Concepts, Rules, and Examples


Classification of Leases—Lessee

For accounting and reporting purposes the lessee has two alternatives in classifying a lease.

  1. Operating

  2. Finance

It should be observed that finance leases are referred to as capital leases under US GAAP. Finance leases are those that essentially are alternative means of financing the acquisition of property or of substantially all the service potential represented by the property. The term capital is used because under accounting standards such leased property is treated as owned, and accordingly, capitalized on the balance sheet. Since, due to the relative paucity of guidance on lease accounting under IAS there will be many issues on which informal direction will be taken from US GAAP, the terms finance and capital will be treated as synonymous in this chapter.

The proper classification of a lease is determined by the circumstances surrounding the leasing transaction. According to IAS 17, whether a lease is a finance lease or not will have to be judged based on the substance of the transaction, rather than the form of the contract. Further, if substantially all of the benefits and risks of ownership have been transferred to the lessee, the lease should be classified as a finance lease; such a lease is normally noncancelable and the lessor is assured of recovery of the capital invested plus a reasonable return on its investment. IAS 17 stipulates that substantially all of the risks or benefits of ownership are deemed to have been transferred if any one of the following four criteria has been met:

  1. The lease transfers ownership to the lessee by the end of the lease term.

  2. The lease contains a bargain purchase option (an option to purchase the leased asset at a price that is expected to be substantially lower than the fair value at the date the option becomes exercisable) and it is reasonably certain that the option will be exercisable.

  3. The lease term is for the major part of the economic life of the leased asset. Title may or may not eventually pass to the lessee.

  4. The present value (PV), at the inception of the lease, of the minimum lease 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. Title may or may not eventually pass to the lessee.

The revised IAS 17 has expanded upon the foregoing list of original IAS 17 criteria with an additional four criteria, which are summarized below.

  1. The leased assets are of a specialized nature such that only the lessee can use them without major modifications being made.

  2. If the lessee can cancel the lease, the lessor's losses associated with the cancellation are borne by the lessee.

  3. Gains or losses resulting from the fluctuations in the fair value of the residual accrue to the lessee.

  4. The lessee has the ability to continue the lease for a supplemental term at a rent that is substantially lower than market rent.

Thus, under current IAS 17, an evaluation of eight criteria would be required to assess whether there is sufficient evidence to conclude that a given arrangement should be accounted for as a finance lease. Of the eight criteria set forth in the standard, the first five are essentially determinative in nature; that is, meeting any one of these would normally result in concluding that a given arrangement is in fact a finance lease. The final three criteria, however, are more suggestive in nature, and the standard states that these "could" lead to classification as a finance lease.

The interest rate used to compute the present value should be the lessee's incremental borrowing rate unless it is practicable to determine the rate implicit in the lease, in which case that rate should be used. It is interesting to note that under US GAAP, in order to use the rate implicit in the lease to discount the minimum lease payments, this rate must be lower than the lessee's incremental borrowing rate. Logically, of course, if the lessee's incremental borrowing rate were lower than a rate offered implicitly in a lease, and the prospective lessee was aware of this fact, it would be more attractive to borrow and purchase, so the US rule may be somewhat superfluous. The IAS does not set this as a condition, however.

In general, if a lease agreement meets one of the eight criteria set forth above, it is to be classified as a finance lease in the financial statements of the lessee. However, a further condition is imposed when the lease includes both land and buildings. In such cases, unless it is expected that title will pass to the lessee at the end of the lease term, those leases would not normally be considered finance leases, regardless of the other terms in the lease agreement. In other words, the first criterion must always be met in case of real estate leases in order for them to be classified as finance leases.

The language used in the third and fourth criteria, as set forth above, makes them rather subjective and somewhat difficult to apply in practice. Thus, given the same set of facts, it is possible for two enterprises to reach different conclusions regarding the classification of a given lease. The IAS 17 approach differs from that adopted by the corresponding US standard, SFAS 13, in that more subjective criteria are established by the international rule. In the US standard, a threshold of 75% or more of the useful life has been specified for classifying a lease as a finance lease, which thus creates a "bright line" test to be applied mechanically. The corresponding language under IAS 17 stipulates that capitalization results when the lease covers a "major part of the economic life" of the asset. Further, a threshold of "the present value of minimum lease payments equaling at least 90% of leased asset fair value" is set under the US standard, rather than the "substantially all of the fair value of the leased asset" employed under the international standard.

In the absence of interpretation or direction from the IASC, it may be argued that the expression "major part" implies 80% to 90%, instead of 75%, of the economic life of the asset, or that "substantially all" represents 95% or, for that matter, even 99% instead of 90% of fair value at the inception of the lease. Thus, some may hope that the IASC will address these issues when it revisits IAS 17, during its promised consideration of more fundamental reform of the standard, since these have been persistent problems in applying the standard.

The revised IAS 17 addresses the issue of change in lease classification resulting from alterations in lease terms, stating that if the parties agree to alter the terms of the lease, other than by renewing the lease, in a manner that would have resulted in a different classification of the lease, had the changed terms been in effect at inception of the lease, then the revised lease agreement is to be considered a new lease agreement.

Classification of Leases—Lessor

The lessor has the following alternatives in classifying a lease:

  1. Operating lease

  2. Finance lease

    1. Plain or regular finance lease, hereinafter referred to as direct financing lease, which is the term used by US GAAP

    2. Finance lease by manufacturers or dealers, hereinafter referred to as sales-type lease, the term used by US GAAP

    3. Leveraged lease, wherein financing is through a third-party creditor instead of the lessor

Consistent accounting by lessee and lessor.

Since the events or transactions that take place between the lessor and the lessee are based on an agreement (the lease) that is common to both the parties, it is normally appropriate that the lease be classified in a consistent manner by both parties. Thus, if any one of the eight criteria specified above for classification of a finance lease by the lessee is met, the lease should also be classified as a finance lease by the lessor. If the lease qualifies as a finance lease from the standpoint of the lessor, it would be classified either as a sales-type lease, a direct financing lease, or a leveraged lease, depending on the conditions present at the inception of the lease.

