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Standard No. 06
LEASES

(Issued and promulged in pursuance of the Minister of Finance

Decision No. 165/QD-BTC dated December 31, 2002)

GENERAL PROVISIONS

01. This standard aims to prescribe and guide for lessees and lessors the accounting principles and methods for financial lease and operating lease, serving as a basis for making accounting entries and financial statements.

02. This standard shall apply to the accounting of all leases, excluding:

a/ Lease contracts for exploiting or using natural resources, such as oil, gas, timber, metals and other minerals;

b/ Lease contracts for using copyrights of items such as motion picture films, video tapes, operas, copyrights and patents.

03. This standard shall apply also to the transfer of the right to use assets even when the lessors are requested to provide services mostly related to the operation, repair or maintenance of the leased assets. This standard shall not apply to service contracts not involving the transfer of the right to use assets.

04. The terms used in this standard are construed as follows:

A lease means an agreement between the lessor and the lessee whereby the lessor transfers the right to use an asset to the lessee for a certain period of time in return for a lease payment made in a lump sum or installments.

A financial lease is a lease whereby the lessor transfers most of the risks and rewards associated with the ownership over an asset to the lessee. The ownership over the asset may be transferred at the end of the lease term.

An operating lease is a lease other than a financial lease.

A non-cancelable lease contract is the one that the two involved parties cannot unilaterally terminate, except in the following cases:

a/ Upon the occurrence of unusual events, such as:

- The lessor fails to hand the leased asset on schedule;

- The lessee fails to make lease payments according to the provisions of the lease contract;

- The lessee or lessor breaches the contract;

- The lessee goes bankrupt or is dissolved;

- The guarantor goes bankrupt or is dissolved while the lessor rejects the lessee’s proposal on guaranty termination or substitute guarantor;

- The leased asset is lost or irreparably damaged.

b/ With the consent of the lessor;

c/ If the two parties enter into a new contract on lease of the same or similar asset;

d/ The lessee pays an additional amount immediately at the start of the lease.

The inception of the lease is the earlier date of either of the two dates: The date when the right to use the asset is transferred to the lessee and the date when the lease payment begins to be calculated under the provisions of the lease contract.

The lease term is the period of the non-cancelable lease contract plus (+) the duration for which the lessee have the option to continue leasing the asset as prescribed in the contract, with or without additional payment; this option is determined with relative certainty right at the inception of the lease.

Minimum lease payments:

a/ For the lessee: They are the payments which the lessee must make to the lessor for a lease over the lease term (excluding service costs and taxes which have been paid by the lessor and must be reimbursed by the lessee, and a contingent rent), plus any value that the lessee or a party related to the lessee has guaranteed to pay.

b/ For the lessor: They are the payments which the lessee must make to the lessor over the lease term (excluding service costs and taxes which have been already paid by the lessor and must be reimbursed by the lessee, and a contingent rent) plus (+) any residual value of the leased asset, which has been guaranteed to be paid by:

- The lessee;

- A party related to the lessee; or

- An independent financially capable third party.

c/ Where the lease contract contains the provision on the lessee’s right to purchase the leased asset at a price lower than the reasonable value on the date of purchase, the minimum lease payments (for both lessor and lessee) shall include the minimum payment inscribed in the contract for the lease term and the payment required for the purchase of such asset.

Reasonable value is the amount for which an asset can be exchanged or the value of a liability which may be settled voluntarily between the knowledgeable parties in the par value exchange.

Residual value of a leased asset is the estimated value at the inception of the lease, which the lessor expects to obtain from the leased asset at the end of the lease.

Guaranteed residual value of a leased asset:

a/ For the lessee: It is the residual value of a leased asset, which is guaranteed to be paid by the lessee or by a party related to the lessee to the lessor (the guaranteed value is the maximum amount that the lessee must pay in any circumstances).

b/ For the lessor: It is the residual value of a leased asset, which is guaranteed to be paid by the lessee or a financially capable third party not related to the lessor.

Unguaranteed residual value of a leased asset: is the residual value of a leased asset, which is determined by the lessor and is not guaranteed to be paid by the lessee or a party related thereto or is guaranteed to be paid only by one party related to the lessor.

Economic life: is the period over which an asset is expected to be economically usable or the number of products or similar units expected to be obtained from the leased asset by one or more users.

Useful life is the remaining economic life of the leased asset, counting from the inception of the lease, but not restricted by the lease term.

Gross investment in the financial lease contract is the aggregate of the minimum lease payments under a financial lease contract (for the lessor) plus (+) the unguaranteed residual value of the leased asset.

Unearned financial revenue is the aggregate of the minimum lease payments plus (+) the unguaranteed residual value and minus (-) the present value of these amounts, calculated at the interest rate implicit in the financial lease.

Net investment in the financial lease is the difference between the gross investment in the financial lease and the unearned financial revenue.

The interest rate implicit in the financial lease contract is the discount rate used, at the inception of the asset lease, to calculate the present value of the minimum lease payment and the present value of the unguaranteed residual value to ensure that their aggregate is equal to the reasonable value of the leased asset.

