guarantee) 47
 Residual Value
b. Sharing of sales proceeds
 Where lease agreement provides for lessee to enjoy
wholly or share with lessor the sale proceeds of leased
asset when disposed of at the end of lease, the amount of
sales proceed accruing to the lessee would represents a
cash inflow (opposed to cash outflow in guaranteed
residual value).
 Minimum lease payments will not be affected and the
capitalised amount & amortisation for finance charges will
not be affected by the existence of lessee’ right to share
the realised amount of residual value.
 However, the depreciable amount of the leased asset will
be reduced by the amount of the expected residual value
accrued to leesee (as in the case of guaranteed residual
value). 48
Residual Value
c. Unguaranteed residual value
 Lessee (or party related to it) does not
guarantee the residual value, nor is the
lessee entitled to the sale proceeds of
the leased asset at the end of the
lease.
 The residual value of the leased asset
is of no relevance to the lessee and
should be ignored.
49
 Disclosures
Disclosure as per MFRS 116 Property, Plant and Equipment;
MFRS117 requires the disclosure of:
 Net carrying amount of each major class of leased assets
at balance sheet date;
 A reconciliation of minimum lease payment at the balance
sheet date and their present value;
 The total of minimum lease payments at the balance sheet
date and their present value for each of the following
period:
i) Not later than one year;
ii) Later than one year and not later than five years;
iii) Later than five years.
50
 Disclosures
 Contingent rents recognised in income for the
period.
Contingent rents are that portion of the lease
payments that is not fixed in amount but is based
on the future amount of a factor that changes
other than with the passage of time (e.g % of
future sales, amount of future use, future price
indices, future market rates of interest).
 The total of future minimum sublease payments
expected to be received under non-cancellable
subleases at the balance sheet date; and
51
 Disclosures
A general description of lessee’s significant leasing
arrangements including, but not limited to, the
following;
i) the basis on which contingent rent payments
are determined;
ii) the existence and terms of renewal or
purchase options and escalation clauses; and
iii) restrictions imposed by lease arrangements,
such as those concerning dividends, additional
debt and further leasing.
52
 Accounting for Finance Leases for Lessor
Initial Recognition
At the commencement of the lease term, lessor should recognize
lease receivable in his statement of financial position. The amount
of the receivable should be equal to net investment in the lease.
Net investment in the lease equals to gross investment in the lease
(minimum lease payments receivable by the lessor under the
finance lease + any unguaranteed residual value accruing to the
lessor) discounted by the interest rate implicit in the lease.
The accounting entry is as follows:

If lessor incurs any direct and incremental costs in negotiating

leases, those must be recognized over the lease term and not to
the expenses when incurred.
53
Accounting for Finance Leases for Lessor
Subsequent Measurement
The lessor should split minimum payments
received into finance income and reduction of the
lease receivable.
Finance income shall be recognized based on a
pattern reflecting constant periodic rate of return
on the lessor’s net investment in the lease.
The accounting entry is as follows:

54
 EXAMPLE
Think High Enterprise, which makes up its accounts to 31
December each year, leases a piece of plant on 1.1.x2 on
the following terms:
Think High Enterprise is to pay RM40,000 immediately,
with three further yearly instalments of RM40,000 each,
beginning on 1.1.x3. The agreed fair value of the asset is
RM139,474 and the interest rate implicit in the lease is
10%. At the end of the lease period the title to the asset is
transferred to the lessee. The expected economic life of
the asset is five years and the residual value of the asset
at the end of that time is zero.
Required:
Show the relevant information in the books of the lessor.
55
 56

Answer
RM
Total rental/installment to be paid
(RM40,000 x 4 years) 160,000
Fair value of the asset 139,474
Finance charge over the lease period 20,526

Present value of the minimum lease payment

(MLP):
= RM40,000 + (RM40,000 x PV factor for 3 periods)
= RM40,000 + (RM40,000 x 2.48685)
= RM40,000 + RM99,474 = RM139,474
 Answer 57

YEAR OPENING PAYMENT OUTSTANDING INTEREST CLOSING

BALANCE BALANCE 10% OF (C) BALANCE (E)
(A) (B) (C) = (A)-(B) (D) (C) + (D)
X2 139,474 (40,000) 99,474 9,947 109,421
X3 109,421 (40,000) 69,421 6,942 76,363
X4 76,363 (40,000) 36,363 3,637 40,000
X5 40,000 (40,000) - - -
20,526

Under the actuarial method, the interest charged is the interest on the outstanding
capital at the beginning of each year.