Notwithstanding this general observation, IAS 17 alludes to an exception to this general rule when it speaks about the "differing circumstances" sometimes leading to the same lease being classified differently by the lessor and lessee. The standard does not, unfortunately, expand on this matter, but once again it is possible to be informed by reference to US GAAP, which clearly sets forth the circumstances or factors which if not satisfied from the standpoint of the lessor would lead to different classifications by the lessor and the lessee. SFAS 13 stipulates that the following two conditions both need to be satisfied in addition to meeting any one of the criteria established for capitalization determination by the lessee, before a lease could be classified as a finance (capital) lease from the standpoint of a lessor:

  1. Collectibility of the minimum lease payments is reasonably predictable.

  2. No important uncertainties surround the amount of nonreimbursable costs yet to be incurred by the lessor under the lease.

Under US GAAP, therefore, if a lease transaction does not meet the criteria for classification as a sales-type lease, a direct financing lease, or a leveraged lease as specified above (by satisfying both of the above noted extra criteria), it is to be classified in the financial statements of the lessor as an operating lease. If the lessee has accounted for the lease as a capital lease, the asset being leased may appear on the balance sheets of both lessee and lessor.

Although guidance under IAS 17 does not establish additional conditions that must be fulfilled for the lessor to treat a lease as a financing transaction, as the US standard does, use of the "differing circumstances" language opens up the possibility that in any given situation, additional subjective considerations could be defined. This remains a matter for each enterprise to address on an individual basis, however.

Distinction among Sales-Type, Direct Financing, and Leveraged Leases

A lease is classified as a sales-type lease when the criteria set forth above have been met and the lease transaction is structured such that the lessor (generally a manufacturer or dealer) recognizes a profit or loss on the transaction in addition to interest revenue. For this to occur, the fair value of the property, or if lower, the sum of the present values of the minimum lease payments and the estimated unguaranteed residual value, must differ from the cost (or carrying value, if different). The essential substance of this transaction is that of a sale, thus its name. Common examples of sales-type leases: (1) when an automobile dealership opts to lease a car to its customers in lieu of making an actual sale, and (2) the re-lease of equipment coming off an expiring lease.

A direct financing lease differs from a sales-type lease in that the lessor does not realize a profit or loss on the transaction other than interest revenue. In a direct financing lease, the fair value of the property at the inception of the lease is equal to the cost (or carrying value, if the property is not new). This type of lease transaction most often involves entities regularly engaged in financing operations. The lessor (a bank or other financial institution) purchases the asset and then leases the asset to the lessee. This transaction merely replaces the conventional lending transaction where the borrower uses the borrowed funds to purchase the asset.

There are many economic reasons why a lease transaction may be considered. These include

  1. The lessee (borrower) is generally able to obtain 100% financing.

  2. There may be tax benefits for the lessee.

  3. The lessor receives the equivalent of interest as well as an asset with some remaining value at the end of the lease term (unless title transfers as a condition of the lease).

  4. The lessee is protected from risk of obsolescence.

In summary, it may help to visualize the following chart when considering the classification of a lease:

click to expand

One specialized form of a direct financing lease is a leveraged lease. This type is mentioned separately both here and in the following section on how to account for leases because it is to receive a different accounting treatment by a lessor. A leveraged lease meets all the definitional criteria of a direct financing lease, but differs because it involves at least three parties: a lessee, a long-term creditor, and a lessor (commonly referred to as the equity participant). Other characteristics of a leveraged lease are as follows:

  1. The financing provided by the long-term creditor must be without recourse as to the general credit of the lessor, although the creditor may hold recourse with respect to the leased property. The amount of the financing must provide the lessor with substantial leverage in the transaction.

  2. The lessor's net investment declines during the early years and rises during the later years of the lease term before its elimination.

Accounting for Leases—Lessee

As discussed in the preceding section, there are two classifications that apply to a lease transaction in the financial statements of the lessee. They are as follows:

  1. Operating

  2. Finance

Operating leases.

The accounting treatment accorded an operating lease is relatively simple; rental expense should be charged to income as the payments are made or become payable. IAS 17 stipulates that rental expense be "recognized on a systematic basis that is representative of the time pattern of the user's benefits, even if the payments are not on that basis." In case the lease payments are being made on a straight-line basis (i.e., equal payments per period over the lease term), recognition of the rental expense would normally be on a straight-line basis. However, if the lease agreement calls for either an alternative payment schedule or a scheduled rent increase over the lease term, the lease expense should still be recognized on a straight-line basis unless another systematic and rational basis is a better representation of actual physical use of the leased property. In such an instance it will be necessary to create either a prepaid asset or a liability, depending on the structure of the payment schedule. In SIC 15, it has been held that all incentives relating to a new or renewed operating lease are to be considered in determining the total cost of the lease, to be recognized on a straight-line basis over the term of the lease. Thus, for example, a rent holiday for six months as part of a five-year lease would not result in only six months' rent expense being recorded during the first full year; rather, four and one-half years' rent would be allocated over the full five-year term. This would apply to both lessor and lessee.

Additionally, if the lease agreement provides for a scheduled increase(s) in contemplation of the lessee's increased (i.e., more intensive) physical use of the leased property, the total amount of rental payments, including the scheduled increase(s), should be charged to expense over the lease term on a straight-line basis. On the other hand, if the scheduled increase(s) is due to additional leased property, recognition should be proportional to the leased property with the increased rents recognized over the years that the lessee has control over the use of the additional leased property. (These suggestions, and many other recommendations made in this chapter, are based on guidance from US GAAP, since the IAS does not address these matters at the present time.)

Notice that in the case of an operating lease there is no balance sheet recognition of the leased asset because the substance of the lease is merely that of a rental. There is no reason to expect that the lessee will derive any future economic benefit from the leased asset beyond the lease term. There may, however, be a deferred charge or credit on the balance sheet if the payment schedule under terms of the lease does not correspond with the expense recognition, as suggested in the preceding paragraph.

