Chapter16

Leasing
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Contents

1. Types of leases 2. Leases

Types of leases
Accounting standards: IAS 17
Lease
According to IAS17

Finance lease

Operating lease

Key definition What is Lease?

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.

substantially all the risks and rewards incident to ownership of an asset. Title may or may not eventually be transferred. An operating lease is a lease other than a finance lease.

A finance lease is a lease that transfers

Types of leases
Key terms
The present value should be calculated by using the interest rate implicit in the lease. Minimum lease payments .The payments over the lease term that the lessee that the lessee is or can be required to make. Interest rate implicit in the lease The discount rate that ,at the inception of the lease ,causes the aggregate present value of (a) The minimum lease payments ,and (b) The unguaranteed residual value to be equal to the sum of (a) the fair value of the leased asset, and (b) any initial direct costs

Types of leases
The lease term is the non-cancelable period
for which the lessee has contracted to lease the asset together with any further terms for which the lessee has option to continue to lease the asset, with or without further payment, which option at the inception of the lease it is reasonably certain that the lessee will exercise.

The commencement of the lease term

is the date from which the lessee is entitled to exercise its right to use the leased asset. It is the date of initial recognition of the lease.

Types of leases
Accounting for operating leases

 The lessee pays amounts periodically to

the lessor and these are charged to the income statement  Where the lessee is offered an incentive such as a rent free period or cash back incentive, this is effectively a discount.

Types of leases
Accounting for finance leases  If a lessor leases out an asset on a finance lease, the asset will probably never be seen on his premises or used in his business again. The asset is an amount receivable rather than a non-asset.

 The substance of the transaction is that he has acquired a non-asset, even though in law the lessee never becomes the owner of the asset.

Accounting for Leases in the Financial Statements

in the Financial Statements of Lessees

In the Financial Statements of Lessors

Finance lease

Operating lease

Finance lease
TEXT

Operating lease

Accounting for Leases in the Financial Statements of Lessees

Finance leases

Lessees should recognize finance leases as assets and liabilities in their balance sheets at the inception of the lease of the fair value of the leased property or, if lower, at the present value of the minimum lease payments. In calculating the present value of the minimum lease payments the discount factor is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessees incremental borrowing rate should be used.

 Initial direct costs are often incurred in connection with specific leasing activities, as in negotiating and securing leasing arrangements. The costs identified as directly attributable to activities performed by the lessee for a finance lease are included as part of the amount recognized as an asset under the lease.

Accounting for Leases in the Financial Statements of Lessees  Lease payments should be apportioned between the finance charge and the reduction of the outstanding liabilities. The finance charge should be allocated to periods during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability for each period.

 Lessees should make the following disclosures for finance leases:

1.For each major class of asset, the net carrying amount at the balance sheet date;

Accounting for Leases in the Financial Statements of Lessees  2.A reconciliation between the total of minimum lease payments at the balance sheet date, and their present value. In addition, an enterprise should disclose the total of minimum lease payments at the balance sheet date, and their present value, for each of the following periods: Not later than one year Later than one year and not later than five Later than five years

years

Accounting for Leases in the Financial Statements of Lessees 3.Contingent rents recognized in income for the period 4.The total of future minimum sublease payments expected to be received under noncancelable subleases at the balance sheet date, and 5.A general description of the lessees significant leasing arrangements

Accounting for Leases in the Financial Statements of Lessees

Operating leases
1.Lease payments under an operating lease should be recognized as an expense in the income statement on a straight-line basis over the lease term. 2.The following disclosures should be made: The total of future minimum lease payments under non-cancelable operating leases for each of the following periods: 1 Not later than one year 2 Later than one year and not later than five years 3 Later than five years

Diagram

Three periods for disclosures

Later than five years Later than one year and not later than five years Not later than one year

Accounting for Leases in the Financial Statements of Lessees

 2. The total of future minimum sublease payments expected to be received under non-cancelable sublease at the balance sheet date Lease and sublease payments recognized in income for the period, with separate amounts for minimum lease payments, contingent rents, and sublease payments, and A general description of the lessees significant leasing arrangements.

Accounting for Leases in the Financial Statements of Lessors  Finance lease

1.Lessors should recognize assets held under a finance lease in their balance sheets and present them as receivable at an amount equal to the net investment in the lease. For finance leases other than those involving manufacturer or lealer lessors, initial direct costs are included in the initial measurement of the finance lease receivable and reduce the amount of income recognized over the lease term. Costs incurred by manufacturer or dealer lessors in connection with negotiating and arranging a lease are excluded from the definition of initial direct costs. As a result they are excluded from the net investment in the lease and are recognized as expenses when the selling profit is recognized.

Accounting for Leases in the Financial Statements of Lessors  2.The recognition of finance income should be based on a pattern reflecting a constant periodic rate of return on the lessors net investment outstanding in respect of the finance lease. 3.Manufacturer or dealer lessors should recognize selling profit or loss in income for the period in accordance with the policy followed by the enterprise for outright sales. If artificially low rates of interest are quoted, selling profit should be restricted to that which would apply if a commercial rate of interest were charged. Initial direct costs should be recognized as an expense in the income statement at the inception of the lease.

Accounting for Leases in the Financial Statements of Lessors  4.Lessors should make the following disclosures for finance leases:
A reconciliation between the total gross investment in the lease at the balance sheet date, and the present value of minimum lease payments receivable at the balance sheet date An enterprise should disclose the total gross investment in the lease and the present value of the minimum lease payments receivable at the balance sheet date, for each of the following periods: 1 Not later than one year 2 Later than one year and not later than five years 3 Later than five years Unearned finance income Unguaranteed residual values accruing to the benefit of the lessor The accumulated allowance for uncollectible minimum lease payments receivable Contingent rents recognized in income, and A general description of the lessors significant leasing arrangements.

Accounting for Leases in the Financial Statements of Lessors

Operating leases
1.Lessors should present assets subject to operating leases in their balance sheets according to the nature of the asset. 2.Lease income should be recognized in income on a straight-line basis over the lease term. 3.The depreciation of leased assets should be on a basis consistent with the lessors normal depreciation policy and on the basis set out in IAS17.

Accounting for Leases in the Financial Statements of Lessors

Operating leases
4.Lessors should make the following disclosures for operating leases:
For each class of asset, the gross carrying amount, the accumulated depreciation and accumulated impairment losses at the balance sheet date Total contingent rents recognized in income, and A general description of the lessors significant leasing arrangements.

Sale and Leaseback Transactions Sale and Leaseback Transactions

1.If a sale and leaseback transaction results in a finance lease, any excess of sale proceeds over the carrying amount should not be immediately recognized as income in the financial statements of a seller-lessee. Instead it should be deferred and amortized over the lease term. The substance of the transaction is a loan secured on the asset rather than a sale.

Sale and Leaseback Transactions

 2.(1)If a sale and leaseback transaction results in an operating lease, and it is clear that the transaction is established at fair value, and profit or loss should be recognized immediately. (2)If the sale price is below fair value, any profit or loss should be recognized immediately except that, if the loss is compensated by future lease payments at below market price, it should be deferred and amortized in proportion to the lease payments over the period for which the asset is expected to be used. (3) If the sale price is above fair value, the excess over fair value should be deferred and amortized over the period for which the asset is expected to be used.

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