Income statement extract for the years ended 31 December

.
X2 X3 X4 X5
RM RM RM RM
Income
Lease interest 9,947 6,942 3,937 -
income
 58

ANSWER
JOURNAL ENTRIES TO RECORD THE LEASE FOR YEAR X2

Debit Credit
RM RM
Lease receivable 139,474
Bank 139,474

Bank 40,000
Lease receivable 40,000

Lease receivable 9,947

Interest income 9,947
 ANSWER
Lease Receivable
RM RM
1.1.x2 Bank 139,474 1.1.x2 Bank 40,000
31.12.x2 Interest income 9,947 31.12.x2 Bal. c/d 109,421
149,421 149,421

1.1.x3 Bal. b/d 109,421 1.1.x3 Bank 40,000

31.12.x3 Interest income 6,942 31.12.x3 Bal. c/d 76,363
116,363 116,363

1..x4 Bal. b/d 76,363 1.1.x4 Bank 40,000

31.12.x4 Interest income 3,637 31.12.x4 Bal. c/d 40,000
80,000 80,000

1.1.x5 Bal. b/d 40,000 1.1.x5 Bank 40,000

59
 ANSWER
Balance sheet extracts as at 31 December
X2 X3 X4 X5
RM RM RM RM
Non-current Asset:
Lease receivable 69,421 36,363 - -
Current Asset:
Lease receivable 40,000 40,000 40,000 -

Notes to the
financial
statements
Finance lease 120,000 80,000 40,000 -
receivable
Less: Unallocated (10,579) (3,637) - -
interest
109,421 76,363 40,000
60
 ANSWER
Working for finance charge under sum-of-digits method

X2 20,526 X 3/6 = 10,263

X3 20,526 X 2/6 = 6,842
X4 20,526 X 1/6 = 3,421
X5 Nil

Note:
The number of periods/ instalments, n, is 3 if payment is
made in advance. Sum of digits will be 6. The formula to
arrive at the sum of digits is:
n(n+1)
2
 ANSWER

Working for finance charge under sum-of-digits method

YEAR OPENING PAYMENT OUTSTANDING INTEREST CLOSING

BALANCE BALANCE 10% BALANCE

X2 139,474 (40,000) 99,474 10,263 109,737

X3 109,421 (40,000) 69,421 6,842 76,579

X4 76,363 (40,000) 36,363 3,421 40,000

X5 40,000 (40,000) - - -

20,526
 DISCLOSURES
A reconciliation between the total of gross investment in the
lease at the balance sheet date, and their present value;
The total of gross investment in the lease and their present
value for each of the following period;
(i) not later than one year;
(ii) later than one year and not later than five years;
(iii) later than five years.
Unearned finance income;
The unguaranteed residual values accruing to the lessor;
The accumulated allowance for uncollectible minimum lease
payment receivable;
A general description of the lessor’s significant leasing
arrangement.

63
 MANUFACTURER OR DEALER LESSOR
• The manufacturer of PPE is also a lessor or
dealer.
• The manufacturer sells the asset outright or
leases it out under a finance lease. The
manufacturer lessor earns two types of income:
a) gross profit; and
b) interest income
• Costs incurred by manufacturers or dealer lessor
in negotiating and arranging the lease shall be
recognized as an expense when selling profit
is recognized.
64
 MANUFACTURER OR DEALER LESSOR

Sales revenue
The revenue recognised at the inception of the lease (
lower of FV and the PV of MLP).
The cost of sales = cost of carrying value – PV of
unguaranteed residual value.
Gross profit= Sales – Cost of Sales
Finance income
The interest income is spread over the lease term

65
 MANUFACTURER OR DEALER LESSOR

Example
ABC Bhd manufactures an equipment for
RM200,000. It can sell it at RM265,300 which is
the fair value. It can also lease the asset under
finance lease by requiring the lessee to make 5
annual installments of RM70,000 each in arrears.
Market interest rate implicit is 10%. Initial cost
incurred in negotiating the lease is RM10,000.
ABC entered into finance lease on 1.1x3.
Required:
Discuss the accounting treatment for ABC Bhd.
66
 MANUFACTURER OR DEALER LESSOR

