Under IFRS 16, a lease is a contract in which the lessor provides the right to use an underlying asset to a lessee for a period of time in exchange for consideration.
A lessor must assess:
- Transfer of risks and rewards of ownership.
- Whether control of the underlying asset substantially passes to the lessee.
Unlike lessees, lessors continue to distinguish between finance and operating leases.
1. Finance Lease (Lessor)
A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of the underlying asset.
a) The lessor removes the underlying asset from the balance sheet.
At lease commencement:
Derecognize the asset from the balance sheet.
Recognize a lease receivable (net investment in the lease).
Dr Lease Receivable (PV of lease payments + unguaranteed residual value)
Cr Asset (carrying amount of leased asset)
Cr Gain on Sale/Finance Lease (if any)
During the lease term:
Recognize interest income on the lease receivable using the effective interest method.
Dr Lease Receivable
Cr Interest Income
When cash is received from lessee:
Dr Cash
Cr Lease Receivable
Recognition of Net Investment:
The lessor recognizes a receivable equal to the net investment in the lease (present value of lease payments plus any unguaranteed residual value).
Income Recognition:
Finance income is recognized over the lease term using a pattern that reflects a constant periodic rate of return on the net investment.
2. Operating Lease (Lessor)
An operating lease (as a lessor) is simply a rental arrangement. The lessor allows someone else to use the asset for a period of time, but ownership does not change. Since the risks and rewards of ownership are not transferred, the asset remains on the lessor’s balance sheet.
Because the lessor still owns the asset, it continues to depreciate just like any other asset they use in their business. The lease payments received are treated as rental income and are usually recognized evenly over the lease term. It can record in below ways.
a) When Lease Payment is Received (or Receivable)
- If cash is received, create a cash receipt document with transaction type Others, and GL can be finance income (User can create a new GL and separate the lease income from other finance income)
The entry below will be created
Debit: Cash
Credit: Lease Income
If a payment is expected but the cash will be collected at a later date, set up a new GL account under Current Financial Assets and generate an Other Income document with the Transaction Type set to Accrual. The journal entry should be:
Debit: Lease Receivable
Credit: Lease Income
Create a Bank/Cash Receipt document with the Transaction Type set to Other. Include the following entries in the document:
Debit: Lease Receivable
Credit: Lease Income
This ensures that the receipt properly records the cash collection against the previously recognized lease receivable.
