FRS 116 Leases – Recognising and Measuring Finance Leases

FRS 116 Leases – Recognising and Measuring Finance Leases

If you lease something to another individual or business (Also see Using Activity Ratios for Business Efficiency), you, as the lessor, may be familiar with the classification of leases. After determining the category of the leases, the next thing you need to do is to record them using the corresponding accounting treatment. The article below may provide you with some insight on this matter, or you may contact an accounting firm in Singapore if you need further assistance.

At the commencement date of the lease, in the balance sheet, the lessor needs to recognise the assets which are under a finance lease. Also, it needs to present them as a receivable amount at a sum which is the same as the net investment in the lease. After recognising them, the lessor should measure them, and there are two phases of measurement, which are initial measurement and subsequent measurement.

For the purpose of measuring the net investment in a lease, the lessor should use make use of the interest rate implicit in the lease. For subleases, the intermediate lessor can use the discount rate that applies to the head lease when measuring the net investment in the sublease if it is unable to identify the interest rate implicit in that sublease. Note that in such cases, the lessor should adjust the discount rate mentioned just now to reflect any initial direct costs which are related to the sublease.

Except for the initial direct costs that the manufacturer or dealer lessor have incurred, these costs should be included in the initial measurement of net investment in a lease. The initial direct cost will decrease the sum of income the lessor recognises throughout the lease term. The lessor should define the interest rate implicit in a lease by including the initial direct cost automatically in the net investment of the lease.

On the day the lease has commenced, when measuring the net investment in the lease (Also see FRS 116 Leases – Recognising and Measuring Operating Leases), the lease payments include different payments. These payments are for the right of using the underlying assets within the lease term that the lessor has not received on the date of commencement. Those payments include the fixed payments, excluding any lease incentives payable, as well as the variable lease payments, which depends on a certain rate or index. The lessor should measure the latter by using the rate or index as at the date the lease commences.

Besides, the lease payments also comprise of the residual value guarantees that the lessee or a party which is relevant to the lessee has provided to the lessor if there is any. Apart from the both of them, a third party that has no relationship with the lessor and has the ability to discharge the obligations under guarantee can also provide the guarantee to the lessor.

The lessor should include in the payments the exercise price of the option of purchasing the assets (Also see FRS 116 Leases – Subsequent Measurement of Right-of-use Asset and Lease Liability by the Lessee) given that the lessee is quite sure that it will implement this option. If the lease term shows that the lessee exercises an option of terminating the lease, the lease payments should also take the payments of penalties for the termination into account.

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