Answer
Sale revenue for year x3 is RM265,300
Cost of sale is RM200,000
FV – Cost = Gross profit
Gross profit = RM265,300 - RM200,000
= RM65,300
MLP = RM70,000 x 5 = RM350,000
PV MLP = RM70,000 x 3.79 (PV Ord. annuity 10%)
= RM265,300
Total finance interest over the lease period is the
difference between FV (RM265,300) – MLP (RM350,000)
= RM84,700 67
 MANUFACTURER OR DEALER LESSOR

Finance income is recognised over the lease

period of 5 years. Interest income recognised
Year Opening Interest Out/s Receipt Closing
Balance 10% Balance Balance

X3 265,300 26,530 291,830 (70,000) 221,830

X4 221,830 22,183 244,013 (70,000) 174,013
X5 174,013 17,401 191,414 (70,000) 121,414
X6 121,414 12,141 133,555 (70,000) 63,555
X7 63,555 6,445 70,000 (70,000) -
84,700

68
 MANUFACTURER OR DEALER LESSOR

Statement of Comprehensive Income (Extract) for

the Year ended 31.12.x3
RM
Sales Revenue 265,300
Cost of sales (200,000)
Gross profit 65,300
Interest Income 26,530
Initial costs (10,000)

69
 ACCOUNTING FOR OPERATING LEASE

As under the operating lease the risks and rewards of

ownership do NOT transfer from lessor to lessee.
In the lessee’s book, MFRS 117 stated that Lessee should
recognize the lease payments as an expense in the profit
or loss over the lease term on a straight-line basis, unless
another systematic basis is more representative of the
time pattern of the user’s benefit.

Journal entry:
Dr Lease rental expense RMxxx
Cr Cash RMxxx
(To record lease rental payment)
70
 ACCOUNTING FOR OPERATING LEASE
Disclosures
a) The total future minimum lease payments under non-
cancellable operating leases for each of the following
period;
i) Not later than one year
ii) Later than one year and not later than five years
iii) Later than five years
b) The total future minimum sublease payments expected to
be received under non-cancellable subleases at the
balance sheet date.
c) ) Lease and sublease payments recognised in income for
the period, with separate amounts for minimum lease
payment, contingent rents and sublease payments; and
71
 ACCOUNTING FOR OPERATING LEASE

Disclosures
d) A general description of the lessee’s significant leasing
arrangements, but not limited to, the following:
i) The basis on which contingent rent payments are
determined’
ii) The existence and terms of renewal or purchase
options and escalation clauses; and
iii) Restrictions imposed by lease arrangements, such as
those concerning dividends, additional debt and
further leasing.

72
 Accounting for Operating Lease - by Lessor
Since the risks and rewards of ownership do NOT transfer from
lessor to lessee, lessor keeps recognizing the leased asset in
his statement of financial position.
Lease income from operating leases shall be recognized as an
income on a straight-line basis over the lease term, unless
another systematic basis is more appropriate.
• Assets should be retained in lessor’s book as fixed assets.
• Account for depreciation expense annually (Depreciation
policy : MFRS116)
• Lease payment received - Rental income (in income
statement)
• Initial direct cost- added to the carrying amount of the leased
asset and recognised as an expense over the lease term on
the same basis as the lease income. 73
 EXAMPLE
Think Well Bhd arranged with XYZ Bhd to
lease a photocopy machine for four years.
The rental payable by Think Well Bhd is
RM20,000 per annum. The fair value of
the asset is RM100,000 and its economic
life is 10 years. The lessor, XYZ Bhd, will
undertake all maintenance and repairs.

74
ANSWER BOOK OF THINK WELL BHD (Lessee)
75

Debit Credit
RM RM
Lease rental expense 20,000
Bank 20,000

BOOK OF XYZ BHD (Lessor)

Debit Credit
RM RM
Office equipment 100,000
Bank 100,000

Bank 20,000
Lease rental income 20,000

Depreciation expense 10,000

Accumulated depreciation 10,000
 SALE AND LEASEBACK
A sale and leaseback transaction involves the sale
of an asset and the leasing the same asset back.
In this situation, a seller becomes a lessee and a
buyer becomes a lessor.

