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Lease Accounting - IAS 17


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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.  
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     Where an operating lease results and the fair value of the asset is less than its carrying amount at the time of the sale, then this loss should be recognised immediately. A loss arising in such circumstances is essentially an impairment of the asset (i.e. a decrease in the recoverable amount of the asset).
      Example :- An entity sells a piece of plant to a 100% owned subsidiary and leases it back over a period of 4 years. The remaining useful life of the plant is 10 years. The selling price of the plant was 20% below its carrying and MV. The lease rentals were based on market rates. The entity has no right to buy the plant back.
     The lease will almost certainly be an operating lease, as the lease period is not for the majority of the plant’s life and the rentals are based on market rates. However, the selling price was below the carrying and MV, and this loss has not been compensated by future rentals. Therefore, the loss should be recognized immediately.
     The transaction will be eliminated on consolidation, but the individual entity accounts will recognize it. Also, the entities are related parties; therefore, the substance of the transaction will have to be scrutinized. Although the entity has no right to reacquire the asset, it can exercise the right
 
 

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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.  
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    Example :-  An entity leases a motor vehicle over a period of five years. The economic life of the vehicle is estimated  at seven years. The entity has the right to buy the vehicle at the end of the lease term for 50% of its market value plus a nominal payment of 0.5% of the market value at that date. This nominal payment is to cover the selling costs of the vehicle.
     How should the lease be classified in the financial statements of the entity?
     The lease will be a finance lease as the entity is likely to buy the vehicle at the price stated because it will be sold at 50% of the market value of the vehicle plus a nominal charge.
     SIC 15, Operating Lease— Incentives, clarifies the recognition of incentives related to operating leases by both the lessee and lessor. Lease incentives should be considered an integral part of the consideration for the use of the leased asset.
      IAS 17 requires an entity to treat incentives as a reduction of lease income or lease expense. Incentives should be recognized by both the lessor and the lessee over the lease term, using a single amortization method applied to the net consideration.
 

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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.  
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Accounting by Lessor– Accounting for finance lease

 

     Under a finance lease the amount receivable should recognise as an asset, rather than the leased item as a non-current asset. The receivables should be measured at the net investment in the lease. Over the lease term, rentals are apportioned between a reduction in the net investment in the lease and finance income. The net investment in the lease is the aggregate of the minimum lease payments and any unguaranteed residual value (the “gross investment”) discounted at the rate implicit in the lease.
     IAS 17 requires that the recognition of finance income should be based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment The method of allocating gross earning to accounting periods is referred to the “actuarial method”. The actuarial method allocate rentals such a way that finance income and repayment of capital in each accounting period in such a way that finance income will emerge as a constant rate of return on the lessor’s net investment in the lease.
      Lessor who are manufacturers or dealers should recognize profit on the transaction in the same way as for normal sales of the entity. Thus a finance lease will create a profit or loss from the sale of the asset at normal selling prices and a finance income over the lease term. If artificially low rates of interest are quoted, profit is calculated using market interest rates.
          
 

 

 

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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.  
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Operating Lease
      Lessors shall show assets subject to operating leases in the financial statement in accordance with the nature of the assets. Lease income from operating leases shall be recognized in the income statement on a straight-line basis over the lease term unless another basis reflects better the nature of the benefit received. As mentioned earlier, any incentives should be considered.
     Depreciation on the asset subject to a lease is recognized as an expense and should be determined in the same manner as similar assets of the lessor. Additionally, the lessor should apply the principles of IAS 16, 36, and 38 as appropriate.
      Initial direct costs of negotiating and arranging the lease shall be added to the cost of the asset and expensed over the lease term in the same pattern as the income is recognized. Only incremental costs may be treated as initial direct costs.
     Internal costs that are not incremental such as administration, selling expenses and generally overheads should be written off as incurred.
 

 

 

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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

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Manufacturer/dealer lessor

    IAS 17 distinguishes manufacturer/dealer lessors from other lessors. Cost makes the different manufacturer/ dealer lessor to normal lessor.

 

 

     The manufacturer obtains the asset at its cost of manufacture or at a wholesale price, its cost will be below a normal arm’s length selling price.
     Where the manufacturer/ dealer enters into an operating lease, no selling profit should be recognised. This is because the risks and rewards associated with the asset’s ownership have not passed to the customer.
      Where a manufacturer  enters into a finance lease with a customer, the manufacturer should recognised selling P/L in income for the period in accordance with the policy followed by the entity for outright sales.  This is because the asset’s risks and rewards of ownership have passed to the customer.
     A finance lease of an asset by a manufacturer gives rise to two type of income :- Finance income and a profit or loss equivalent to that arising on an outright sale.
   
 

 

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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.  
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   --

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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

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Service Concession Arrangements  IFRIC 12
     A service concession is the provision of services that give the public access to major economic and social facilities, Ex:- telecommunication networks, bridges.
     Within such arrangements there are two parties, a concession operator (a private sector entity) and a grantor (a public sector entity), who is the party that grants the service arrangement. The operator is paid for its services over the period of the arrangement and in return has the obligation to provide public services.
     At the end of the arrangement the residual interest in any infrastructure constructed as part of the arrangement, is controlled by the grantor, not the operator. Such arrangements have many of the characteristics of a lease contract & the acquisition of a non-current asset but also may include an executory contract.
     The Interpretation sets out that infrastructure assets are not items of property, plant and equipment of the concession operator, because control over them lies with the grantor. Instead the operator recognises the fair value of the consideration receivable as a financial asset or an intangible asset (or both). Where both a financial asset and an intangible asset exist, the consideration should be separated.
 

 

 

 

 
 
 

 

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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.  
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      A financial asset should be recognised by the concession operator where it has a guaranteed contractual right to receive a specified amount of cash (or other financial asset) over the life of the arrangement.
      For example, where an operator constructs or upgrades the public sector asset and then operates it for a fixed period of time for an agreed amount. Under this method the payments received by the operator are recognised as partial repayments of the financial asset.
     An intangible asset should be recognised by the concession operator where it receives a right, such as a license, to charge users for the public service that it is providing but the revenue receivable is not agreed in advance but is dependant on the public’s usage of the asset.
      Such arrangements typically exist where after the public sector asset has been constructed or upgraded it is operated by the private sector body for a specified period of time
 

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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

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     Example :- An entity agrees to construct and operate a section of motorway on behalf of the national roads authority. The construction cost of 300 minr is payable at the end of Year 1 when the construction will be complete. The operating term of the section of motorway is 10 years and will commence at the start of Year 2. The annual operating costs are 40 minr, payable at the end of each of Years 2 to 11.
     The entity will generate revenue from tolls charged to users of the road. The entity estimates that the annual revenue will be 120 minr per annum. The cost of constructing the section of motorway is recognised as a non-current asset, but as an intangible asset (the right to collect tolls) rather than property, plant and equipment (the motorway itself). This intangible is then amortised over its 10-year useful life.
      Assuming revenue is as estimated the financial statements will contain the following:
§Year 1 Statement of financial position  Intangible asset 300 minr
§Year 2 Statement of financial position Intangible asset 270 minr (300 less 1/10)
§Statement of comprehensive income Revenue120 minr  Operating costs 40 minr   Amortisation 30 minr
 

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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

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Dear All,

This is the summary of IAS 17 which is very much in line of our standard AS 19. But still there are few diferences which i will post later on. Its my request to all of you. Kindly go through and discuss and please share your knowledge or if you have any query kindly ask

Thanks in advance

Amit Daga


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