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Wiecek and Young
IFRS PrimerChapter 24
Leases: IAS 17
2
Leases
Related standards IAS 17 Current GAAP comparisons IFRS financial statement disclosures Looking ahead End-of-chapter practice
Related Standards
FAS 13 Accounting for leases
3
Related Standards
IAS 16 Property, plant and equipment IAS 36 Impairment of assets IAS 38 Intangible assets IAS 40 Investment property IAS 41 Agriculture
4
IAS 17 – Overview
Objective and scope Classification of leases Recognition and measurement by the lessee Recognition and measurement by the lessor Sale and leaseback transactions
5
IAS 17 – Objective and Scope
Accounting and disclosure policies– lessees– lessors
Excludes leases– for exploration and use of non-renewable natural
resources– licensing agreements for many intangible assets
(movies, video recordings, plays, manuscripts, etc.)
6
IAS 17 – Classification of Leases
A lease is an agreement in which a lessor conveys the right to use an asset for an agreed time to a lessee in return for payment(s).
Lease classification– finance lease– operating lease
Decision – whether risks and rewards of ownership are
transferred from lessor to lessee
7
IAS 17 – Classification of Leases
Risk and rewards incidental to ownership transferred = finance lease
Risks and rewards not transferred = operating lease
Use judgment to evaluate individual circumstances and conditions
8
IAS 17 – Classification of Leases
Classification as a finance lease supported by– ownership transferred by end of lease term –
could be by bargain purchase option– lessee receives most of economic benefit of asset
(consider lease term)– lessor obtains a return of investment in asset and
a return on investment (consider PV of lease payments relative to asset’s fair value)
– asset is specialized to lessee’s needs, costly to modify for other use
9
IAS 17 – Classification of Leases
Might lead to classification as a finance lease– lessee bears lessor’s losses from lease
cancellation– changes in asset’s fair value accrue to lessee at
end of lease– lease term extendible at much less than market
rate at end of lease
10
IAS 17 – Classification of Leases
If not a finance lease, then is an operating lease Special issues when land and building are
leased together and title is not transferred:– land lease cannot be a finance lease; building lease
can be – if value of leased interest in land is immaterial, treat
as building– if material, allocate payments between land and
building based on relative values of leased interests in each
11
IAS 17 – Classification of Leases
Minimum lease payments (MLP) –lessee’s definition1. payments over the lease term that the lessee is
required to make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor
2. if applicable, the payment required to exercise a “bargain purchase” option
3. amounts guaranteed by the lessee or party related to the lessee
12
IAS 17 – Recognition and Measurement by the Lessee
Finance lease accounting– recognize as acquisition of an asset and incurring
of a liability– after acquisition, asset depreciation policies are
those in IAS 16 or IAS 38– lease payments are split between interest,
principal and operating-type costs, if applicable
13
Finance lease disclosures– net carrying amount by class of asset– MLP and the PV of MLP due within 1 year;
between years 2 and 5; and beyond 5 years from B/S date
– reconciliation of total of MLP to the PV of the MLP– contingent rents expensed in period; – sublease payments expected in future– information about leasing arrangements,
purchase options, contingent rents, restrictions
14
IAS 17 – Recognition and Measurement by the Lessee
Operating lease accounting– expense over lease term, usually on a straight-line basis
Operating lease disclosures– total future MLP due within 1 year, between years 2 and
5; and beyond 5 years from B/S date– sublease payments expected in future– expense recognized in period for each of MLP,
contingent rents, sublease payments– information about leasing arrangements, purchase
options, contingent rents, restrictions
15
IAS 17 – Recognition and Measurement by the Lessee
IAS 17 – Recognition and Measurement by the Lessor Classification decision
– same as for lessee, but using lessor definition of MLP
– if risks and rewards of ownership are transferred to lessee – remove asset from lessor’s accounts
– if risks and rewards retained by lessor, asset remains in lessor’s accounts
16
IAS 17 – Recognition and Measurement by the Lessor Lessor uses different definition of minimum
lease payments (MLP)– the payments over the lease term that the lessee
is required to make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor
– if applicable, the payment required to exercise a “bargain purchase” option
– any residual value guaranteed by a party not related to the lessor
17
IAS 17 – Recognition and Measurement by the Lessor Finance lease - lessor could be either
– a manufacturer or dealer in business to earn a gross profit on the sale of the asset and finance income to compensate for delayed payment terms, or
– primarily a financial intermediary in business to facilitate the financing of assets by others and to earn finance income as its primary source of income
Situations differ – therefore entries differ
18
IAS 17 – Recognition and Measurement by the Lessor
19
At beginning of lease term Throughout lease term
Lease Receivable x Sales x Unearned Finance Income xCost of Goods Sold x Inventory xTo record the lease transaction.