Finance leases.

The classification of a lease must be determined prior to consideration of the accounting treatment. Therefore, it is necessary first to evaluate the lease transaction against the eight criteria set forth in IAS 17 (revised 1997). Assuming that the lease agreement satisfies one of these (while recognizing that the last three of the eight are not absolutely determinative, but are instead persuasive), it must be accounted for as a finance lease.

According to IAS 17, the lessee shall record a finance lease as an asset and an obligation (liability) at an amount equal to the lesser of (1) the fair value of the leased property at the inception of the lease, net of grants and tax credits receivable by the lessors, or (2) the present value of the minimum lease payments. For purposes of this computation, the minimum lease payments are considered to be the payments that the lessee is obligated to make or can be required to make, excluding contingent rent and executory costs such as insurance, maintenance, and taxes. The minimum lease payments generally include the minimum rental payments, and any guarantee of the residual value made by the lessee or a party related to the lessee. If the lease includes a bargain purchase option (BPO), the amount required to be paid under the BPO is included in the minimum lease payments. The present value shall be computed using the incremental borrowing rate of the lessee unless it is practicable for the lessee to determine the implicit rate computed by the lessor.

(Under US GAAP, an important exception is made when the FMV of the leased asset is lower than the PV of the minimum lease payments, which exception has not yet been considered under IAS 17. In such a case an implicit rate is computed through a series of trial-and-error calculations. This rule is entirely logical, since it is well established in GAAP that assets are not to be recorded at amounts greater than fair value or net realizable value at acquisition. This exception has been illustrated in a numerical case study that follows.)

The lease term to be used in the present value computation is the fixed, noncancelable term of the lease, plus any further terms for which the lessee has the option to continue to lease the asset, with or without further payment, provided that it is reasonably certain, as of the beginning of the lease, that lessee will exercise such a renewal option.

Depreciation of leased assets.

The depreciation of the leased asset will depend on how the lease qualified as a finance lease. If the lease transaction met the criteria as either transferring ownership or containing a bargain purchase option, the asset arising from the transaction is to be depreciated over the estimated useful life of the leased property. If the transaction qualifies as a finance lease because it met either the major part of economic life criteria, or because the present value of the minimum lease payments represented substantially all of the fair value of the underlying asset, then it must be depreciated over the shorter of the lease term or the useful life of the leased property. The conceptual rationale for this differentiated treatment arises because of the substance of the transaction. Under the first two criteria, the asset actually becomes the property of the lessee at the end of the lease term (or on exercise of the BPO). In the latter situations, title to the property remains with the lessor.

Thus, the leased asset is to be depreciated (amortized) over the shorter of the lease term or its useful life if title does not transfer to the lessee, but when it is reasonably certain that the lessee will obtain ownership by the end of the lease term, the leased asset is to be depreciated over the asset's useful life. The manner in which depreciation is computed should be consistent with the lessee's normal depreciation policy for other depreciable assets owned by the lessee, recognizing depreciation on the basis set out in IAS 16. Therefore, the accounting treatment and method used to depreciate (amortize) the leased asset is very similar to that used for an owned asset. The leased asset should not be depreciated (amortized) below the estimated residual value.

In some instances when the property is to revert back to the lessor, there may be a guaranteed residual value. This is an amount that the lessee guarantees to the lessor. If the fair value of the asset at the end of the lease term is greater than or equal to the guaranteed residual amount, the lessee incurs no additional obligation. On the other hand, if the fair value of the leased asset is less than the guaranteed residual value, the lessee must make up the difference, usually with a cash payment. The guaranteed residual value is often used as a device to reduce the periodic payments by substituting the lump-sum amount at the end of the term that results from the guarantee. In any event the depreciation (amortization) must still be based on the estimated residual value. This results in a rational and systematic allocation of the expense through the periods and avoids recognizing a large expense (or loss) in the last period as a result of the guarantee.

The annual (periodic) rent payments made during the lease term are to be apportioned between the reduction in the obligation and the finance charge (interest expense) in a manner such that the finance charge (interest expense) represents a constant periodic rate of interest on the remaining balance of the lease obligation. This is commonly referred to as the effective interest method. However, it is to be noted that IAS 17 also recognizes that an approximation of this pattern can be made, as an alternative.

At the inception of the lease the asset and liability (relating to future rental obligation) are recorded in the balance sheet of the lessee at the same amounts. However, since the depreciation charge for use of the leased asset and the finance expense during the lease term differ due to different policies being used to recognize them, as explained above, it is likely that the asset and related liability balances would not be equal in amount after inception of the lease.

The following examples illustrate the treatment described in the foregoing paragraphs:

Example of accounting for a finance lease—Asset returned to lessor

start example

Assume the following:

  1. The lease is initiated on 1/1/03 for equipment with an expected useful life of 3 years. The equipment reverts back to the lessor on expiration of the lease agreement.

  2. The FMV of the equipment is $135,000.

  3. Three payments are due to the lessor in the amount of $50,000 per year beginning 12/31/03. An additional sum of $1,000 is to be paid annually by the lessee for insurance.

  4. Lessee guarantees a $10,000 residual value on 12/31/05 to the lessor.

  5. Irrespective of the $10,000 residual value guarantee, the leased asset is expected to have only a $1,000 salvage value on 12/31/05.

  6. The lessee's incremental borrowing rate is 10% (lessor's implicit rate is unknown).

  7. The present value of the lease obligation is as follows:

    PV of guaranteed residual value

    =

    $10,000 x 0.7513[a]

    =

    $ 7,513

    PV of annual payments

    =

    $50,000 x 2.4869[b]

    =

    124,345

    $131,858

    [a]The present value of an amount of $1 due in 3 periods at 10% is 0.7513.

    [b]The present value of an ordinary annuity of $1 for 3 periods at 10% is 2.4869.

