Accounting Standard for Leases

In June 1993, the Business Accounting Deliberation Council, which is an advisory body for the Ministry of Finance (Prime Minister, currently), released its 'Opinion on Accounting Standards for Leases' (the 'Standards'). Based on the opinion of the deliberation council, the Ministry of Finance revised its ordinances relating to the Securities and Exchange Law. The Standards are to be adopted gradually, starting from the fiscal year beginning April 1, 1994. Individual financial statements are to fully comply with the standards beginning April 1, 1996 and consolidated financial statements are to be in full compliance by April 1, 1998.

• To Whom the Standards Apply
  The Accounting Standards for Leases set forth basic principles for the accounting treatment of leasing and prescribe disclosure requirements for financial statements to be prepared by the lessee and the lessor under the Securities and Exchange Law. The Securities and Exchange Law in Japan provides that companies as below that issue securities must submit financial statements to the Prime Minister:
  1. companies listed on the stock exchange
  2. over the counter public stock companies
  3. companies that issue corporate bonds, commercial paper, or other types of securities
  4. companies having 500 or more shareholders
  
  Even if enterprises do not fall under any of the above categories, subsidiaries subject to the consolidation of accounts with the parents that fall under the above four categories are obligated to provide the accounts prepared in accordance with the Accounting Standards for Leases.

• Definition and Classification of Lease Transactions
  According to the Accounting Standards for Leases, lease transactions are defined as below (the point is the same as letting agreements of the Civil Code) and classified into two types, finance leases and operating leases.
  [Definition of Lease Transactions]
  Lease transactions mean that lessor, an owner of the assets, provides the lessee with the right to use and to make profits for the agreed period (lease term); the lessee pays the agreed rents (lease payment) to the lessor.

  [Classification of Lease Transactions]
  ＜Finance Lease Transactions＞
  A lease with a contract that is non-cancelable during the lease term, and in which the lessee is able to enjoy substantially all of the economic benefits derived from the leased assets, and bears substantially all of the costs arising from the use of assets over the lease term.
  ＜Operating Lease Transactions＞
  Those are the lease transactions other than finance lease ones.

• Finance Lease Transaction Judgement Standards
  Leases with the prohibition of early cancellation during the lease term and the requirement of full payout (The risks and rewards of leased assets are substantially transferred to the lessee.) are finance lease transactions. In addition to this, those that apply to any of the conditions from (i) to (v) are judged as finance lease transactions. Accounting Standards for Leases defines: those that apply to from (i) to (iii) are the ownership-transfer finance lease transactions and those that apply to (iv) and (v) are the non-ownership-transfer finance lease transactions.
  ＜Ownership-transfer Finance Lease Transactions＞

  1. Lease transactions with ownership transfer conditions: The ownership of leased assets is transferred to the lessee after or during the lease term.
  2. Lease transactions with purchase option bargain: The right to purchase leased assets on nominal value or sufficiently lower value than market value after or during the lease term is provided to the lessee on the condition that its right may be undoubtedly enforced.
     Lease transactions for special specification assets: Leased assets are created for the special edition ordered by the lessee and only the lessee use the assets during the lease term

  ＜Non-ownership-transfer Finance Lease Transactions＞

  4. The present value of total lease payment during non-cancellable lease term is more than 90% of estimated purchase amount of leased assets, provided that the lessee would purchase the leased assets in cash.
  5. Lease term during which lease transaction cannot be cancelled is longer than or equal to 75% of economic life of leased assets (excepting that the present value above undoubtedly mark well below 90% of the estimate).
• Accounting Treatment
  ＜Finance Lease Transactions＞
  As a matter of principle, finance lease transactions should be accounted for on a basis akin to those which set out for an ordinary sale and purchase contract. However, in case of the non-ownership-transfer finance lease transactions, the lessee can elect the off balance treatment. The lessee treats lease payment as an expense, while the lessor lists the amount of leased assets on the balance sheet, treats depreciation as an expense, and recognizes the lease payment collected by themselves as revenue.
  In this case, the lessee and lessor should disclose in the footnote to their financial statement as to:
  1. assets information (types of assets)
  2. liabilities information (which should be classified into those where the remaining lease term is within a year and those where it is longer than a year)
  3. profit and loss information
  4. accounting methods of equivalent of depreciation expenses and equivalent of interest expenses.
  Almost all companies in Japan treat 'non-ownership-transfer finance lease transactions' as letting transactions for accounting.

  ＜Operating Lease Transactions＞
  The lessor and lessee treat this kind of transactions as letting transactions for accounting, though the lease payment payable must be disclosed in the footnote to their financial statement classifying into those where the remaining lease term is within a year and those where it is longer than a year.
  Footnotes for Non-ownership-transfer Finance Lease Transactions (PDF)