CCI Online Learning
What do you want to learn today?
     
CIBIL

Upgrad

Share on Facebook

Share on Twitter

Share on LinkedIn

Share on Email

Share More

Lease Accounting - IAS 17


avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

Classification Indicators

 

 

Example :- 1 Entity A (the lessor) leases a truck to entity B (the lessee) for a period of 3 years. Lease rentals are set by the lessor assuming a residual value for the truck of 4 MINR at the end of the lease term. Market data suggest that the likely range of residual values at the end of 3 years is 4 to 5 MINR. The lessee will guarantee any fall in the residual value of the truck below 4 down to 2.5 MINR of the original cost. The lessor will bear the cost of any fall in the residual value below 2.5 MINR. How should this lease be classified ?
     The lease should be classified as a finance lease. The sharing of the residual value risk is not even as it is unlikely that the residual value of the truck will fall bellow 2.5 MINR. The risk retained by the entity A is remote and should, therefore, be ignored. The residual value risk is in substance borne by entity B.
Example :- 2 Entity A borrows C 1.5 MINR from a bank to acquire property. Entity A leases the property to entity C for a 10 yr. Entity C provides a guarantee to the bank in respect of loan. The terms of the loan require repayment over 40 yrs, property estimated useful life. Title of the property will pass from entity A to entity C in the even of entity C being called on to meet its guarantee.
     The lease will qualify as a finance lease although the term is only for 10 out of 40 yrs. This is because the guarantee is, in substance, a residual value guarantee and is, therefore, part of the minimum lease payments.
 

 

 

1 Like
avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

Accounting by Lessees– Accounting for finance lease

 

 

     At the commencement of the lease term, a lessee shall recognize an asset and a liability at the F.V of the leased asset or, if lower, at the P.V of the minimum lease payments. The appropriate discount rate in the present value calculation is the rate implicit in the finance lease—that rate which discounts the lease payments to the fair value of the asset plus any initial direct costs of the lessor.
     However, where this is not possible, the standard requires the lessee to use his incremental borrowing rate to determine the PV of the minimum lease payments.
     Subsequent to initial recognition, the lease payments are apportioned between the repayment of the outstanding liability and the finance charge so as to reflect a constant periodic rate of interest on the liability. Methods of calculation vary and include sum of the digits, which is a rough approximation, and more complex amortization models.
     The asset needs to be depreciated over its expected useful life under IAS 16, using rates for similar assets. However, if there is no reasonable certainty that ownership will transfer to the lessee, then the shorter of the lease term and the useful life should be used.
 

 

 

avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

 

    Example :- On 1 January 2008 an entity enters into a finance lease for a photocopier with a fair value of Rs. 8,000. 
     The lease term is for 3 years, with no option to extend, and the copier will be returned to the lessor at the end of the 3 years. The present value of the minimum lease payments is Rs. 7,600.
     The copier should therefore be initially recognised at Rs. 7,600, which is the lower of the fair value and the present value of the minimum lease payments.
     The useful life of the copier is estimated to be 4 years with a nil residual value. The entity operates a straight-line method of depreciation.
      The depreciation charge on the copier in 2008 is:
      Rs. 7,600 / 3 years = Rs. 2,533
      Because the lessee will not gain ownership at the end of the 3 year period, the copier is depreciated over a 3 year period being the shorter of the lease term and  the asset’s useful life..
   
 

avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

 

 

  Finance Charge

  Finance charge :- Each installment made under a finance lease consists of a mixture of a finance charge and the repayment of capital.
   The total finance charge over the total period of the lease is:
   Total lease rentals                                   X
   Less: initial finance lease obligation being the lower of fair value and PV of the minimum lease payments                    (X)
   Total finance charges                              X
     The total interest cost should be recognised in profit or loss over the accounting periods for which the lease liability is in existence. This is from the start of the lease until the last repayment is made.
     The period over which the lease liability is in existence is not necessarily the same as the term of the lease. For example, if lease rentals are paid annually in advance, the lease finance will be paid off when the final payment is made at the start of the last year, but the lease term will include the last year, even though no liability will remain.
 

 

 

 

 
 

avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

 

 

Accounting for finance lease

 

Example :- Entity T is a telecom company and has entered into a lease contract with entity S for exclusive use of submarine cable for overseas communication. The contract is for 10 years, which corresponds to the economic life of the cable. Ownership transfers at the arrangement for no additional consideration. The lease payments are dependent on the usage of the cable. The ceiling amount is 10 MINR per year at 100% usage and the minimum amount (floor) is 6 MINR per year, which correspondence to a usage of 60% of lower.
     Management of entity T estimates that the average usage of the cable will be approximately 85% and the average annual lease payments are expected to be 8.5 MINR. How should be minimum lease payments (MLP) be calculated ?
     The undiscounted MLP is 60 MINR. Entity T should not include a best estimate of the contingent rents in the MLP.  The additional 25 MINR that expects to pay over term of the contract are contingent rents, because this amount varies based on the future use of the leases asset.
     Contingent rent are expensed as incurred. Its excluded from the measurement of finance lease assets and liabilities except in circumstances where its clear that the contingency is not genuine. In any circumstances where a lease does not appear to make economic sense or either party to the contract, the facts should be challenged and further investigated.
   