The first step in dealing with any lease transaction is to classify the lease. In this case, the lease term is for 3 years, which is equal to 100% of the expected useful life of the asset. Notice that the test of fair value versus present value is also fulfilled, as the PV of the minimum lease payments ($131,858) could easily be considered as being equal to substantially all the FMV ($135,000), being equal to 97.7% of the FMV. Thus, this lease should be accounted for as a finance lease.

In assumption 7 above the present value of the lease obligation is computed. Note that the executory costs (insurance) are not included in the minimum lease payments and that the incremental borrowing rate of the lessee was used to determine the present value. This rate was used because the implicit rate was not determinable.

Note

To have used the implicit rate it would have to have been known to the lessee.

The entry necessary to record the lease on 1/1/03 is

Leased equipment

131,858

  • Lease obligation

131,858

Note that the lease is recorded at the present value of the minimum lease payments, which in this case is less than the FMV. If the present value of the minimum lease payments had exceeded the FMV, the lease would be recorded at FMV.

The next step is to determine the proper allocation between interest and a reduction in the lease obligation for each lease payment. This is done using the effective interest method as illustrated below.

Year

Cash payment

Interest expense

Reduction in lease obligation

Balance of lease obligation

Inception of lease

$131,858

1

$50,000

$13,186

$36,814

95,044

2

50,000

9,504

40,496

54,548

3

50,000

5,452

44,548

10,000

The interest is calculated at 10% (the incremental borrowing rate) of the balance of the lease obligation for each period, and the remainder of the $50,000 payment is allocated to a reduction in the lease obligation. The lessee is also required to pay $1,000 for insurance on an annual basis. The entries necessary to record all payments relative to the lease for each of the 3 years are shown below.

12/31/03

12/31/04

12/31/05

Insurance expense

1,000

1,000

1,000

Interest expense

13,186

9,504

5,452

Lease obligation

36,814

40,496

44,548

Cash

51,000

51,000

51,000

The leased equipment recorded as an asset must also be amortized (depreciated). The balance of this account is $131,858; however, as with any other asset, it cannot be depreciated below the estimated residual value of $1,000 (note that it is depreciated down to the actual estimated residual value, not the guaranteed residual value). In this case, the straight-line depreciation method is applied over a period of 3 years. This 3-year period represents the lease term, not the life of the asset, because the asset reverts back to the lessor at the end of the lease term. Therefore, the following entry will be made at the end of each year:

Depreciation expense

43,619

  • Accumulated depreciation

43,619 [($131,858 - $1,000) 3]

Finally, on 12/31/05 we must recognize the fact that ownership of the property has reverted back to the owner (lessor). The lessee made a guarantee that the residual value would be $10,000 on 12/31/05; as a result, the lessee must make up the difference between the guaranteed residual value and the actual residual value with a cash payment to the lessor. The following entry illustrates the removal of the leased asset and obligation from the books of the lessee:

Lease obligation

10,000

Accumulated depreciation

130,858

  • Cash

9,000

  • Leased equipment

131,858

end example

The foregoing example illustrated a situation where the asset was to be returned to the lessor. Another situation exists (under BPO or transfer of title) where the asset is expected to remain with the lessee. Remember that leased assets are amortized over their useful life when title transfers or a bargain purchase option exists. At the end of the lease, the balance of the lease obligation should equal the guaranteed residual value, the bargain purchase option price, or a termination penalty.

Example of accounting for a finance lease—Asset ownership transferred to lessee and fair market value of leased asset lower than present value of minimum lease payments

start example

Assume the following:

  1. A 3-year lease is initiated on 1/1/03 for equipment with an expected useful life of 5 years.

  2. Three annual lease payments of $52,000 are required beginning on 1/1/03 (note that the payment at the beginning of the year changes the PV computation). The lessor pays $2,000 per year for insurance on the equipment.

  3. The lessee can exercise a bargain purchase option on 12/31/05 for $10,000. The expected residual value at 12/31/06 is $1,000.

  4. The lessee's incremental borrowing rate is 10% (lessor's implicit rate is unknown).

  5. The fair market value of the property leased is $140,000.

Once again, the classification of the lease must take place prior to the accounting for it. This lease is classified as a finance lease because it contains a bargain purchase option (BPO). Note that in this case, the PV versus FMV test is also clearly fulfilled.

The PV of the lease obligation is computed as follows:

PV of bargain purchase option

=

$10,000

x 0.7513[a]

=

$ 7,513

PV of annual payments

=

($52,000 - $2,000)

x 2.7355[b]

=

136,755

$144,288

[a]The present value of an amount of $1 due in 3 periods at 10% is 0.7513.

[b]The present value of an annuity due of $1 for 3 periods at 10% is 2.7355.

Notice that in the example above, the present value of the lease obligation is greater than the FMV of the asset. Also notice that since the lessor pays $2,000 a year for insurance, this payment is treated as executory costs and hence excluded from calculation of the present value of annual payments. In conclusion, since the PV is greater than the FMV, the lease obligation (as well as the leased asset) must be recorded at the FMV of the asset leased (being the lower of the two). The entry on 1/1/03 is as follows:

Leased equipment

140,000

  • Obligation under finance lease

140,000

According to IAS 17, the apportionment between interest and principal is to be such that interest recognized reflects the use of a constant periodic rate of interest applied to the remaining balance of the obligation. As noted above, a special rule applies under US GAAP (which are illustrated here) when the present value of the minimum lease pay-ments exceeds the fair market value of the leased asset. When the PV exceeds the FMV of the leased asset, a new rate must be computed through a series of trial-and-error calculations. In this situation the interest rate was determined to be 13.265%. The amortization of the lease takes place as follows:

Year

Cash payment

Interest expense

Reduction in lease obligation

Balance of lease obligation

Inception of lease

$140,000

1/1/03

$50,000

$ --

$50,000

90,000

1/1/04

50.000

11,939

38,061

51,939

1/1/05

50,000

6,890

43,110

8,829

12/31/05

10,000

1,171

8,829

--

The following entries are required in years 2003 through 2005 to recognize the payment and depreciation (amortization).

