IAS 17 provides guidance on accounting for leases. Key aspects include classifying leases as either finance or operating based on transfer of risks and rewards of ownership. Lessees account for finance and operating leases differently, with finance leases requiring recognition of leased assets and liabilities on the balance sheet. Lessors also account for finance and operating leases differently, with finance leases requiring recognition of a net investment receivable that is amortized over the lease term to achieve a constant rate of return. Sale and leaseback transactions are also addressed.
8. DEFINITIONS
Other
Interest rate implicit in the lease:
◦ PV of Minimum lease payment + unguaranteed residual value = fair value of
asset + initial direct costs of lessor
◦ or COST of asset x implicit interest rate x period of lease = income from
lease to the lessor
Gross investment in the lease:
◦ minimum lease payments receivable + unguaranteed residual value accruing to
lessor (Income to lessor or total cost to lessee)
Net investment in the lease:
◦ gross investment discounted at interest rate implicit in the lease (NPV of the
lease, likely to be the same as the fair value of the asset)
Unearned finance income:
◦ gross investment – net investment
9. DEFINITIONS
Other
Lessee’s incremental borrowing rate of interest:
◦ interest rate of comparable loan with same initial advance and
terms of repayment
Initial direct costs:
◦ directly attributable to negotiating and arranging the lease,
◦ except for manufacturers or dealers of leased assets
Contingent rent:
◦ lease payments linked to variable factors e.g. % of sales
◦ I.e. not fixed amounts
12. Finance Lease Operating lease
Transfer ownership of asset Transfer of ownership
at end of lease requires payment @
Option to buy asset < Market Market Value at end of
Value at end of lease lease
Lease term = majority of
economic life of asset Contingent rent leaves
PV of minimum lease risks and rewards with
payments = FV of asset lessor
Specialised asset (not Losses on cancellation
transferrable) borne by lessor
Continuation clause @ < FV movement in residual
Market Value
value retained by lessor
SUBSTANCE OVER FORM
13. CLASSIFICATION OF
LEASES
Changes in Lease Terms
If terms change during lease, treat as new
agreement and reassess classification as
operating or finance lease for the rest of the
lease term
No reclassification for
◦ Changes in estimates
◦ Changes in circumstances
15. CLASSIFICATION OF
LEASES
Minimum Lease Payments
Allocate minimum lease payments to Fair
Value of separate land and buildings at
inception of the lease
If allocation not reliable, treat entire lease as
either operating or finance
If land immaterial, use only economic life of
building
16. CLASSIFICATION OF
LEASES
Investment Property IAS 40
Separate allocation of minimum lease payments to FV
of land and buildings not required for Investment
Property
Operating lease can be classified as investment
property (IAS 40)
◦ Carry asset at Fair Value
◦ Calculate interest based on classification as finance lease
◦ Continue to treat as finance lease if asset no longer
classified as investment property (e.g. if asset taken over
or sublet)
17. LEASES IN THE FS OF
LESSEES
Finance Leases: Initial recognition
To ensure that obligations are not understated distorting financial ratios:
State asset and liability at Fair Value in Balance Sheet
◦ FV = lower of
FV of leased asset
Present Value of minimum lease payments
At inception of the lease
◦ Discount rate of PV =
Interest rate implicit in the lease
If not practicable, incremental borrowing rate
Increase Asset cost with initial direct costs of the lessee
◦ Costs to negotiate and secure the lease
Split current and non-current liabilities on the face of the balance sheet
18. Subsequent Measurement Disclosures
Lease payments reduce remaining IFRS 7 Financial Instruments
liability IAS 16, IAS 36, IAS 38, IAS 40, IAS 41
Asset carrying amount at BS date
Allocate lease payments to finance
charge and outstanding liability Reconciliation of total minimum lease payments in
future and their PV
◦ Expense finance charge Contingent rent expense
◦ May use approximations Minimum non-cancellable sublease payments receivable
Expense contingent rent as incurred Terms
