APC311 INTERNATIONAL FINANCIAL REPORTING
Lecture 7
Accounting for Leases
Learning Outcomes
To describe and distinguish basic definitions in terms of leases
To describe IAS 17 requirements of leases on:
Classification
Accounting treatment by lessee
Accounting treatment by lessor
Disclosure
To debate implications of different accounting treatments of leases on financial statements
Introduction
Off-balance sheet item: leases
Management vs. leases: creative accounting
Relevant regulations
IAS 17 Leases
Basic Definitions
Lease
An agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time
Finance lease
A lease that transfers substantially all the risks and rewards incidental to ownership of an asset
Operating lease
A lease other than a finance lease
IAS 17 (revised 2003)
Objective
To describe, for lessees and lessors, the appropriate accounting policies and disclosures to apply in relation to finance and operating leases
Scope
Apply to all leases, except
Lease agreements for minerals, oil, natural gas, and licensing agreements for films, videos, plays, patents, copyrights and similar items
IAS 17
Classification
The substance of the transaction rather than the form
A finance lease is classified if
The lease transfers ownership of the asset to the lessee by the end of the lease term
The lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised
The lease term is for the major part of the economic life of the asset, even if title is not transferred
At the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset
The lease assets are of a specialised nature such that only the lessee can use them without major modifications being made
Accounting by Lessees
Principles for finance leases
At commencement of the lease term, finance leases should be recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (i.e. discounted at the interest rate implicit at the lease, or else at the enterprise’s incremental borrowing rate)
Principles for finance leases
Finance lease payments should be apportioned between the finance charge and the reduction of the outstanding liability (i.e. the finance charge to be allocated so as to produce a constant periodic rate of interest on the remaining balance of the liability).
Principles for finance leases
The depreciation policy of assets should be consistent with that for owned assets. If there is no reasonable certainty that the lessee will obtain ownership at the end of the lease, the asset should be depreciated over the shorter of the lease term or the life of the asset
Principle for operating leases
The lease payments should be recognised as an expense in the income statement over the lease term on a straight-line basis, unless another systematic basis is more representative of the time pattern of the user’s benefit
Principles for finance leases
At commencement of the lease term, the lessor should record a finance lease in the balance sheet as a receivable, at an amount equal to the net investment in the lease
The lessor should recognise finance income based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment outstanding in respect of the finance lease
Principles for operating leases
Assets should be presented in the balance sheet of the lessor according to the nature of the asset
Lease income should be recognised over the lease term on a straight line basis, unless another systematic basis is more representative of the time pattern in which use benefit is derived from the leased asset is diminished
Principles for operating leases
The asset should be depreciated on a basis consistent with the lessor’s policy for similar assets
Relevant IASs 16, 38 and 36 need to be considered
Costs (depreciation included) which are incurred in earning the lease income are recognised as an expense
Sale & Leaseback Transactions
Results in a finance lease
Any excess of proceeds over the carrying amount is deferred and amortised over the lease term
Results in an operating lease
If the transaction is clearly carried out at fair value – the profit or loss should be recognised immediately
If the sale price is above fair value – the excess over the fair value should be deferred and amortised over the period of use
Results in an operating lease
If the sale price is below fair value – profit or loss should be recognised immediately, except if a loss is compensated for by future rentals at below market price, the loss should be amortised over the period of use
If the fair value at the time of the transaction is less than the carrying amount – a loss equal to the difference should be recognised immediately
Disclosure
Lessees – Finance lease
Carrying amount of asset
Amount of minimum lease payments at balance sheet date and the present value thereof for certain time period
Contingent rent recognised as an expense
General description of significant leasing arrangements, including contingent rent provisions, renewal or purchase options, and restrictions imposed on dividends, borrowings, or further leasing
Lessees – operating lease
Amounts of minimum lease payments at balance sheet date under noncancellable operating lease for certain time period
Lease and sublease payments recognised in income for the period
Contingent rent recognised as an expense
General description of significant leasing arrangements, including contingent rent provisions, renewal or purchase options, and restrictions imposed on dividends, borrowings, or further leasing
Lessors – Finance lease
Gross investment and present value of minimum lease payments receivable for future certain time period
Unearned finance income
Contingent rent recognised in income/
Unguaranteed residual values
General description of significant leasing arrangements
Lessors – Operating lease
Amounts of minimum lease payments at balance sheet date under noncancellable operating leases in the aggregate and for certain time period
Contingent rent recognised as in income
General description of significant leasing arrangements
Example – White Ltd