2003

2004

2005

1/1

Operating expense

2,000

2,000

2,000

Obligation under finance lease

50,000

38,061

43,110

Accrued interest payable

11,939

6,890

  • Cash

52,000

52,000

52,000

12/31

Interest expense

11,939

6,890

1,171

  • Accrued interest payable

11,939

6,890

  • Obligation under finance lease

1,171

12/31

Depreciation expense

27,800

27,800

27,800

  • Accumulated depreciation ($139,000, five years)

27,800

27,800

27,800

12/31

Obligation under finance lease

10,000

  • Cash

10,000

end example

Impairment of leased asset.

The original IAS 17 did not address the issue of how impairments of leased assets are to be assessed or, if determined to have occurred, how they would need to be accounted for. The revised IAS 17 does note that the provisions of IAS 36 should be applied to leased assets in the same manner as they would be applied to owned assets. IAS 36 is discussed more fully in Chapter 8.

Accounting for Leases—Lessor

As illustrated above, there are four classifications of leases with which a lessor must be concerned.

  1. Operating

  2. Sales-type

  3. Direct financing

  4. Leveraged

Operating leases.

As in the case of the lessee, the operating lease requires a less complex accounting treatment than does a finance lease. The payments received by the lessor are to be recorded as rent income in the period in which the payment is received or becomes receivable. As with the lessee, if either the rentals vary from a straight-line basis or the lease agreement contains a scheduled rent increase over the lease term, the revenue is to be recorded on a straight-line basis unless an alternative basis of systematic and rational allocation is more representative of the time pattern of earning process contained in the lease. Additionally, if the lease agreement provides for a scheduled increase(s) in contemplation of the lessee's increased physical use of the leased property, the total amount of rental payments, including the scheduled increase(s), is allocated to revenue over the lease term on a straight-line basis. However, if the scheduled increase(s) is due to additional leased property, recognition should be proportional to the leased property, with the increased rents recognized over the years that the lessee has control over use of the additional leased property.

The lessor must show the leased property on the balance sheet under the caption "Investment in leased property." This account should be shown with or near the property, plant, and equipment owned by the lessor, and depreciation should be determined in the same manner as for the rest of the lessor's owned property, plant, and equipment. IAS 17 stipulates that "when a significant portion of the lessor's business comprises operating leases, the lessor should disclose the amount of assets by each major class of asset together with the related accumulated depreciation at each balance sheet date." Further, "assets held for operating are usually included as property, plant, and equipment in the balance sheet."

In the case of operating leases, any initial direct (leasing) costs incurred by a lessor are either to be amortized over the lease term as the revenue is recognized (i.e., on a straight-line basis unless another method is more representative) or, alternatively, charged to expense as they are incurred.

Although there is no guidance on this matter under the international accounting standards, logically any incentives made by the lessor to the lessee are to be treated as reductions of rent and recognized on a straight-line basis over the term of the lease. This is also the position taken under US GAAP.

Depreciation of leased assets should be on a basis consistent with the lessor's normal depreciation policy for similar assets, and the depreciation expense should be computed on the basis set out in IAS 16.

Sales-type leases.

In the accounting for a sales-type lease, it is necessary for the lessor to determine the following amounts:

  1. Gross investment

  2. Fair value of the leased asset

  3. Cost

From these amounts, the remainder of the computations necessary to record and account for the lease transaction can be made. The first objective is to determine the numbers necessary to complete the following entry:

Lease receivable

XX

Cost of goods sold

XX

  • Sales

XX

  • Inventory

XX

  • Unearned finance income

XX

The gross investment (lease receivable) of the lessor is equal to the sum of the minimum lease payments (excluding contingent rent and executory costs) from the standpoint of the lessor, plus the nonguaranteed residual value accruing to the lessor. The difference between the gross investment and the present value of the two components of gross investment (i.e., minimum lease payments and nonguaranteed residual value) is recorded as "unearned finance income" (also referred to as "unearned interest revenue"). The present value is to be computed using the lease term and implicit interest rate (both of which were discussed earlier).

IAS 17 stipulates that the resulting unearned finance income is to be amortized and recognized into income using the effective interest method, which will result in a constant periodic rate of return on the "lessor's net investment" (which is the "lessor's gross investment" less the "unearned finance income"). The requirement that only a single computational approach be employed is the key change from the original IAS 17, which had permitted a free choice of method in allocation of finance income by the lessor using the effective interest method based on either

  1. The lessor's net investment outstanding in respect of the finance lease; or

  2. The lessor's net cash investment outstanding in respect of the finance lease.

Because this choice of computational methods permitted significantly different results to be reported by entities engaged in substantially identical transactions, it was eliminated by IAS 17.

Consideration of "prudence" is called for by IAS 17 in recognizing finance income, which is in any event a qualitative characteristic or attribute of financial statements prepared under the IAS. The IASC's Framework for Preparation and Presentation of Financial Statements makes it incumbent on financial statement preparers to exercise prudence; in other words, it requires caution in the exercise of judgment. IAS 17 clarifies this in the context of spreading income on a systematic basis, by giving the example of recognition of uncertainties relative to collectibility of lease rentals or to fluctuation of interest rates in the future. For instance, the uncertainties surrounding collectibility of lease rentals usually increase with the lease term (i.e., the longer the lease term, the greater are the risks involved), and thus in keeping with the principle of prudence, modification of the pattern of income recognition may be required to compensate.

For example, a lessor may decide to delay the recognition of finance income into the later years in the case of leases with terms spread over twenty years and above, as opposed to short-term leases with terms of three to five years, since predicting with certainty long-term collectibility, which depends on a number of factors such as the future financial position of the lessee, is a very difficult task. Effectively, more of the earlier collections might be seen as returns on investment, rather than income, until longer-term viability has been demonstrated.

