Leases

International Accounting Standards (IAS 17)

Lease
is 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.

Types of Leases
An operating lease takes the transaction at face value, with the lessee simply recording rentals paid as an expense while the lessor records the rentals as lease income and continues to show the asset on its balance sheet. A finance lease, on the other hand, recognizes that the substance of the transaction is equivalent to an outright sale. In other words, the lessee shows the leased property as an asset in its balance sheet, and the obligation to pay rentals as a payable; the lessor removes the property from its balance sheet and replaces it with a lease receivable, net of unearned interest.

Indicators of a Finance Lease

Transfer of ownership Bargain purchase option Economic life lease term is for the major part of the economic life of the asset (75%) Minimum lease payment PV of minimum lease payment amounts to substantially all of its fair value

On 23 July, Contrado Limited contracted with Al-Taweel Est. for the use of a truck. Contrados business also started on the same date, with a cash contribution for capital of 100,000. Contrado recognized 100,000 of revenue from operations during Year 1 and incurred no expenditures other than those related to this. All of Contrados revenues and expenses are currently made in cash. Inception date: 23 July 2004 Term: 36 months Monthly payment amount: 6,062.50, made on the last day of each month Unguaranteed residual: 25,000 Equipment fair value: 200,000 (cost to Al-Taweel Est.) Purchase option: Fair value at lease termination Assets economic life: 40 months Contrados incremental borrowing rate: 10 percent Contrados rate implicit in the lease: 1% per month (known to Contrado) Contrados initial direct costs of the lease: 6,000 Depreciation policy for trucks: Straight-

Which one is an indicator of an operating lease?

a. In one situation, a lessor transferred ownership of an asset in this case, a bulldozerto the lessee before the end of the lease term b. At inception of the lease, the present value of the minimum lease payments was much lower than the fair value of the leased asset. c. In another case, the assets leased by an entity were of such a specialized nature that only the lessee could use them without making a major modification d. Oneentity signed a contract stipulating that if the lessee canceled the lease, then the lessors losses related to the cancellation were to be borne by the lessee e. In the final case, the term of a certain lease

According to IAS 17, which of the following is NOT normally an indicator of an finance lease?
a. The lease transfers ownership of the property to the lessee by the end of the lease term b. The conveyance of the right to use an asset for an agreed-upon period of time in return for a payment or series of payments. c. The lease term is for the major part of the assets economic life, even if the title is not transferred d. The leased assets are of such a specialized nature that only the lessee can use them without making a major modification e. Gains or losses from fluctuations in

Operating Lease
Lessee: Advance rental payments Handling incentives Recording lease payments Lessor: Asset classification Initial direct costs Depreciation policy Income recognition Other costs

FINANCE LEASE Lessee Accounting

Accounting

for finance lease

requires:

>recognition of an asset >recording of an obligation

The

amount recorded is equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments.

Minimum Lease Payment

Rental payment required during the lease term Any payment required under a bargain purchase option Any guaranteed residual value made by the lessee or party related to the lessee in the absence of bargain purchase option *does not include contingent rent

Issues on Lessee Accounting

Using the discount rate to calculate present value (PV) Asset depreciation for finance lease Note: Depreciate over useful life of asset if:
If the lease transfers ownership of the property to the lessee by the end of the lease term if the lease contains a bargain purchase option

*if thereis noreasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset should be fully depreciated over the shorter of the lease term or its useful life.

FINANCE LEASE Lessor Accounting

Lessor should recognize receivables from finance lease at net investment Payments are divided into principal and interest

Types of Finance Lease

Direct financing lease Sales type lease

Sale and leaseback

Is an arrangement whereby on party sells a property to another party and then immediately leases the property back from its owner.