NOTES ON CRITICAL POINTS OF LEASE ACCOUNTING

NOTES ON CRITICAL POINTS OF LEASE ACCOUNTING - Note on the...

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Note on the critical aspects of Lease Accounting There are two parts of lease accounting; one relates to the accounting for the lessee and the other relates to the accounting for the lessor. Let us discuss the issues simultaneously from both the lessee and lessor’s point of view. To determine the nature of a lease transaction (whether capital or operating lease), one has to consider the following four criteria from lessee’s point of view: 1. Transferability of ownership interests. 2. Economic life test. 3. Bargain purchase option. 4. Recovery of investment test. At least one of those criteria must be met to classify a lease as a capital lease in the lessee’s book. In addition to the above, the following two conditions that must be met to classify a lease as a capital lease in the lessor’s book. 1. Collection of lease payment from the lessee is reasonably assured. 2. There is no important uncertainty surrounding the lessor’s future performance, or, lessor’s performance is substantially complete. Therefore, you can sometimes see a situation where based on the conditions mentioned above, a lease transaction may be a capital lease in the lessee’s book but is an operating lease in the lessor’s book. First of all, let me discuss a little bit about operating lease. When a lease is operating in nature, the lessee will only record periodic lease rental payment as rent expense and thus, as a charge in the relevant fiscal period against revenue in income statement. This is fairly straight forward and you need not worry about applying the present value techniques. The lessor has the responsibility of maintaining the accounts for the asset under the operating lease (i.e., depreciation) like any other long-term asset used by it in the business. The lease rental revenue will appear in its income statement along with all other lease-related expenses (e.g., maintenance, insurance and taxes) and the
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depreciation of the leased property. So, when you are asked to provide an account of operating lease from the lessor’s point of view, you need to consider those
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NOTES ON CRITICAL POINTS OF LEASE ACCOUNTING - Note on the...

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