Recall that the fair market value (FMV) of the leased property is by definition equal to the normal selling price of the asset adjusted by any residual amount retained (this amount retained can be exemplified by an unguaranteed residual value, investment credit, etc.). According to IAS 17, the selling price to be used for a sales-type lease is equal to the fair value of the leased asset, or if lower, the sum of the present values of the MLP and the estimated unguaranteed residual value accruing to the lessor, discounted at a commercial rate of interest. In other words, the normal selling price less the present value of the unguaranteed residual value is equal to the present value of the MLP. (Note that this relationship is sometimes used while computing the MLP when the normal selling price and the residual value are known; this is illustrated in a case study that follows.)

The cost of goods sold to be charged against income in the period of the sale is computed as the historical cost or carrying value of the asset (most likely inventory) plus any initial direct costs. Initial direct costs should be recognized as an expense at the inception of the lease, since these costs are related to earning the manufacturer's or dealer's profit.

The estimated unguaranteed residual values used in computing the lessor's gross investment in a lease should be reviewed regularly. In case of a permanent reduction (impairment) in the estimated unguaranteed residual value, the income allocation over the lease term is revised and any reduction with respect to amounts already accrued is recognized immediately.

To attract customers, manufacturer or dealer lessors sometimes quote artificially low rates of interest. This has a direct impact on the recognition of built-in profit, which is an integral part of the deal and is inversely proportional to the finance income generated from the deal. Thus, if finance income is artificially low, this results in recognition of excessive profit from the transaction at the time of the sale. Under such circumstances, the standard requires that selling profit be restricted to that which would have resulted had a commercial rate of interest been used in the deal. Thus, the substance of the transaction should be reflected in the financial statements.

The difference between the selling price and the amount computed as the cost of goods sold is the gross profit recognized by the lessor on the inception of the lease (sale). Manufacturer or dealer lessors often give an option to their customers of either leasing the asset (with financing provided by them) or buying the asset outright. Thus, a finance lease by a manufacturer or dealer lessor, also referred to as a sales-type lease, generates two types of revenue for the lessor.

  1. The gross profit (or loss) on the sale, which is the equivalent to the profit (or loss) that would have resulted from an outright sale at normal selling prices.

  2. The finance income or interest earned on the lease receivable to be spread over the lease term based on a pattern reflecting a constant periodic rate of return on either the lessor's net investment outstanding or the net cash investment outstanding in respect of the finance lease.

The application of these points is illustrated in the example below.

Example of accounting for a sales-type lease

start example

XYZ Inc. is a manufacturer of specialized equipment. Many of its customers do not have the necessary funds or financing available for outright purchase. Because of this, XYZ offers a leasing alternative. The data relative to a typical lease are as follows:

  1. The noncancelable fixed portion of the lease term is 5 years. The lessor has the option to renew the lease for an additional 3 years at the same rental. The estimated useful life of the asset is 10 years. Lessee guarantees a residual value of $40,000 at the end of 5 years, but the guarantee lapses if the full 3 renewal periods are exercised.

  2. The lessor is to receive equal annual payments over the term of the lease. The leased property reverts back to the lessor on termination of the lease.

  3. The lease is initiated on 1/1/03. Payments are due on 12/31 for the duration of the lease term.

  4. The cost of the equipment to XYZ Inc. is $100,000. The lessor incurs cost associated with the inception of the lease in the amount of $2,500.

  5. The selling price of the equipment for an outright purchase is $150,000.

  6. The equipment is expected to have a residual value of $15,000 at the end of 5 years and $10,000 at the end of 8 years.

  7. The lessor desires a return of 12% (the implicit rate).

The first step is to calculate the annual payment due to the lessor. Recall that the present value (PV) of the minimum lease payments is equal to the selling price adjusted for the present value of the residual amount. The present value is to be computed using the implicit interest rate and the lease term. In this case, the implicit rate is given as 12% and the lease term is 8 years (the fixed noncancelable portion plus the renewal period, since the lessee guarantee terms make renewal virtually inevitable). Thus, the structure of the computation would be as follows:

Normal selling price - PV of residual value = PV of minimum lease payment

Or, in this case,

$150,000

-

(0.40388 [a] x $10,000)

=

4.96764[b] x Minimum lease payment

$145,961.20

4.96764

=

Minimum lease payment

$29,382.40

=

Minimum lease payment

[a]0.40388 is the present value of an amount of $1 due in 8 periods at a 12% interest rate.

[b]4.96764 is the present value of an annuity of $1 for 8 periods at a 12% interest rate.

Prior to examining the accounting implications of a lease, we must determine the lease classification. In this example, the lease term is 8 years (discussed above) while the estimated useful life of the asset is 10 years; thus this lease qualifies as something other than an operating lease. (Note that it also meets the FMV versus PV criterion because the PV of the minimum lease payments of $145,961.20, which is 97% of the FMV [$150,000], could be considered to be equal to substantially all of the fair value of the leased asset.) Now it must be determined if this is a sales-type, direct financing, or leveraged lease. To do this, examine the FMV or selling price of the asset and compare it to the cost. Because the two are not equal, we can determine this to be a sales-type lease.

Next, obtain the figures necessary to record the entry on the books of the lessor. The gross investment is the total minimum lease payments plus the unguaranteed residual value, or

($29,382.40 x 8) + $10,000 = $245,059.20

The cost of goods sold is the historical cost of the inventory ($100,000) plus any initial direct costs ($2,500) less the PV of the unguaranteed residual value ($10,000 x 0.40388). Thus, the cost of goods sold amount is $98,461.20 ($100,000 + $2,500 - $4,038.80). Note that the initial direct costs will require a credit entry to some account, usually accounts payable or cash. The inventory account is credited for the carrying value of the asset, in this case $100,000.

