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increased proportionately throughout the year (ie [230 + 163] /2)

4. This question concerns the accounting for a variety of leases under IAS17 Leases(13.4) and the proposal for its amendment under the IASB/FASB convergenceproject.

a) (i) The lease is a finance lease because it is for substantially all of the machines

economic life (5 out of 6 years) and the present value of the minimum leasepayments is substantially all (95.2%) of the fair value of the asset.

IAS17 distinguishes between the inception date (when leases are classified) and thelease term commencement date (when recognition takes place) so that, under afinance lease, Trench Quarries could make an initial calculation of the asset andliability at inception but may not recognise these in the financial statements until thecommencement date, if later. Tutorial note: these amounts may in somecircumstances be revised.

The inception date is the earlier of the date of the lease agreement and the date ofcommitment of the parties to its principal provisions, which is 1 October 2009. The

lease term commencement date is the date on which Trench Quarries is entitled toexercise its right to use the machine and is the date of initial recognition of theassets, liabilities, income and expenses related to the lease in its financialstatements. This is also 1 October 2009. Therefore, despite the postponement of thelease rental payments the asset and liability should be recognised from 1 October2009.

Trench Quarries should recognise an asset and liability in its statement of financialposition at the commencement of the lease term (1 October 2009), at an amountequal at the inception of the lease to the fair value of the leased item or, if lower, atthe present value of the minimum lease payments; ie $8.1 million. The initial costs

incurred by Trench Quarries are directly attributable to activities it has performed toobtain the finance lease, and are added to the amount recognised as an asset,making the asset total $8.3 million. This amount will be depreciated over the leaseterm of 5 years.

Interest will accrue from 1 October 2009 using the interest rate implicit in the lease.The rental payments from 1 January 2010 must be apportioned as to the payment ofthis accrued interest and repayment of the lease liability.

(ii) Under IAS17, in classifying a lease of land and buildings, land and buildings elementswould normally be accounted for separately. As with this agreement, the minimumlease payments should be allocated between the land and buildings elements in

proportion to their relative fair values. The land element is normally classified as anoperating lease unless title passes to the lessee at the end of the lease term. Asownership of the land remains with the lessor, the land will be dealt with as anoperating lease. Land will not be recognised in the statement of financial positionand rentals of $10 million per annum will be recognised as an expense in the incomestatement, unless another systematic basis is more representative of the timepattern of Trench Quarries benefit.

The buildings element is classified as an operating or finance lease by applying theclassification criteria in IAS 17. Transfer of ownership will take place at the end of


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the lease, they can only be used by Trench Quarries without major modification andthe present value of the minimum lease payments is a significant proportion of theirfair value at inception (92.8%); therefore the buildings must be accounted for as afinance lease as shown below.

Tutorial note: separate measurement of the land and buildings elements is notrequired if the lessee's interest in both land and buildings is classified as an

investment property in accordance with IAS 40 and the fair value model is adopted.

Year ended31 March

Capital sumat start of

year

Rentalspaid

Capitalsum during

year

Financecharge

@6.62% perannum

Capital sumat end of

year

$m $m $m $m $m2009 15.77 3.57 12.20 0.81 13.012010 13.01 3.57 9.44 0.62 10.06

Tutorial note: for information

2011 10.06 3.57 6.49 0.43 6.922012 6.92 3.57 3.35 0.22 3.572013 3.57 3.57 - - -

At 31 March 2010 the liability of $10.06m must be allocated between long-term andshort-term; ie $6.92m and $3.14m respectively.

The depreciation policy for assets held under finance leases; i.e. the buildings,should be consistent with that for owned assets.

(iii) The property interest held by Trench Quarries under an operating lease may (it is

optional) be classified and accounted for as investment property provided: it would otherwise meet IAS40s investment property definition, the fair value model is applied, and the operating lease is accounted for as if it were a finance lease in accordance

with IAS 17 Leases

This situation arises where, for example as in this case, Trench Quarries has acquiredan operating leasehold interest as an investment property by effectively prepaying acertain number of years' operating lease rentals (three years in this case).

This classification alternative is available on a property-by-property basis so that theentity need not classify all property interests held under operating leases asinvestment property. However, IAS 40 requires that once one operating leaseholdinterest is classified as an investment property, all property classified as investmentproperty must be accounted for under the fair value method. These leaseholdinterests are subject also to the same disclosure requirements as other investmentproperties.

b) Tutorial note: IAS 17 was first issued in 1982 and has therefore been in force in variousamended forms for a very long time. Practice under the standard is therefore very well

established. However, it is a standard that is showing its age (International GAAP2009). Inconsistencies between IAS17s rules and those of other standards with which itoverlaps are increasingly causing problems.


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Several commentators find it difficult to produce a convincing argument to support thedifference in accounting between the treatment of prepaid operating lease rentals underIAS 17 and the purchase of an intangible asset under IAS 38 when both may representthe right to use an asset for a finite period of time. The essential difference appears tobe that the underlying asset is tangible in the first case but intangible in the second. Asthey both have essentially the same income generating characteristics, this does not

seem to be sufficient reason to support different treatments.

Trench Quarries will account for the large number of individual pieces of equipment asoperating leases. Despite constant difficulty in supporting IAS17s different approach tooperating and finance leases, consensus on the way forward has proved difficult toachieve. Many suggestions have simply proved to be unworkable. However, theconvergence project has given added impetus to the need for change. In due course,the distinction between operating and finance leases will be removed, resulting incompanies such as Trench Quarries having to account for the rights and obligations ofall leases being recorded on the statement of financial position.

On 19 March 2009, the IASB and the US FASB published for comment a discussion

paper Leases: Preliminary Views. Comments were requested by 17 July 2009. In theDP the IASB and the FASB propose a possible new model for lease accounting. Themodel is based on the principle that all leases give rise to liabilities (for future rentalpayments) and assets (the right to use the leased asset) and should be recognised in anentity's statement of financial position.

5. This question concerns the treatment of related party transactions under IAS24Related-party Disclosures.

(i) IAS24 states that a supplier is not necessarily a related party merely by virtue of the

resulting economic dependence.

Tutorial note: others would include: two entities 'simply' because they have a director or other member of key

management personnel in common, notwithstanding parts (d) and (f) in thedefinition of 'related party';

two venturers simply because they share control over a joint venture; providers of finance, trade unions, public utilities, and government departments and

agencies, simply by virtue of their normal dealings with an entity (even though theymay affect the freedom of action of an entity or participate in its decision-making

process); a customer, franchisor, distributor or general agent with whom the entity transacts

a significant volume of business, merely by virtue of the resulting economicdependence.

If the standard did not contain these exclusions, many entities that would normally beregarded as unrelated could potentially fall within the detailed definition of a relatedparty, resulting in a plethora of financial statement disclosures. Effective control is adeciding issue in determining whether a party is related to another; so, for example, asmall food manufacturer selling over 75% of its output to a high street supermarketcould be said to be under the effective control of that customer.For exclusion to be effective, the party should be considered as related to the reporting

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