Category Archives: 1 Basic Accounting

Initial recognition of finance lease

When you have worked out your contract and deemed it is more a finance rather an operating lease, you need consider it as your own asset. “Finance” essentially means that someone else financed the purchase of your asset. As a result, this ‘someone’ is leasing the asset out to you asking for a rental fee. In accounting this is called a finance lease liability as in essence you acquired an asset with third party resources.

As you no doubt can already figure out, the first steps are to recognize both the asset and the corresponding liability on the balance sheet. The very first entry is as follows:

Db PPE (into the group the asset most suits and in the amount yet to be paid for the asset)

Cr Finance lease liability (the amount yet to be paid for the asset)
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Finance lease – when can we talk about finance lease?

When operating lease is really straightforward and only comprises of one linear expense on the income statement, finance lease is a bit more complicated than that and also comprises of couple of other financial statement lines being affected.

Before we can however start digging deeper into recognizing the finance lease on the balance sheet, we need to determine when we are even talking about finance lease. There are a couple of situations which usually indicate that the contract should be accounted as a finance lease (although the name of it may be ‘operating lease’). Mind you that if already one of those conditions is met, it is high chance the lease is in essence a finance lease.
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Generally speaking of leases – finance and operating leases

You may encounter leases in all sorts of businesses. It can be to lease machinery for production, a car for everyday use or small office supplies like a coffee machine. As such when we talk about leases and leasing, we essentially mean gaining a right to use an asset.

When you lease an asset, you regularly pay a certain amount to the lessor for the right to use the asset. However, in certain types of leases you may also get the obligation to take care of maintenance and all similar costs, so in essence, in addition to the right to use the asset (‘reward’), you also gain the risks. In accounting, the leases where substantial risks and rewards transfer from the lessor to the lessee are called ‘finance leases’. When defining ‘substantial’, we do mean on the scale it is incidental to the ownership itself.
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Bonus reserve

There are essentially two types of bonuses – those that are given from year to year and those which are decided ad hoc and given only on certain exceptional occasions. Whilst there are a few differences when it comes to accounting for them, in essence they are fairly the same. Both need to be recognized on the balance sheet and income statement just when it has become apparent that they will be paid and people have reason to be expecting them.

As for the year to year bonuses (whether paid on monthly, quarterly or annual basis), the expense should be spread out over the period the bonus relates to. When it is not so much of an issue when it comes to monthly bonuses obviously (though keep in mind posting them into the month the bonus is for), it is highly recommended to spread the expense more or less evenly over the months when it comes to annual bonuses. The reason behind this is simple fact that your monthly expenses stay on stabile levels instead fluctuating significantly at year end or at the end of each quarter.
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Vacation pay reserve

When people go on a vacation, they depending on local regulation may have to be paid up front before leaving or the payment shall continue as regular monthly salary, however the rule is that people do have to get paid when they are on vacation. Fact of the matter is that they can go on a holiday even with short notice and you have to be prepared to make the upfront payment to them if so required by local law.

In fact, as a general rule, your balance sheet should always reflect the liability you owe to your employees when it comes to vacations. For an example, when an employee decides to leave the post for good, he or she is entitled to all those vacation days and also respective payment.

So what some companies do is simply accruing a certain percentage of monthly salaries to vacation pay reserve account every month. If let’s say the employees are allowed to take 28 days off with full pay, the reserve should essentially be in the amount of one month’s payroll expense more or less depending of course on the days people have to receive. As an example, when accruing for the reserve in December, if you have all the employees having their vacation in summer and all of them have give or take 14 days on their reserve in mentioned December, the reserve amount on the balance sheet should be in the amount of roughly half of the monthly salary expense.
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Wrongly shipped goods

Every now and then it may happen that you may get let’s say extra goods that you really did not order – either the shipment comprising of all wrong goods, some missing or some extra, doesn’t really matter – but it happens. When this does occur, depending on the goods and the situation really (i.e. excess of goods or wrong items sent) you have quite a few opportunities to deal with it.

One option is to always to send the excess goods back and account on the balance sheet for the goods that you did order. It essentially means that you are not accepting part of the invoice and as such are also requesting for the vendor to make a credit note on the wrong invoice. However, if the invoice itself is correct, but just the goods don’t match with what is on the paper, they simply need to be reshipped and sorted out with the vendor.
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Goods are received, but not the invoice with them

It happens in many companies that deal with inventory – they get the goods with a note, but no invoice. Usually an invoice is sent separately and a bit later on. However, during normal course of business and in most companies, you would expect to start selling the goods as soon as possible. But how can you do it with goods that the supplier has not yet sent the invoice for? You need a source document for every entry on your balance sheet and in this case for proper entry it’s missing.

Essentially you cannot leave those goods out of the balance sheet, because they are your company’s assets. So, to overcome this problem, you will recognize those items as goods held for sale (or materials etc) and on the other side of the balance sheet you take up a liability on a separate line called ‘Payables to suppliers (invoice not yet received)’. The entry looks something like this:
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