The adjusted selling price is equal to the PV of the minimum payments, or $145,961.20. Finally, the unearned finance income is equal to the gross investment (i.e., lease receivable) less the present value of the components making up the gross investment (the minimum lease payment of $29,382.40 and the unguaranteed residual of $10,000). The present value of these items is $150,000 [($29,382.40 x 4.96764) + ($10,000 x 0.40388)]. Therefore, the entry necessary to record the lease is

Lease receivable

245,059.20

Cost of goods sold

98,461.20

  • Inventory

100,000.00

  • Sales

145,961.20

  • Unearned finance income

95,059.20

  • Accounts payable (initial direct costs)

2,500.00

The next step in accounting for a sales-type lease is to determine proper handling of the payment. Both principal and interest are included in each payment. According to IAS 17, interest is recognized on a basis such that a constant periodic rate of return is earned over the term of the lease. This will require setting up an amortization schedule as illustrated below.

Year

Cash payment

Interest

Reduction in principal

Balance of net investment

Inception of lease

$150,000.00

1

$ 29,382.40

$18,000.00

$ 11,382.40

138,617.00

2

29,382.40

16,634.11

12,748.29

125,869.31

3

29,382.40

15,104.32

14,278.08

111,591.23

4

29,382.40

13,390.95

15,991.45

95,599.78

5

29,382.40

11,471.97

17,910.43

77,689.35

6

29,382.40

9,322.72

20,059.68

57,629.67

7

29,382.40

6,915.56

22,466.84

35,162.83

8

29,382.40

4,219.57

25,162.83

10,000.00

$235,459,24

$95,059.20

$140,000.00

A few of the columns need to be elaborated on. First, the net investment is the gross investment (lease receivable) less the unearned finance income. Notice that at the end of the lease term, the net investment is equal to the estimated residual value. Also note that the total interest earned over the lease term is equal to the unearned interest (unearned finance income) at the beginning of the lease term.

The entries below illustrate the proper treatment to record the receipt of the lease payment and the amortization of the unearned finance income in the first year.

Cash

29,382.40

  • Lease receivable

29,382.40

Unearned finance income

18,000.00

  • Interest revenue

18,000.00

Notice that there is no explicit entry to recognize the principal reduction. This is done automatically when the net investment is reduced by decreasing the lease receivable (gross investment) by $29,382.40 and the unearned finance income account by only $18,000. The $18,000 is 12% (implicit rate) of the net investment. These entries are to be made over the life of the lease.

At the end of the lease term the asset is returned to the lessor and the following entry is required:

Asset

10,000

  • Leased receivable

10,000

If the estimated residual value has changed during the lease term, the accounting computations would have also changed to reflect this.

end example

Direct financing leases.

The accounting for a direct financing lease holds many similarities to that for a sales-type lease. Of particular importance is that the terminology used is much the same; however, the treatment accorded these items varies greatly. Again, it is best to preface our discussion by determining our objectives in the accounting for a direct financing lease. Once the lease has been classified, it must be recorded. To do this, the following amounts must be determined:

  1. Gross investment

  2. Cost

  3. Residual value

As noted, a direct financing lease generally involves a leasing company or other financial institution and results in only interest revenue being earned by the lessor. This is because the FMV (selling price) and the cost are equal, and therefore no dealer profit is recognized on the actual lease transaction. Note how this is different from a sales-type lease, which involves both a profit on the transaction and interest revenue over the lease term. The reason for this difference is derived from the conceptual nature underlying the purpose of the lease transaction. In a sales-type lease, the manufacturer (distributor, dealer, etc.) is seeking an alternative means to finance the sale of his product, whereas a direct financing lease is a result of the consumer's need to finance an equipment purchase. Because the consumer is unable to obtain conventional financing, he or she turns to a leasing company that will purchase the desired asset and then lease it to the consumer. Here the profit on the transaction remains with the manufacturer while the interest revenue is earned by the leasing company.

Like a sales-type lease, the first objective is to determine the amounts necessary to complete the following entry:

Lease receivable

xxx

  • Asset

xxx

  • Unearned finance income

xx

The gross investment is still defined as the minimum amount of lease payments (from the standpoint of a lessor) exclusive of any executory costs plus the unguaranteed residual value. The difference between the gross investment as determined above and the cost (carrying value) of the asset is to be recorded as the unearned finance income because there is no manufacturer's/dealer's profit earned on the transaction. The following entry would be made to record initial direct costs:

Initial direct costs

xx

  • Cash

xx

Net investment in the lease is defined as the gross investment less the unearned income plus the unamortized initial direct costs related to the lease. Initial direct costs are defined in the same way that they were for purposes of the sales-type lease; however, the accounting treatment is different. Unlike under the sales-type lease, where these costs are required to be charged to expense immediately, under the direct finance lease there is an option available either

  1. To amortize initial direct costs over the lease term, or

  2. To charge them to expense immediately.

Thus, for a direct financing lease, when the first option is chosen, the unearned lease (i.e., interest) income and the initial direct costs will be amortized to income over the lease term so that a constant periodic rate is earned either on the lessor's net investment outstanding or on the net cash investment outstanding in the finance lease (i.e., the balance of the cash outflows and inflows in respect of the lease excluding executory costs chargeable to the lessee). Thus, the effect of the initial direct costs, in case the option to amortize is chosen, is to reduce the implicit interest rate, or yield, to the lessor over the life of the lease.

An example follows that illustrates the preceding principles.

Example of accounting for a direct financing lease

start example

Emirates Refining needs new equipment to expand its manufacturing operation; however, it does not have sufficient capital to purchase the asset at this time. Because of this, Emirates Refining has employed Consolidated Leasing to purchase the asset. In turn, Emirates will lease the asset from Consolidated. The following information applies to the terms of the lease:

  1. A 3-year lease is initiated on 1/1/03 for equipment costing $131,858, with an expected useful life of 5 years. FMV at 1/1/03 of equipment is $131,858.

  2. Three annual payments are due to the lessor beginning 12/31/03. The property reverts back to the lessor on termination of the lease.

  3. The unguaranteed residual value at the end of year 3 is estimated to be $10,000.

  4. The annual payments are calculated to give the lessor a 10% return (the implicit rate).

  5. The lease payments and unguaranteed residual value have a PV equal to $131,858 (FMV of asset) at the stipulated discount rate.