Cash x Lease Receivable xTo record lease payment received.Unearned Finance Income x Finance Income xTo recognize finance income earned in period.
Manufacturer/dealer lessorsManufacturer/dealer lessors
Manufacturer/dealer lessors
Financial intermediary lessors
20
Manufacturer/dealer lessors
IAS 17 – Recognition and Measurement by the Lessor
At beginning of lease term Throughout lease termLease Receivable x Unearned Finance Income x Assets Purchased to Lease xTo record the lease transaction.
Cash x Lease Receivable xTo record lease payment received.Unearned Finance Income x Finance Income xTo recognize finance income earned in period.
Lease receivable = gross investment in the lease:– undiscounted total of MLP + bargain purchase option, if
applicable, + guaranteed and unguaranteed residual values by non-related parties, if applicable
Present value of Lease Receivable = net investment in lease
Unearned finance income = gross investment minus net investment
= finance income to be earned over lease term
21
Manufacturer/dealer lessors
IAS 17 – Recognition and Measurement by the Lessor
Other measurement issues– initial direct costs of manufacturer/dealer: deduct
as expense in period sale is recognized– initial direct costs of financial intermediary: add to
carrying amount of asset and use lower interest rate to recognize finance income
– for manufacturer/dealer with unguaranteed residual amount: reduce Sales and Cost of Sales by PV of unguaranteed residual – no other changes
– review residual values regularly
22
Manufacturer/dealer lessors
IAS 17 – Recognition and Measurement by the Lessor
Disclosures by lessors for finance leases– gross investment in lease, PV of MLP due within 1
year, years 2 to 5, and after year 5 from B/S date– reconciliation between gross investment and PV of
MLP at B/S date– unearned finance income, unguaranteed residual
values, allowance for uncollectible MLP receivable– contingent rent income– information about material leasing arrangements
23
Manufacturer/dealer lessors
IAS 17 – Recognition and Measurement by the Lessor
Accounting for operating leases:– Leased assets remain on B/S– Recognize lease income on straight-line basis
over lease term– Add initial direct costs to leased asset and
depreciate over lease term on same basis as lease income is recognized
– Depreciation and impairment covered by IAS 16, 38 and 36
24
Manufacturer/dealer lessors
IAS 17 – Recognition and Measurement by the Lessor
Disclosures for operating leases:– Total MLP due within 1 year, between years 2
and 5, and beyond year 5– Contingent rental income recognized– Description of leasing arrangements
25
Manufacturer/dealer lessors
IAS 17 – Recognition and Measurement by the Lessor
Entity owns asset Sells it and leases it back Decision by seller-lessee: finance lease or
operating lease? Sale and leaseback are interdependent
transactions
26
Manufacturer/dealer lessors
IAS 17 – Sale and Leaseback Transactions
IAS 17 – Sale and Leaseback Transactions
Leaseback is a finance lease– Gain on sale is deferred– Amortized to income over term of lease
27
IAS 17 – Sale and Leaseback Transactions
Leaseback is an operating lease– Sale made at FV - recognize gain or loss in current
income– Sale < FV and lease payments are at FV – recognize
loss in current income– Sale < FV and lease payments are lower to
compensate – defer loss & amortize on same basis as lease payments
– Sale > FV excess over FV is deferred and amortized over period of expected use
– If FV < carrying amount, impairment; recognize loss currently
28
Current GAAP Comparisons
Pages 21 to 23 of 49 of http://www.ey.com/Global/assets.nsf/International/IFRS_US_GAAP_vs_IFRS/$file/US_GAAP_vs_IFRS.pdf
Pages 124 to 127 of 164 of http://www.kpmg.co.uk/pubs/IFRScomparedtoU.S.GAAPAnOverview(2008).pdf
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IFRS Financial Statement Disclosures
The Nestlé Group
http://www.nestle.com/Resource.axd?Id=24E5A5E2-93F8-43A3-956E-0F259448CB90
Accounting policy for leased assets Page 21 of 118
Note 11, PP&E note Page 37 of 118
Note 28, lease commitments Page 73 of 118
30
Looking Ahead
No short-term changes expected IASB & FASB have longer-term joint project IASB tentative decision – move away from
risks and rewards of ownership criterion Replace with defining assets as “right to use
the leased asset” and obligation to make payments as a liability
31
Looking Ahead
Effect – all non-cancellable lease agreements may be recognized as assets and liabilities, including what are now operating leases
Approach affected by current project on conceptual framework
Exposure draft expected 2010 New lease standard expected 2011
32
End-of-Chapter Practice24-1 Lessee Corp. entered into a non-cancellable agreement with Lessor Corp. on May 15, 2008 to lease equipment manufactured by Lessor according to Lessee’s specifications. If Lessee had purchased the equipment outright from Lessor, it would have cost Lessee $100, although Lessor’s cost was only $80. The following information is available:
Lease term May 15, 2008 – May 14, 2012
Economic life of equipment 6 years
Annual rental payment $25.8
1st payment due May 15, 2008
Estimated residual value, unguaranteed $13
Interest rate implied in lease 10%
Title transfer in lease? No
n = 4, i = 10:
PV factor, lump sum 0.68301
PV factor, annuity due 3.48685
Lessee and Lessor Corp. year ends December 31
33
End-of-Chapter Practice24-1 Instructions (round all amounts to one decimal place)
a) Discuss the nature of this lease to Lessee Corp.
