Chapter 14: Leases

Perspective and Issues

Leasing has long been a popular financing option for the acquisition of business property. During the past few decades, however, the business of leasing has experienced staggering growth. The tremendous popularity of leasing is quite understandable, as it offers great flexibility, often coupled with a range of economic advantages over ownership. Thus, with leasing, a lessee (borrower) is typically able to obtain 100% financing, whereas under a traditional credit purchase arrangement the buyer would generally have to make an initial equity investment. In many jurisdictions, a leasing arrangement offers tax benefits compared to the purchase option. The lessee is protected to an extent from the risk of obsolescence, although the lease terms will vary based on the risk of obsolescence. For the lessor, there will be a regular stream of lease payments, which include interest that often will be at rates above commercial lending rates, and, at the end of the lease term, usually some residual value.

The accounting for lease transactions has a number of complexities, which derive partly from the range of alternative structurings available to the parties. For example, in many cases leases can be configured to allow manipulation of the tax benefits, with other features such as term and interest rate adjusted to achieve the intended economics of the arrangement. Leases can be used to transfer ownership of the leased asset, and they can be used to transfer some or all of the risks of ownership. In any event, the accounting objective is to have the economic substance of the transaction dictate the accounting treatment.

The accounting for lease transactions is one of the best examples of the application of the principle of substance over form, as set forth in the IASC's Framework for the Preparation and Presentation of Financial Statements. If the transaction effectively transfers ownership to the lessee, the substance of the transaction is that of a sale and should be recognized as such even though the transaction takes the form of a lease.

Before its revision, IAS 17 required that lessors recognize finance income based on a pattern reflecting a constant rate of return, but they were permitted to compute that return on either the net investment outstanding (i.e., the book investment), or the net cash investment (which would be a different amount). The revised standard eliminated the second alternative and requires that the net (book) investment serve as the basis for the constant rate of return computation.

The guidance on lease accounting under IAS is not as fully elaborated as is that provided under certain national GAAP. The IASB has indicated that it intends to thoroughly review the existing rules with the possible result that IAS 17 will either be revised or superseded by a new standard. However, the general principle that the substance of the arrangement govern the accounting, with finance-type leases being reported almost inevitably as leveraged acquisitions of property, will remain in place. New guidance may be offered for the areas of lease practice not currently addressed in the standards, such as leveraged leasing.

In the near term, the IASB's Improvements Project has proposed several modest revisions to lease accounting, which are explained in this chapter.

While almost any type of arrangement that satisfies the definition of a lease is covered by this standard, the following specialized types of lease agreements are excluded:

1. Lease agreements to explore for or use natural resources, such as oil, gas, timber, metals, and other mineral rights

2. Licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents, and copyrights

The accounting for rights to explore and develop natural resources has yet to be formally addressed by IAS; no accounting guidance existed under the standards. Licensing agreements are addressed by IAS 38, which is discussed in Chapter 9.

Sources of IAS

IAS 4, 5, 17, 24, 36, 38

SIC 15, 27