60 BowtockThis is a finance lease because it transfers substantially all the risks and rewards of ownership to the lessee, as shown by the following indicators:

• The asset's useful life is five years and the lease is also for five years. Therefore the asset is being held for the whole of its useful life.• The cash price of the asset is equivalent to its present value of minimum lease payments.

The asset is capitalised and depreciated over its five year useful life, and the obligation to make lease payments is recognised as a liability.

Initial accounting: recognise the asset and the lease liability (1 Jan 20X2)Dr Property, plant and equipment 52,000Cr Finance lease obligations 52,000

Subsequent acounting : leased asset - depreciationDr Retained earning (9 mths) 7,800Dr Depreciation - I/S 10,400 Cr Accumulated depreciation 18,200

Year PaymentHalf

interestYear end -

30 Sept20X2 (12,000) 2,400 42,40020X3 (12,000) 1,872 33,07220X4 (12,000)

NCLCurrent year

33,696 21,696

for 30 Sept 20X3

Subsequent acounting : leased liability - interest and principal allocation plus current andnon current split

52,000 800 43,20043,200 624 33,696

Lease start - 1 Jan

Half interest Lease end - 31 Dec

Fino

If a leased is classified as an operating lease, there would not be a leased asset or lease obligation recorded in the statement of financial position; whereas there would be if it were a finance lease or an outright purchase. Thus capital employed under an operating lease would be lower leading to a higher (more favourable) ROCE. The finance director’s comment that if the lease is classified as operating lease, the ROCE would improve, is true.

IAS 17 Leases defines a finance lease as one which transfers to the lessee substantially all the risks and rewards incidental to ownership. In this case, as the asset will be used by Fino for its entire useful life makes a classification as a finance lease seems appropriate. Thus the finance director’s intention to mislead the users will be prohibited by IAS 17.

(2) Finance lease

Initial accounting: recognise the asset and the lease liability (1 Apr 2007)Dr Property, plant and equipment 350,000Cr Finance lease obligations 350,000

Subsequent acounting : leased asset - depreciationDr Depreciation - I/S 43,750 Cr Accumulated depreciation 43,750

Year PaymentHalf

interestYear end -

30 Sept2007 (100,000) 12,500 262,5002008 (100,000) 175,000

NCL

Current year

Finance leaseIncome statement – cost of sales (depreciation) 43,750Income statement – finance costs 12,500

Balance sheetNon-current assetsLeased plant - carrying amount 306,250

Non-current liabilitiesLease obligation (250,000 – 75,000) 175,000 175,000Current liabilitiesAccrued interest 12,500Lease obligation (100,000 – 21,700) 75,000

for 30 Sept 2007

275,000

Lease start - 1 Apr

Half interest Lease end - 31 Mar

350,000 12,500 275,000

Subsequent acounting : leased liability - interest and principal allocation plus current andnon current split