b) Discuss the nature of this lease to Lessor Corp.
c) Prepare Lessee Corp.’s entries for 2008 and 2009 assuming the lease is classified as:
( i) a finance lease
(ii) an operating lease
d) Prepare Lessor Corp.’s entries for 2008 and 2009 assuming the lease is classified as:
( i) a finance lease
(ii) an operating lease
e) Explain how your answers to parts (a) and (b) above would change, if at all, if the following additional features were added to this lease agreement. Assume each feature is an independent case. In addition, explain how any entries in parts (c) and (d) would differ, if at all, from those prepared above.
( i) the lessee’s incremental borrowing rate is 12%
(ii) the residual value is guaranteed by Lessee Corp.
(iii) the residual value is guaranteed by a third party not related to Lessee Corp.
(iv) the agreement contains an option permitting Lessee Corp. to purchase the leased asset on May 14, 2012 for $4
(v) the equipment is so specialized to Lessee Corp.’s needs that Lessor Corp.’s only option at the end of the lease term is to sell off the component parts for the estimated residual value34
End-of-Chapter Practice
24-2 Prepare a decision chart or diagram to accompany IAS 17 that can be used by seller-lessees to determine the correct accounting for gains and losses on disposal of an asset that is sold and leased back. Write a brief explanation of why the standard provides a reasonable treatment in each situation.
35
End-of-Chapter Practice
24-3 Jamal Corp. enters into a four-year operating lease for the rental of two floors of a new building, and makes a payment of $2 in advance to hold the space. The monthly rental is $10 and Jamal qualifies for a special promotion, getting the last four months of the lease rent-free.
Instructions
a) Determine the rent expense to be recognized each year of the four-year lease.
b) Prepare the journal entries to record the $2 payment, the $10 rental payment for months 1 and 2 of the lease, and any entries required in each of months 45, 46, 47 and 48. Round the monthly rent expense to one decimal place.
36
End-of-Chapter Practice24-4 On June 30, 2008 Lor Ltd., a lessor, enters into a six-year non-cancellable finance lease that requires annual rental payments of $100 beginning June 30, 2008. In addition, the lessee is required to make payments in advance of $12 each year to Lor Ltd. to cover a maintenance agreement on the equipment. The equipment has an estimated residual value of $40 at the end of the lease term. Lor Ltd. is a dealer that ordinarily sells this equipment inventory which cost $450, for $524.50. Lor Ltd. expects to earn an 8% return on any delayed payment terms.
Instructions
a) Assuming the lessee has guaranteed the residual value, prepare Lor Ltd.’s entries on June 30, 2008, December 31, 2008 (its year end) and June 30, 2009. Identify the lessor’s gross investment in the lease and the net investment in the lease on December 31, 2008, and the profit or loss reported on the lease arrangement for the year that just ended.
b) Assuming the residual value is not guaranteed, prepare Lor Ltd.’s entries on June 30, 2008, December 31, 2008 (its year end) and June 30, 2009. Identify the lessor’s gross investment in the lease and the net investment in the lease on December 31, 2008 and the profit or loss reported on the lease arrangement for the year that just ended. Comment on your results in this part compared with your results in part (a).
c) Explain briefly how initial direct costs of negotiating the lease of $10 would be accounted for on June 30, 2008 and how this would affect any subsequent entries. You are not required to make any calculations.
37
End-of-Chapter Practice
24-5 In this chapter, flag icons identify areas where there are GAAP differences between IFRS requirements and national standards.
Instructions
Access the website(s) identified on the inside back cover of this book, and prepare a concise summary of the differences that are flagged throughout the chapter material.
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