wiecek and young ifrs primer chapter 24 leases: ias 17

Wiecek and Young

IFRS PrimerChapter 24

Leases: IAS 17

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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

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Related Standards

IAS 16 Property, plant and equipment IAS 36 Impairment of assets IAS 38 Intangible assets IAS 40 Investment property IAS 41 Agriculture

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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

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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.)

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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

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Risk and rewards incidental to ownership transferred = finance lease

Risks and rewards not transferred = operating lease

Use judgment to evaluate individual circumstances and conditions

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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

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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

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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

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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

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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

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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

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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

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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

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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

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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

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IAS 17 – Recognition and Measurement by the Lessor

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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

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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

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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

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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

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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

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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

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Entity owns asset Sells it and leases it back Decision by seller-lessee: finance lease or

operating lease? Sale and leaseback are interdependent

transactions

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IAS 17 – Sale and Leaseback Transactions


Leaseback is a finance lease– Gain on sale is deferred– Amortized to income over term of lease

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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

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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

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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

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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

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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

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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.

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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.

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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.

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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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