Depreciation charge on same basis as ◦ Contingent rent
owned assets ◦ Purchase & renewal options
◦ Escalation clauses
◦ Depreciate over shorter of Lease Term and
UEL of asset ◦ Restrictions
As depreciation not = finance charge, Total future minimum lease payments and PV for
liability not = asset ◦ < 1 year
◦ 2 – 5 years
Apply IAS 36 Impairment to leased
assets ◦ > 5 years
LEASES IN THE FS OF LESEES
FINANCE LEASES
21. LEASES IN FS OF
LESSORS
Finance Lease: Initial recognition
22. LEASES IN FS OF LESSORS
Finance Leases: Subsequent measurement
Finance Income Review unguaranteed
◦ Constant periodic rate of residual values used to
return on net investment calculate gross
in lease investment regularly
◦ Systematic and rational Revise income allocation
basis
over lease term
◦ Constant return on
investment Recognise reduction in
Lease Payments amounts accrued
◦ Reduce gross investment immediately
by principal and unearned Classify asset as held for
future income sale (IFRS 5)
23. LEASES IN FS OF LESSORS
Finance Leases: Subsequent measurement
Manufacturere & Dealer Lessors:
◦ Recognise selling profit/loss in period of
inception of lease
◦ Use policy for normal sales
◦ Restrict profit to that achievable under
market rate of interest
◦ Expense negotiation & arrangement costs
when selling profit recognised
24. Sale proceeds less discounts Finance income
LEASES IN FS OF LESSORS
FINANCE LEASE: LESSOR INCOME
25. Sale proceeds less discounts Finance income
Sale proceeds are lower of: Artificially low rates
◦ Present Value of minimum lease sometimes used to attract
payments @ market rate of customers
interest Results in excessive profits at
◦ Fair value of leased asset time of sale
Cost of sales Standard requires use of
market rate to calculate profit
◦ Cost of leased asset
Arrangement costs relate to
◦ Present value of unguaranteed
residual value
selling profit and are
recognised at the time of sale
Sale – COS = selling profit
◦ Recognise as outright sale
LEASES IN FS OF LESSORS
FINANCE LEASE: LESSOR
INCOME
26. LEASES IN FS OF LESSORS
FINANCE LEASE: Disclosures
IFRS 7
Reconciliation between gross investment in lease and PV of minimum lease
payments receivable at the balance sheet date
Gross investment in lease and present value of minimum payments
◦ <1 year
◦ 2-5 years
◦ > 5 years
Unearned finance income
Unguaranteed residual values accrued to lessor
Allowance for uncollectible minimum lease payments receivable
Contingent rent income
Material leasing arrangements
Useful disclosures
◦ Gross investment – unearned income of new business in period – cancelled leases
◦ Indicates growth
28. Operating leases in FS of Lessors:
Disclosures
Non-cancellable minimum lease payments
◦ < 1year
◦ 2-5 years
◦ > 5 years
Contingent rent income in the year
Lease arrangements
IAS 16
IAS 36
IAS 38
IAS 40
IAS 41
29. Finance Lease Operating lease
Sale proceeds – CA = If at Fair Value
◦ Recognise profit immediately
deferred income ◦ Treat as normal sale
Amortise over lease term If < Fair Value
◦ If lease payments < MV compensate loss,
Finance secured over asset defer and amortise over UEL
◦ If lease payments @ MV, recognise
profit/loss immediately
If > Fair Value
◦ Excess deferred and amortised over UEL
If Fair Value < carrying amount of
asset, recognise loss immediately
Normal disclosures + special terms
IAS 1 separate disclosures
Sale and leaseback: Sell asset and
lease it back to raise finance
31. SUMMARY
Accounting treatment differs for lessors
and lessees
Classification as finance/operating lease
depends on transfer of risks and rewards
of ownership
◦ Classify economic substance over legal form
of agreement
Land classified separately from buildings
as UEL infinite
32. SUMMARY
Lessees expense payments under
operating leases as they become payable
Lessees show finance leases as assets and
liabilities @ fair value
◦ Spread finance charges over lease term
◦ Spread depreciation over UEL of asset
33. SUMMARY
Lessors show operating leases as assets
◦ Spread income over lease term
Lessors show finance lease as net
investment receivable
◦ Spread finance income at constant rate of return
◦ Recognise selling profit as a normal sale
Sale and leaseback treated in relation to
market value of the asset sold and leased
back