International Accounting Standard 17 Leases

IAS 17, Leases Objective Advantages Definitions Types of arrangement Disclosure Sale and Leaseback transactions

IAS 17, Leases Objective The objective of this standard is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to leases.

Advantages of Leasing Up to100% Financing at Fixed Rates Protection against obsolescence Flexibility Less costly financing Tax Advantages Off-Balance-Sheet Financing

IAS 17, Leases Definitions A lease: is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time. A lease is a contractual agreement between a lessor, who conveys the right to use real or personal property (an asset), he is the one who grants the lease (in french “Bailleur” , and a lessee, who agrees to pay periodic rents over specific time (agreed period of time) in french “Locataire”. A major goal in accounting for leases is to recognize the economic substance of the agreement over its mere legal form.

IAS 17, Leases Types of Arrangements Lease classification: two types Finance lease: A finance lease transfers substantially all of the benefits and risks inherent in ownership of property to the lessee. Title may or may not eventually be transferred. Operating lease- is a lease other than a finance lease A sales-type lease results in a dealer’s or manufacturer’s profit or loss to the lessor. A direct financing lease does not result in a dealer’s or manufacturer’s profit or loss.

IAS 17, Leases Types of Arrangements (cont’d) Lessee, finance lease Criteria : Must meet just one condition to capitalize: Ownership transfers at end of lease (upon final payment or required buyout) Written option for bargain purchase Ninety (90%) percent of leased property FMV < PV of lease payments Seventy-five (75%) percent of asset economic life is being committed in lease term. Illustration “A,B” Note: The last 2 criteria cannot be used for a lease that begins within the last 25% of the original estimated economic life of leased property.

Types of Arrangements (cont’d) Risks and rewards of ownership Risks may be represented by the possibility of: Losses from idle capacity or technological obsolescence; Variations in return due to changing economic conditions Rewards may be represented by the expectation of: Profitable operation over the asset’s economic life; Gain from appreciation in value or realization of residual value

Types of Arrangements (cont’d) Indicators IAS 17 lists the following as examples of situations where a lease would normally be classified as a finance lease: The lease transfers ownership of the asset to the lessee by the end 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

Types of Arrangements (cont’d) Terms of the lease The status of the lease may often be determined from an examination of the lease terms. A transference of risks and rewards is assumed if: The lessee has the use of the asset for most of its economic life. The lessee bears the cost normally associated with ownership. The present value of the amounts guaranteed by the lessee is materially equivalent to the cost of purchase. Any amounts accruing to the lessor at the end of the lease are relatively small

Types of Arrangements (cont’d) Land and buildings Normally has an indefinite economic life. If title does not pass at the end of the lease term, the lease should normally be classified as an operating lease

Types of Arrangements (cont’d) Land and buildings Useful life will probably extend well beyond the lease term. If title does not pass at the end of the lease term, the lease will be classed as operating lease If it pass, both are classified as finance leases

IAS 17, Leases Disclosure Operating Leases Lessor and Lessee shall disclose the following for operating leases: The future minimum lease payments under non-cancelable operating leases in the aggregate Total contingent rents recognized as income in the period. A general description of the lessor’s leasing arrangements. Illustration “C”

IAS 17, Leases Disclosure (Cont’d) Finance Leases Lessor shall disclose the following for finance leases: A reconciliation between the gross investment in the lease at the BS date, and the PV of minimum lease payments receivable at the BS. Unearned finance income. The accumulated allowance for uncollectible minimum lease payments receivable. A general description of the lessee’s leasing arrangements.

IAS 17, Leases Disclosure (Cont’d) Lessee shall disclose the following for finance leases: For each class of asset, the net carrying amount at the balance sheet date. A reconciliation between the total of future minimum lease payments at the BS date, and their PV.

Sale and Leaseback as a finance lease The substance of the transaction is that is no sale-risks and rewards of ownership have not passed from the original lessee. Any excess of sales proceeds over the carrying amount should be deferred and amortized over the lease term. Illustration “D”

Sale and leaseback as an operating lease If the rentals and the sale price are established at a fair value, there has in effect been a normal sale transaction. If the sale price is above fair value, the excess should be deferred and amortized over the period for which the asset is expected to be used. If the sale price is below fair value, any profit or loss should be recognized immediately.

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