IAS 17 LeasesIAS 17 Leases

Scope of the IAS 17• The definition of the standard includes Hire purchase p

contracts and conditional sale  agreements.

• However it excludes the following:‐

1. Lease agreements to explore for or use minerals , oil, natural gas and similar non‐regenerative resources.

(IFRS 6)

1. Licensing agreements for such items as motion pictures, films video recordings plays manuscripts patents andfilms, video recordings, plays, manuscripts, patents and copyrights. (IAS 38)

• Contracts under finance leases are financialContracts under finance leases are financial instruments but only for impairment and derecognition,        principles of  IAS 39 are applied.                                Though there are some disclosures                         required as per IFRS 7 F.I. Disclosures

DefinitionsDefinitions• Lease: An agreement which conveys to the lessee the right 

to use an asset, for a specified period of time, in return for payment(s) to the lessor (Substance over form)payment(s) to the lessor.  (Substance over form)

• Accounting for leases based on the lease classification (finance or Operating) and can have significant impact on the financial statements of both lessees and lessors

• Finance lease: a lease which transfers substantially all risks and rewards incident to ownership of an asset.    Title may or may not eventually be transferred.y y

• Operating lease: a lease other than  afinance lease.

Classification of leases

“Normal”  “Could be” Indicators  Indicators

Lease and its Classification

Lease TermSIC 27IFRIC 4 

TAG LINE

Classification of leases• IAS 17 lists the following as examples of situations that individually 

or in combination would normally lead to a lease being classified as a finance lease are:a finance lease are:

• the lease transfers ownership of the asset to the lessee by the end of the lease term;of the lease term;

• the lessee has the option to purchase the asset at a “bargain price” and it seems likely that, at the inception of the lease, that this option will be exercised;

• the lease term is for the major part of the useful life of the asset; and 

• at the inception of the lease, the present value of the minimum lease payments is greater than or equal to substantially all of thelease payments is greater than, or equal to substantially all of, the fair value of the leased asset (net of grants and tax credits to the lessor at that time.

• Lease asset are of specialized natureLease asset are of specialized nature

Classification of leases• IAS 17 lists the following as examples of situations that individually or in 

combination could also lead to a finance lease:

• if the lessee can cancel the lease any losses associated with the• if the lessee can cancel the lease any losses associated with the cancellation are borne by the lessee;

• gains or losses from the fluctuation in the fair value of the residual fall to the lessee (e g in the form of a rent rebate equaling most of the salesthe lessee (e.g. in the form of a rent rebate equaling most of the sales proceeds at the end of the lease);

• the lessee has the ability to continue the lease for a secondary period at a rent which is substantially lower than market rent; andrent which is substantially lower than market rent; and

IFRIC 4: Determining whether an arrangement contains a lease.

f f fSIC 27: Substance of transactions with the legal form of a lease. 

The list is not conclusive

Classification of lease• The lease term is the key to classifying a lease and is defined 

as non‐cancellable period for which lessee has contracted to lease asset, together with any further terms (Break clauses, renewal clauses, penalties ) for which the lessee has the option to lease the asset with or without further payment, option to lease the asset with or without further payment,when at the inception of the lease it is reasonably certain that the lessee will exercise the option.

{T li } Th i l i h h h l f• {Tag line}‐ The prime rule is whether the lease transfers substantially all risks (losses from idle capacity or technological obsolescence; variations in return due to changing economic conditions) and rewards (profitable operation over the asset’s economic life; gain from appreciation in value or realization of residual value)appreciation in value or realization of residual value) .

Lessee Accounting: Finance LeaseLessee Accounting: Finance Lease

Inception of the Lease

Commencement of the lease

Recognition of Assets and subsequent treatment

Recognition of Liabilities and s bseq ent treatmentRecognition of Liabilities and subsequent treatment

INCEPTION OF THE LEASELessee‐

• Lease classification and measurement is made

INCEPTION OF THE LEASEFinance Lease

Lease classification and measurement is made at the inception of the lease.

• Inception of the lease is the earlier of the date• Inception of the lease is the earlier of the date of the lease agreement and the date of parties’ commitment to the lease’s principal provisionscommitment to the lease s principal provisions.

• The assets and liabilities to be recognized at h f lthe commencement of lease term are determined at the date of inception

INCEPTION OF THE LEASELessee‐Finance Lease

• Measure the non‐current asset and the finance lease liability (at similar amounts) at the lower of:ease ab ty (at s a a ou ts) at t e o e o :

• the present value of amounts guaranteed by the• the present value of amounts guaranteed by the lessee (Minimum lease payments);

Or

• the fair value of asset (as an approximation, usually the cash price of asset).

2

Minimum lease payments: Lessee

+ t t d b th l+          the payments over the lease term

amounts guaranteed by the lessee orby a party related to the lessee

Minimum lease payments: Lessor residual value guaranteed by lessee

+          the payments over the lease term

residual value guaranteed by lessee, Or any party related to the lesseeOr a third party (manufacturer)

Unguaranteed Residual Value (E.g. Scrap Proceeds)

+Fair value of the leased asset Initial Direct cost of lessor

= PV of Minimum lease payments 2

COMMENCEMENT OF THE LEASELessee‐

• Date of commencement of the lease is the date from which 

COMMENCEMENT OF THE LEASEFinance Lease

the lessee is entitled to exercise the right.