76
 SALE AND LEASEBACK
The seller-lessee receives a lump sum for the sales
proceeds when the asset is sold, but will only need to
pay lease rentals periodically under the lease, while
maintaining the right to use the same asset.
Accounting treatment of sale and leaseback transactions
depends on the character of the resulting lease.
The leaseback may be an operating lease or a finance
lease.

77
 LEASEBACK IS A FINANCE LEASE
• If the seller-lessee retains the risks and rewards
incident to the ownership of the asset, then it is a
finance lease.
• This transaction is actually a loan securitized by
the leased asset and seller / lessee keeps
recognizing the asset.
• Any excess of proceeds over the carrying amount
of the leased asset is deferred and amortized
over the lease term.
• The lease payments are repayment of capital and
interest.
78
 EXAMPLE 1
KR Bhd sold its plant with carrying value of
RM130,000 to FUN Bhd for RM150,000 and
immediately leased it back. The arrangement was
that KR Bhd will use the plant for the rest of its
economic life and pay RM45,000 per annum (4
years) in arrears.
KR Bhd retained all the risks and rewards attached
to the plant.
Solution
Since KR retained all risks and rewards, the lease
are qualifies as finance lease. KR Bhd in essence
borrowed RM150,000.
79
 EXAMPLE 1
 RM45,000 annual repayment would comprise
interest plus capital repayment. Assume interest
rate is 12.5% p.a, then at the end of the year, the
interest expense would be = RM18,750 (150,000 x
12.5%) + capital repayment = RM26,250 ($45,000 –
18,750)
 Any excess of the sales proceeds over the carrying
value should not be recognised as income
immediately. The gain should be deferred and
amortised over the lease period.
RM130,000 (CV) - RM150,000 (SP) = RM20,000
 RM20,000 is deferred and amortised over 4 years.
80
 EXAMPLE 2
On 1.1.x3 JR Bhd purchased a machine costing
RM800,000 and depreciated it on a straight-line basis
over 10 years.
On 1.1.x6, a sale and leaseback was arranged. The
machine was sold for RM700,000 which was the fair
value. JR leased it back as a finance lease for seven
years at an annual rental of RM110,000, payable in
arrears. Interest is to be allocated using sum-of-digits
method.
Required:
Journalise the transactions in the books of JR Bhd
for year x6. 81
 82

ANSWER
Debit Credit
RM RM
Bank 700,000
Accumulated depreciation (80,000 x 3) 240,000
Machine 800,000
Deferred gain 140,000

Machine 700,000
Lease creditor 700,000

Lease creditor 110,000

Bank 110,000
 83

ANSWER
Debit Credit
RM RM
Interest expense (70,000 x 7/28)* 17,500
Lease creditor 17,500

Depreciation expense 100,000

Accumulated Depreciation 100,000

Deferred gain (B/S) (140,000/7) 20,000

Income statement 20,000
LEASEBACK IS AN OPERATING LEASE
If the resulting lease is an operating lease, then a
seller/lessee derecognizes the asset and a
buyer/lessor recognizes the asset.
Further accounting treatment depends on the
sale price:
• If the sale price is close to asset’s fair value, then
the profit or loss from sale should be
recognized immediately.

84
LEASEBACK IS AN OPERATING LEASE
• If the sale price is below asset’s fair value, then it
is necessary to check the rental payments. If the
future payments are below market price, then the
loss from the sale of asset should be amortized
over the period of use. If the future payments are
close to market rentals, then the loss from the
sale of asset should be recognized immediately.
• If the sale price is above fair value, then the
excess over fair value or “profit from sale” should
be deferred and amortized over the period
of use.
85
LEASEBACK IS AN OPERATING LEASE
Treatment for sale and leaseback, if it is an operating lease,
is summarised as follows:
 Step 1 : Compare fair value with carrying amount
If the fair value of the asset is less than the carrying
amount, write down the asset to fair value, then proceed
to step 2.
 Step 2 : Compare selling price and fair value
 If the selling price of the asset is greater than the fair
value, defer and amortise over the period of use.
 If the selling price is less than the fair value and rental
is at fair value, recognise loss immediately.
 If the selling price is less than the fair value and rental
is not at fair value, defer and amortise over the lease
term. 86
 EXERCISE
On 1.1.x3, Tas Berhad purchased a machine costing
RM800,000 and depreciated it on a straight-line basis over 10
years.
On 1.1.x6 a sale and leaseback was arranged. The leaseback
was an operating lease.
Journalise the transactions in the books of Tas Berhad if:
a) the machine was sold for RM700,000 which was the
fair value and leased back for four years at an annual
rental of RM100,000;
b) the machine was sold at RM800,000 (the fair value
was RM700,000) and leased back for four years at an
annual fair rental of RM100,000;
87
 EXAMPLE
c) the machine was sold for RM500,000 and leased back
for four years at a fair rental of RM100,000;
d) the machine was sold at RM500,000 and rental was
RM70,000 for four years assuming fair rental to be
RM100,000; and
e) the fair value of the machine on 1.1.x6 was RM500,000
and it was sold for RM530,000 and leased back as an
operating lease at a fair rental of RM100,000.

