Journal Entries Finance Lease

Finance leases, under both IFRS and US GAAP (though terminology varies slightly), are agreements that effectively transfer substantially all the risks and rewards of ownership from the lessor to the lessee. As such, they are treated similarly to the purchase of an asset financed with a loan. Here’s a breakdown of the journal entries involved:

Lessee Accounting

1. At the Inception of the Lease:

The lessee recognizes both an asset (the leased asset) and a corresponding liability (the lease liability) on their balance sheet. The initial measurement is typically the lower of the fair value of the leased asset or the present value of the minimum lease payments. Discounting these payments requires using the interest rate implicit in the lease, if readily determinable; otherwise, the lessee’s incremental borrowing rate is used.

Debit: Right-of-Use (ROU) Asset  $XXX Credit: Lease Liability      $XXX 

2. Subsequent Lease Payments:

Each lease payment is split between interest expense and a reduction of the lease liability. The interest expense is calculated based on the carrying amount of the lease liability at the beginning of the period and the effective interest rate.

Debit: Interest Expense          $YYY Debit: Lease Liability           $ZZZ Credit: Cash                    $AAA  (Where AAA = YYY + ZZZ) 

3. Depreciation of the ROU Asset:

The ROU asset is depreciated over its useful life, or the lease term, whichever is shorter, unless ownership of the asset transfers to the lessee at the end of the lease term, in which case depreciation occurs over the asset’s useful life. The depreciation method used should be consistent with the lessee’s depreciation policy for similar owned assets.

Debit: Depreciation Expense       $BBB Credit: Accumulated Depreciation  $BBB 

Lessor Accounting

For the lessor, finance leases are treated as sales-type or direct financing leases. The accounting differs slightly depending on whether a manufacturer or dealer profit is involved (sales-type) or not (direct financing).

1. At the Inception of the Lease (Sales-Type Lease):

The lessor derecognizes the asset from its balance sheet and recognizes a lease receivable (representing the future lease payments). They also recognize a profit or loss on the sale, similar to a regular sale of goods.

Debit: Lease Receivable         $XXX Credit: Sales Revenue              $YYY Credit: Cost of Goods Sold        $ZZZ Debit: Inventory                 $ZZZ 

2. At the Inception of the Lease (Direct Financing Lease):

The lessor derecognizes the asset and recognizes a lease receivable. No immediate profit is recognized; instead, the profit is recognized over the lease term as interest income.

Debit: Lease Receivable         $XXX Credit: Asset                         $XXX 

3. Subsequent Lease Payments (Both Types):

The lessor recognizes interest income and reduces the lease receivable. The interest income is calculated based on the carrying amount of the lease receivable at the beginning of the period and the effective interest rate.

Debit: Cash                       $AAA Credit: Interest Income          $YYY Credit: Lease Receivable        $ZZZ (Where AAA = YYY + ZZZ) 

Proper accounting for finance leases is critical for both lessees and lessors to accurately reflect their financial position and performance. It requires careful consideration of the lease terms, discount rates, and asset lives. Understanding these journal entries provides a fundamental basis for understanding finance lease accounting.