Incremental borrowing interest rate is the interest rate the lessee must pay for a similar financial lease or that at the inception of the asset lease the lessee must pay to borrow for a similar term and with a similar security an amount necessary to purchase the asset.

Contingent rent is part of the lease payments, which is not fixed in amount but is based on a factor other than the passage of time, for example: percentage (%) of revenue, used amount, price indices, market interest rates.

05. Lease contracts that include provisions permitting the lessees to purchase the assets upon the satisfaction of all conditions agreed in such contracts are called hire purchase contracts.

CONTENTS OF THE STANDARD

Classification of leases

06. The classification of leases adopted in this standard is based on the extent to which risks and rewards associated with the ownership of a leased asset are transferred from the lessors to the lessees. Risks include the possibilities of losses from idle production capacity or technological backwardness and of unfavorable changes in the economic situation, thus affecting the capital recoverability. Rewards are profits expected to be earned from the operation of the leased assets over their economic life and incomes expected to be gained from the increased value of the assets or the value recoverable from the assets’ liquidation.

07. Leases will be classified as financial leases if the contents of the lease contracts include the transfer of most of risks and rewards associated with the assets’ ownership. Leases will be classified as operating leases if the contents of the lease contracts do not include the transfer of most of risks and rewards associated with the assets’ ownership.

08. The lessors and lessees must determine the leases as financial or operating leases right at the inception of the asset lease.

09. The classification of leases as financial or operating leases must be based on the nature of the provisions of the contracts. Below are the examples of cases that normally lead to financial leases:

a/ The lessor transfers the asset’s ownership to the lessee at the end of the lease term;

b/ At the inception of the lease, the lessee has the right to purchase the leased asset at a price expected to be lower than the reasonable price at the end of the lease term;

c/ The lease term accounts for most of the economic life of the asset even if the ownership is not transferred;

d/ At the inception of the lease, the present value of the minimum lease payment accounts for most of the reasonable value of the leased asset;

e/ The leased asset is of a special-use type which can be used only by the lessee without major modification or overhaul.

10. Lease contracts will be also considered financial lease contracts if they fall into at least one of the following three cases:

a/ If the lessee cancels the contract and pays compensation for damage associated with the contract cancellation to the lessor;

b/ Incomes or losses from the change in the reasonable value of the residual value of the leased asset are associated with the lessee;

c/ The lessee is able to continue leasing the asset after the lease contract expires at a rent lower than market rents.

11. Lease classification shall be made at the inception of the lease. If at any time the lessee and the lessor agree to change the provisions of the contract (but not on the renewal of the contract), which leads to a different classification of the lease under the criteria in paragraphs 06 thru 10 at the inception of the lease, the revised provisions shall apply to the entire lease term. Changes in estimates (for example, changes in estimates of the economic life or of the residual value of the leased asset) or changes in the lessees’ payment capability, however, shall not result in a new classification of the lease.

12. Lease of assets being the right to use land and houses will be classified as operating or financial lease. Nevertheless, as land normally has an indefinite economic life and the ownership is not transferred to the lessees at the end of the lease term and the lessees do not accept most of risks and rewards associated with the land ownership, the lease of assets being the land use right will be usually classified as operating lease. The rents paid for assets being the land use right shall be amortized over the entire lease term.

Recognition of leases in the financial statements of lessees

Financial leases

13. At the inception of a financial lease, the lessee will recognize the financial leased asset as an asset and liability in its balance sheet with the same value equal to the reasonable value of the leased asset. If the reasonable value of the leased asset exceeds the present value of the minimum lease payments for the lease, the present value of the minimum lease payments shall be recorded. The discount rate used for calculating the present value of the minimum lease payments for the lease will be the interest rate implicit in the asset lease contracts or the interest rate inscribed therein. If the interest rate implicit in the lease contract is undeterminable, the lessee’s incremental borrowing interest rate will be used for calculating the present value of the minimum lease payments.

14. When presenting liabilities concerning financial leases in the financial statements, short-term and long-term liabilities must be distinguished.

15. Initial direct costs incurred in connection with financial leasing activities, such as costs for lease contract negotiation and signing will be recognized into the historical costs of the leased assets.

16. Payments for a financial lease of assets will be apportioned between financial costs and the amounts payable for debt principals. Financial costs must be calculated according to each accounting period of the entire lease term at a constant periodic interest rate on the remaining debit balance of each accounting period.

17. A financial lease shall give rise to asset depreciation costs as well as financial costs in each accounting period. The depreciation policy for a leased asset must be consistent with the depreciation policy for assets of the same kind under the ownership of the lessee-enterprises. If it is uncertain that the lessees would obtain the assets’ ownership by the end of the lease term, the leased asset will be depreciated over the shorter duration between the lease term and its useful life.

18. When presenting leased assets in the financial statements, the provisions of the accounting standard "Tangible fixed assets" must be complied with.

Operating leases

19. Payments for an operating lease (excluding service, insurance and maintenance costs) must be recognized as production and business costs by the straight line method during the entire asset lease term regardless of the payment mode, unless more reasonable calculation methods are applied.