88
 89

ANSWER
a) the machine was sold for RM700,000 which was
the fair value and leased back for four years at
an annual rental of RM100,000
- gain or loss is recognised immediately.

Debit Credit
RM RM
(a) Bank 700,000
Acc. Depreciation (80,000 x 3) 240,000
Machine 800,000
Gain (I/S) 140,000

Lease rental expense 100,000

Bank 100,000
ANSWER 90

b) the machine was sold at RM800,000 (the fair value was RM700,000) and
leased back for four years at an annual fair rental of RM100,000
- excess above the fair value should be deferred and amortised over the
period the asset is expected to be used
Debit Credit
RM RM

(b) Bank 800,000

Acc. Depreciation 240,000
Machine 800,000
Gain (I/S) 140,000
Deferred gain (SP – FV) 100,000

Lease rental expense 100,000

Bank 100,000

Deferred gain (100,000 / 4yrs) 25,000

Income statement 25,000
ANSWER 91

c) the machine was sold for RM500,000 and

leased back for four years at a fair rental of
RM100,000
- the loss is to be recognised immediately
Debit Credit
RM RM
(c) Loss (I/S) 60,000
Bank 500,000
Accumulated depreciation 240,000
Machine 800,000

Lease rental expense 100,000

Bank 100,000
ANSWER 92

d) the machine was sold at RM500,000 and rental was

RM70,000 for four years assuming fair rental to be
RM100,000 - Loss deferred & amortised over lease period.
Debit Credit
RM RM
(d) Bank 500,000
Deferred loss* 60,000
Accumulated depreciation 240,000
Machine 800,000

Lease rental expense 70,000

Bank 70,000

Income statement 15,000

Deferred loss (60,000/4 years) 15,000
ANSWER 93

e)the fair value of the machine on 1.1.x6 was RM500,000 and it was sold
for RM530,000 and leased back as an operating lease at a fair rental of
RM100,000 - asset should write down to FV before recording the sale.
Debit Credit
RM RM
(e) Income statement – Impairment loss * 60,000
Machine 60,000

Bank 530,000
Machine (NBV) 500,000
Deferred gain 30,000

Lease rental expense 100,000

Bank 100,000

Deferred gain (30,000 / 4 years) 7,500

Other income 7,500
 ANSWER

e. * Review for impairment of assets

Cost of assets $800,000
Less Acc. Dep $240,000
NBV 560,000
FV 500,000
Impairment Loss $60,000

94
 Issues In Accounting For Leases
• IFRS 16
– to cater for the issues involving off-balance
sheet financing
– the single lease accounting for lessee based
on the right-of-use model
– effect - lessee will need to recognize all
leases as finance leases, except for short-
term leases and low-value asset leases.
 Issues In Accounting For Leases
• Recognition of assets (the right-of-use) and liabilities
(lease obligation) by lessees for all leases
• At the commencement date, a lessee shall measure the
right-of-use asset at cost
• The right-of-use asset would be subsequent measured
using a cost model (Cost – Acc. Amortisation –
Impairment)
• The lease obligation would be initial and subsequent
measured similar way as MFRS 117
 Issues In Accounting For Leases
• Other elements of IFRS 16 are:

– The need to distinguish between a lease contract or a

service contract

– The right-of-use model including for subleases

– Sale and leaseback transactions—the sale must meet

the requirements in IFRS 15, i.e. the new revenue

standard
 Tutorial Question
Questions from Jane Lazar & Huang Ching
Choo. 2014. Financial Reporting Standards for
Malaysia. Revised 4th Edition - Chapter 23
•Question 2
•Question 4
•Question 9

98