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Accounting For Leases. Picker Et Al (2012) Ch. 12

This document discusses accounting standards for lease transactions. It defines different types of leases, including finance and operating leases, and provides guidance on classifying leases. It also outlines how to account for finance and operating leases from the perspectives of lessees and lessors. Additionally, it covers sale and leaseback transactions and potential future changes to lease accounting standards.

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Brenden Kapo
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31 views16 pages

Accounting For Leases. Picker Et Al (2012) Ch. 12

This document discusses accounting standards for lease transactions. It defines different types of leases, including finance and operating leases, and provides guidance on classifying leases. It also outlines how to account for finance and operating leases from the perspectives of lessees and lessors. Additionally, it covers sale and leaseback transactions and potential future changes to lease accounting standards.

Uploaded by

Brenden Kapo
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Accounting for Leases.

Picker et al (2012) Ch. 12


Learning Objectives
1. Discuss the characteristics of a lease
2. Explain the difference between a finance and operating lease
3. Use IAS 17 to correctly classify leases
4. Discuss the incentives to misclassify leases
5. Account for finance leases from the perspective of both lessee
and lessor
6. Account for finance leases by manufacturer or dealer lessors
7. Account for operating leases from the perspective of both
lessee and lessor
8. Recognise and account for sale and leaseback transactions
9. Discuss possible future changes to lease accounting
What Is a 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”
(IAS 17 para 4)
 May result in the eventual transfer of ownership
 Hire purchase agreement

 IAS 17 excludes:
 Resource exploration rights
 Licensing agreements
Classification Of Leases
 IAS 17 recognises the following types of leases:
 Finance lease
 Operating lease
 A finance lease is a lease which transfers substantially all
ownership risk and rewards, with or without eventual title
transfer
 Risks of ownership include – obsolescence, loss on sale
 Rewards of ownership include – use of asset, gains on sale

 An operating lease is a lease other than a finance lease


Classification Guidance
Incentives To Misclassify Leases
 Divergent accounting treatments provide an incentive to
misclassify leases as operating leases

 Classification as a finance lease may have the following


adverse impacts on a lessee’s financial statements:
 Increases non-current assets – reducing ROA ratios
 Increases non-current liabilities – adversely affecting debt/equity
ratios
 Depreciation and interest charges may exceed lease payment in
early years of lease – resulting in lower profits
Incentives To Misclassify Leases
 In an attempt to avoid misclassification of leases as
operating leases additional guidance is contained within
the following:

 Interpretation 27 Evaluating the Substance of Transactions Involving


the Legal Form of a Lease

 IFRIC Interpretation 4 Determining Whether an Arrangement


Contains a Lease
Accounting for Finance Leases by Lessees
Initial recognition

 Initially determine and recognise a lease asset &


liability (IAS 17 para 20)

 Recorded at the fair value of the asset or if lower


the present value of the minimum lease payments
Accounting for Finance Leases by
Lessees
bsequent measurement

 For assets
 Depreciation – Calculated in accordance with IAS 16
 Impairment – need to apply IAS 36

 For liabilities lease payment to be allocated between:


 Reduction of the lease liability
 Interest expense incurred
 Reimbursement of lessor costs
 Contingent rent
Accounting for Finance Leases by
Lessors
Initial recognition

 IAS 17 para 36 requires lessor to recognise assets held under a


finance lease in it’s statement of financial position and present
them as a receivable at an amount equal to the net investment in
the lease
 Net Investment defined IAS 17 para 4

Subsequent measurement

 Receipts from lessee need to be allocated between:


 Reduction of the lease receivable
 Interest revenue earned
 Reimbursement of costs paid on behalf of the lessee
 Receipt of contingent rent
Accounting For Finance Leases By
Manufacturer or Dealer Lessors
 When manufacturers or dealers offer customers the choice
of either buying or leasing an asset, the lease gives rise to
two types of income:
 Profit or loss equivalent to the outright sale of the asset being leased
 Finance income over the lease term

 As well as recording the lease receivable a profit or loss on


sale is also recorded at the commencement of the lease
 IAS 17 para 42
Accounting For Operating
Leases
Lessees
 Lease payments are expensed on a straight line basis over
the term of the lease (IAS 17 para 33)
Lessors
 Lease receipts are recognised as revenue on a straight line
basis over the term of the lease
 Initial direct costs relating to the lease are capitalised as
part of the carrying amount of the asset being leased and
are expensed over the lease term on the same basis as the
lease income is recognised
 The asset is depreciated by the lessee on the same basis as
for similar assets held by the lessee
Accounting For Lease Incentives
 Lessors may offer lease incentives to encourage lessees to
enter into non-cancellable operating leases:
 Rent-free periods,
 Upfront cash payments
 Contributions towards lessee expenses such as fit-out costs

 They are rarely truly free as rental payments are normally


higher than for leases that do not offer incentives

 Interpretation 115 Operating Leases -Incentives provides


guidance on accounting for incentives by both lessors and
lessees.
Accounting For Sale &
Leaseback Transactions
 Involves the sale of an asset that is then leased back from
the purchaser for all or part of the remaining economic life
of the asset

 Used to generate immediate cash flow while retaining asset


use

 Creates accounting problems for lessees

 Lease component of the transaction is accounted for in the


same way as normal lease transactions

 The ‘sale’ component transaction differs, depending on


whether it is classified as a finance or operating lease
Creates accounting problems for
lessees
 Under a finance lease the lessee’s gain or loss from the
sale of the asset is deferred and amortised over the term of
the lease

 Under an operating lease the lessee’s gain or loss is:


 Recognised immediately if ‘sale’ is calculated at fair value
 Deferred and amortised over the term of the lease when the sale
price is above or below fair value
Future Developments
 IASB and FASB have released an ED on leases
 Converged standard will result in significant changes
to current accounting methods
 Key objective is to ensure asset and liabilities arising
from lease contracts are recognised on the balance
sheet
 Proposed model will eliminate off balance sheet
accounting and remove the distinction between
operating and finance leases
 No agreement has been reached as to the scope and
timing of changes

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