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IAS 17 Leases


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IAS 17 Leases

  1. 1. IAS 17 LEASES
  4. 4. DEFINITIONS Types of Leases
  5. 5. DEFINITIONS Lease Terms
  6. 6. DEFINITIONS Lease Value
  7. 7. DEFINITIONS Residual Value
  8. 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. 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
  11. 11. EXAMPLE The same lease can have different classification in books of lessor and lessee
  12. 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. 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
  14. 14. CLASSIFICATION OF LEASES Land and Buildings
  15. 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. 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. 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. 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
  20. 20. FS OF LESSEE’S Operating Lease: Disclosures
  21. 21. LEASES IN FS OF LESSORS Finance Lease: Initial recognition
  22. 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. 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. 24. Sale proceeds less discounts Finance income LEASES IN FS OF LESSORS FINANCE LEASE: LESSOR INCOME
  25. 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. 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
  27. 27. LEASES IN FS OF LESSORS Operating leases
  28. 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. 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
  30. 30. IAS 17 Transitional Provisions
  31. 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. 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. 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