Recognition of asset leases in the financial statements of lessors

Financial leases

20. The lessors must recognize the value of financial leased assets in their balance sheets as a receivable equal to the value of net investment stated in the financial lease contracts.

21. For financial leases, most of risks and economic rewards are associated with the assets’ ownership transferred to the lessees, and, therefore, all receivables therefrom must be recognized as receivables for principal capital and financial revenues from the lessors’ investments and services.

22. The recognition of financial revenues must be based on the constant periodic interest rate on the total balance of net investment in financial leases.

23. The lessors shall amortize financial revenues over the entire lease term on the basis of the constant periodic interest rate over the balance of net investment in financial leases. Payments paid for financial leases in each accounting period (excluding costs for the provision of services) shall be allowed to be reduced from gross investment in order to reduce both the principal capital and the unearned financial revenues.

24. Initial direct costs to create financial revenues, such as commissions and legal fees incurred in the contract negotiation and signing, are often paid by lessors and shall be recognized as cost in the period as soon as they are incurred or be amortized into costs over the lease term in a way suitable to the recognition of revenues.

Operating leases

25. The lessors must recognize assets under operating leases in their balance sheets, using the method of classification of enterprises’ assets.

26. Revenues from operating leases must be recognized by the straight line method over the entire lease term, regardless of the payment modes, unless more reasonable calculation methods are applied.

27. Costs of operating leases, including depreciation of leased assets, will be recognized as costs in the period during which they are incurred.

28. Initial direct costs to create revenues from operating leases shall be immediately recognized as costs in the period during which they are incurred or be amortized into the costs over the entire lease term in a way suitable to the recognition of revenues from operating leases.

29. The depreciation of leased assets must be on a basis consistent with the lessors’ depreciation policy applicable to similar assets, and the depreciation costs must be calculated under the provisions of the accounting standards "Tangible fixed assets" and "Intangible fixed assets."

30. The lessors being manufacturing or trading enterprises shall recognize revenues from operating leases according to each lease term.

Asset sale and leaseback transactions

31. A asset sale and leaseback transaction is effected when an asset is sold then leased back by the same seller. The accounting method applicable to sale and leaseback transactions depends on the type of lease.

32. If an asset sale and leaseback transaction is a financial lease, the difference between the sale proceeds and the residual value of the asset must be amortized over the entire lease term.

33. If the asset leaseback is a financial lease, whereby the lessor provides finance for the lessee, with asset security. The difference between the proceeds from the sale of the asset and the residual value of the asset in the accounting books shall not be immediately recognized as a profit from the sale of the asset; instead it must be recognized as unearned income and amortized over the entire lease term.

34. Sale and leaseback transactions being operating leases will be recognized when:

- The sale price is agreed upon at the reasonable value, any profit or loss must be recognized immediately in the period during which it arises;

- If the sale price is lower than the reasonable value, any profit or loss must be also recognized immediately in the period during which it arises, except where the loss is offset with future lease payments lower than the market rent. In this case, the loss shall not be immediately recognized but must be amortized into costs corresponding to the lease payments over the entire period during which the asset is expected to be used;

- If the sale price is higher than the reasonable value the excess over the reasonable value must be amortized into incomes corresponding to the lease payments over the entire period during which the asset is expected to be used.

35. If an asset leaseback is an operating lease, and the rent and sale price are agreed at the reasonable value, that is, a normal sale transaction has been conducted, any profit or loss will be accounted immediately in the period during which it arises.

36. For operating leases, if the reasonable value of assets at the time of sale and leaseback is lower than the residual value thereof, the loss being the difference between the residual value and the reasonable value must be recognized immediately in the period during which it arises.

37. The requirements on the presentation of the financial statements of lessees and lessors regarding asset sale and leaseback operations must be alike. Where the lease agreements contain a special provision, it must be presented in the financial statements.

Presentation Of Financial Statements

For the lessees

38. The lessees must present the following information on financial leases:

a/ The residual value of the leased asset on the financial statement date;

b/ Contingent rent recognized as a cost in the period;

c/ Bases for determining the contingent rent;

d/ Provision on continued lease or the right to purchase the asset.

39. The lessees must present the following information on operating leases:

a/ The total future minimum lease payments under non-cancelable operating lease contracts with the following terms:

- Of one year or under;

- Of between over one year and five years;

- Of over five years.

b/ Bases for determining contingent rent.

For the lessors

40. The lessors must present the following information on financial leases:

a/ The table of comparison between the total gross investment in leases and the present value of the minimum lease payments receivable on the financial statement date of the reporting periods, with the following terms:

- Of one year or under;

- Of between over one year and five years;

- Of over five years.

b/ Unearned revenues from financial leases;

c/ The unguaranteed residual value of leased assets, calculated by the lessor;

d/ Accumulated reserve for the bad receivables regarding the minimum lease payments;

e/ Contingent rent recognized as revenues in the period.

41. The lessors must present the following information on operating leases:

a/ Future minimum lease payments under non-cancelable operating lease contracts with the following terms:

- Of one year or under;

- Of between over one year and five years;

- Of over five years.

b/ Total contingent rent recognized as revenues in the period.