 

 

 

 

1 Like
avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

 

 Example :- An entity leases an asset from another entity. The F.V of the asset is Rs.100,000, and the lease rentals are Rs.18,000, payable half yearly. The first payment is made on the delivery of the asset. The unguaranteed residual value of the asset after the 3yr lease period is Rs. 4,000. The implicit interest rate in the lease is 9.3%, and the P.V of the minimum lease payment is Rs. 96,936. Show how this lease would be accounted for in the accounts of the lessee.
      The number of payments is six with a total value of $108,000. The use of the approximate implicit interest rate will give a rounding error.
      Payment            Balance            Finance Charge        Payment         Lease Liability
         1                      96,936                     0                         (18,000)              78,936
         2                      78,936                 3,670                       (18,000)             64,606
         3                      64,606                 3,004                       (18,000)             49,610
         4                      49,610                 2,306                       (18,000)             33,916
         5                      33,916                 1,577                        (18,000)             17,493
         6                      17,493                  507 (813 – 306)      (18,000)                0
      There is a rounding error of 306, which would be taken off the last finance charge to be taken to the income statement.
 

avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

 

Accounting for Operating leases

     Operating lease should not be capitalised. Lease payments under operating leases shall be recognized as an expense on a straight-line basis over the lease term unless another basis is more representative of the pattern of the user’s benefit, even if the payments follow a different pattern.
      It should be noted that lease payments exclude costs for services such as insurance and maintenance. The requirement to spread the lease rentals on a Straight line basis over the lease term applies even if the payments are not made on such a basis.
      SIC 15 deals with “Operating leases- Incentives”.
      It is important to recognize the impact of incentives in operating leases. Often incentives to enter into operating leases take the form of up-front payments, rent-free periods, and the like. These need to be appropriately recognized over the lease term from its commencement.
     Thus, a rent-free period does not mean that the lessee avoids a rent charge in its income statement. It has to apportion the rent for the entire lease over the entire period, resulting in a reduced annual charge.
 

1 Like
avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

 

 Example :- Jay has entered into a lease of property whereby the title to the land does not pass to the entity at the end of the lease but the title to the building passes after 15 years.
     The lease commenced on July 1, 20X5, when the value of the land was 54 minr & the building value was 18 minr. Annual lease rentals paid in arrears commencing on June 30,20X6, are 6 minr for land & 2 minr for buildings. The entity has allocated the rentals on the basis of their relative F.V at the start of the lease.
     The payments under the lease terms are reduced after every 6 years, and the minimum lease term is 30 years. The net P.V of the MLP at July 1, 20X5, was 40 minr for land & 17 minr for buildings. The buildings are written off on the straight-line basis over their useful life of 15 years.
     Assume an effective interest rate of 7%.
     Discuss how Jay should treat this lease under IAS 17 ?
     IAS 17 requires the substance of the transaction to be reviewed and the extent to which the risks and rewards of ownership of the leased asset are transferred to be determined. If the risks and rewards of ownership are substantially transferred to the lessee, then the lease is a finance lease.
 
 

avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

 

     The Standard requires the land and buildings elements to be considered separately. Normally a lease of land will be regarded as an operating lease unless the title passes to the lessee.
     In this case the title does not pass and the P.V of the lease payments is only 74% of the F.V of the land, which does not constitute substantially all of the fair value of the leased asset, one of the criteria for the determination of a finance lease.
     In the case of the buildings, the title passes after 15 years, and the lease runs for the whole of its economic life, which indicates a finance lease. The P.V of the MLP is 94% of the fair value of the lease at its inception, an amount that indicates that the lessee is effectively purchasing the building. 
     Thus it would appear to be a finance lease. Property, plant, and equipment would increase by 17 minr with a corresponding increase in non current liabilities. The non current liability (17 minr) will be reduced by the payment on June 30, 20X6 (2 minr), and increased by the interest charge (17 minr × 0.07, or 1.2 minr).
     The land will not appear on the balance sheet and the operating lease rentals will be charged to the income statement.
 

avater

CA. Amit Daga (Finance Controller CA. CS. CFA. CIFRS. M.COM. )     11 August 2009

CA. Amit Daga
Finance Controller CA. CS. CFA. CIFRS. M.COM.  
 416 likes  8997 points

View Profile | My Other Post

  Sale and leaseback transaction 

      In sale and leaseback transaction, the entity sells the asset to a third party, receives proceeds for the sale and then leases the asset back and pays rentals for its use. A sale and leaseback transaction can result in a finance or operating lease, depending on the substance of the transaction.   
      If the lease is identified as a Finance Lease, Finance has been provided and the asset has been given as security for that finance. The excess of sale proceeds over the carrying amount of the asset at the date of the transaction is deferred in the Financial statement and amortised through P/L over the period of the lease.
      If the lease is identified as an Operating Lease and sale price are established at FV, any profit made on the sale should be recognised immediately in P/L.
      If, however, the sale price is below fair value, then any loss arising should be deferred to the extent that future rental payments are below market value. The loss will be recognised in profit or loss as the rentals are recognised.
      If the sale price was above FV, the excess profit over fair value should be deferred and recognised in the period over which the asset is expected to be utilised. 
 


Leave a reply

Your are not logged in . Please login to post replies

Click here to Login / Register  


Bajaj Finserv

Related Threads


Loading

Trending Tags
GST Live Class    |    x