• Recognize Non‐current asset and finance lease obligation in the financial statements as determined at the date ofthe financial statements as determined at the date of inception.

• Any initial direct costs (incremental costs, excluding marketing and general administration costs) will be added to the amount recognised as non current asset.

Recognition of Assets and subsequent treatment

Recognition of Liabilities and subsequent treatment

Non current Asset Finance lease obligation

‐Recognize as per measurement rule.

‐Depreciate over shorter of lease d f l l f l bl

‐Recognize on commencement as permeasurement rules.

d bperiod or useful life unless reasonably certain that the title passes to lessee.

Depreciation policy used will be

‐Lease payments apportioned betweenfinance charges and reduction ofoutstanding liability in a way to producea constant periodic interest rate on the‐Depreciation policy used will be 

consistent with that of nature of the asset and as usual all rules applicable as NCA will be applied e g IAS 36

a constant periodic interest rate on theremaining balance of the liability foreach year.

as NCA  will be applied, e.g., IAS 36.‐ Finance lease obligation will bedivided into current and non currentdistinction, including interest in thecurrent when accrued and nototherwise.2

Lessee‐Operating Lease

Recognition in Income StatementRecognition in the statement of 

Financial Position

‐ Rentals are charged as EXPENSE to the Statement of Comprehensive income on a straight line basis or

‐ No balances appear in the Statementof financial position other thanACCRUALS and PREPAYMENTS onincome on a straight line basis or 

other systematic basis.ACCRUALS and PREPAYMENTS onrented assets

4

Lessor Accounting: Finance LeaseLessor‐Finance Lease

Initial RecognitionInitial Recognition

Subsequent M tMeasurement

Lessor Accounting: Finance Lease

Calculate Gross investment in the lease(lessors’ MLPs + unguaranteed residual)

Lessor‐Finance Lease

(lessors  MLPs + unguaranteed residual)

discounted @ interest rate implicit in the lease (as previously calculated)

Initial Recognition

=  Net Investment in the lease

Lessor‐Finance Lease

Subsequent  Rentals received will be allocated using a constant periodic rate of return dividingMeasurement constant periodic rate of return dividing 

into

REPAYMENT INTEREST INCOME OF CAPITAL 

ELEMENT

Statement of comprehensive 

Statement of Financial Positionp

IncomeInvestment in lease)

Financial Position (reduction from Net Investment in lease)

Lessor‐Operating Lease

Recognition in Income StatementRecognition in the statement of 

Financial Position

‐ Rentals Received will be credited as INCOME in the Statement of Comprehensive income on a straight

‐ Assets subject to operating lease willremain in the financial statement asbefore according to the nature of theComprehensive income on a straight 

line basis or other systematic basis.before according to the nature of theasset.‐ Any initial direct cost incurred will beadded to the carrying amount of theadded to the carrying amount of theleased asset and recognize as expenseon the same basis as the lease income.

Other Issues in IAS 17 

Manufacturer or Dealer Lessor

Lease of Land and Building

Manufacturer or Dealer Lessor

Lease of Land and Building

SALE AND LEASEBACK TRANSACTIONSSALE AND LEASEBACK TRANSACTIONS

Manufacturer or Dealer Lessor

IAS 17 distinguish manufacturer/dealer lessors from other lessors. Although the term is not defined in the standard, a manufacturer/dealer lessor is a lessor that either manufacturers the leased asset or acquires the leased assetis a lessor that either manufacturers the leased asset or acquires the leased assetas part of its dealing activities.

The issue is whether the manufacturer/dealer lessor should recognize a normalsale profit/loss or not, Which depends on the classification of the lease.

In case of the finance lease.

‐Sales revenue (Lower of the FV of the asset or PV of the MLPs computed At Market rate of Interest) Initial Direct costs should be

‐(less) Cost of sales less PV of any unguaranteed RV

Recognized as expense

= Profit/Loss in Comprehensive Income

Lease of Land and Building

MLPs are allocated S lit th MLP f L&B

Is the split of MLPs between the land and

MLPs are allocated in proportion to the relative fair 

values of leasehold 

Split the MLPs of L&B

between the land and building element  possibleYes

No

interest

Land  Building

D th titl

By applying other criteria, 

can both Apply the normal 

No

Does the title pass to the lessee

element be termed as 

operating lease

rules of classification as discussed and 

classify

Treat it Finance

Treat it Operating

Treat both element  Treat both element 

classifyYes NoYes

No

Finance Lease

Operating Lease

as operating lease as Finance lease

SALE AND LEASEBACK TRANSACTIONS

Sale and…

Leaseback is an Operating lease

Leaseback is a Finance Lease

*Repurchase options- Certain or not-

Defer the Profit/ loss on sale transaction and amortized 

If transaction is at fair value, profit or loss on sale is recognized

over the lease termsale is recognized 

immediately. If not, Rules apply*