  6. The annual payment to the lessor is computed as follows:

    PV of residual value

    =

    $10,000 x .7513[a] = $7,513

    PV of lease payments

    =

    Selling price - PV of residual value

    =

    $131,858-$7,513 = $124,345

    Annual payment

    =

    $124,345 + 2.4869[b] = $50,000

    [a].7513 is the PV of an amount due in 3 periods at 10%.

    [b]2.4869 is the PV of an ordinary annuity of $1 per period for 3 periods, at 10% interest.

  7. Initial direct costs of $7,500 are incurred by ABC in the lease transaction.

As with any lease transaction, the first step must be to classify the lease appropriately. In this case, the PV of the lease payments ($124,345) is equal to 94% of the FMV ($131,858), thus could be considered as equal to substantially all of the FMV of the leased asset. Next, determine the unearned interest and the net investment in lease.

Gross investment in lease [(3 x $50,000) + $10,000]

$160,000

Cost of leased property

131,858

Unearned finance income

$ 28,142

The unamortized initial direct costs are to be added to the gross investment in the lease, and the unearned finance income is to be deducted to arrive at the net investment in the lease. The net investment in the lease for this example is determined as follows:

Gross investment in lease

$160,000

Add:

  • Unamortized initial direct costs

7,500

Less:

  • Unearned finance income

28,142

Net investment in lease

$139,358

The net investment in the lease (Gross investment - Unearned finance income) has been increased by the amount of initial direct costs. Therefore, the implicit rate is no longer 10%. We must recompute the implicit rate, which is really the result of an internal rate of return calculation. We know that the lease payments are to be $50,000 per annum and that a residual value of $10,000 is available at the end of the lease term. In return for these payments (inflows) we are giving up equipment (outflow) and incurring initial direct costs (outflows), with a net investment of $139,358 ($131,858 + $7,500). The only way to obtain the new implicit rate is through a trial-and-error calculation as set up below.

Where: i = implicit rate of interest

In this case, the implicit rate is equal to 7.008%. Thus, the amortization table would be set up as follows:

(a)

(b)

(c)

(d)

(e)

(f)

Lease payments

Reduction in unearned Interest

PV x Implicit rate (7.008%)

Reduction in initial direct costs (b-c)

Reduction in PVI net investment (a-b + d)

PVI net investment in lease (f)(n + 1) = (f)n - (e)

At inception

$139,358

2003

$ 50,000

$13,186 (1)

$ 9,766

$3,420

$ 40,234

99,124

2004

50,000

9,504 (2)

6,947

2,557

43,053

56,071

2005

50,000

5,455 (3)

3,929

1,526

46,071

10,000

$150,000

$28,145[a]

$20,642

$7.503

$129,358

[a]Rounded

(b.1) $131.858 x 10% = $13,186

(b.2) [$131,858 - ($50,000 - 13,186)] x 10% = $9,504

(b.3) [$95,044 - ($50.000 - 9,504)1 x 10% = $5,455

Here the interest is computed as 7,008% of the net investment. Note again that the net investment at the end of the lease term is equal to the estimated residual value.

The entry made initially to record the lease is as follows:

Lease receivable** [($50,000 x 3) + $10,000]

160,000

  • Asset acquired for leasing

131,858

  • Unearned lease revenue

28,142

When the payment (or obligation to pay) of the initial direct costs occurs, the following entry must be made:

Initial direct costs

7,500

  • Cash

7,500

Using the schedule above, the following entries would be made during each of the indicated years:

2003

2004

2005

Cash

50,000

50,000

50,000

  • Lease receivable**

50,000

50,000

50,000

Unearned finance income

13,186

9,504

5,455

  • Initial direct costs

3,420

2,557

1,526

  • Interest income

9,766

6,947

3,929

Finally, when the asset is returned to the lessor at the end of the lease term, it must be recorded on the books. The necessary entry is as follows:

Used asset

10,000

  • Lease receivable[a]

10,000

[a]Also commonly referred to as the "gross investment in lease."

end example

Leveraged leases.

Leveraged leases are discussed in detail in Appendix B of this chapter because of the complexity involved in the accounting treatment based on guidance available under US GAAP, where this topic has been given extensive coverage. Under International Accounting Standards, this concept has been defined, but with only a very brief outline of the treatment to be accorded to this kind of lease. A leveraged lease is defined in IAS 17 as a finance lease which is structured such that there are at least three parties involved: the lessee, the lessor, and one or more long-term creditors who provide part of the acquisition finance for the leased asset, usually without any general recourse to the lessor. Succinctly, this type of a lease is given the following unique accounting treatment:

  1. The lessor records his or her investment in the lease net of the nonrecourse debt and the related finance costs to the third-party creditor(s).

  2. The recognition of the finance income is based on the lessor's net cash investment outstanding in respect of the lease.

Sale-Leaseback Transactions

Sale-leaseback describes a transaction where the owner of property (seller-lessee) sells the property and then immediately leases all or part of it back from the new owner (buyer-lessor). These transactions may occur when the seller-lessee is experiencing cash flow or financing problems or because there are tax advantages in such an arrangement in the lessee's tax jurisdiction. The important consideration in this type of transaction is recognition of two separate and distinct economic transactions. However, it is important to note that there is not a physical transfer of property. First, there is a sale of property, and second, there is a lease agreement for the same property in which the original seller is the lessee and the original buyer is the lessor. This is illustrated as follows:

click to expand

A sale-leaseback transaction is usually structured such that the sales price of the asset is greater than or equal to the current market value. The result of this higher sales price is a higher periodic rental payment over the lease term. The transaction is usually attractive because of the tax benefits associated with it, and because it provides financing to the lessee. The seller-lessee benefits from the higher price because of the increased gain on the sale of the property and the deductibility of the lease payments, which are usually larger than the depreciation that was previously being taken. The buyer-lessor benefits from both the higher rental payments and the larger depreciable basis.

Under IAS 17, the accounting treatment depends on whether the sale and leaseback results in a finance lease or an operating lease. If it results in a finance lease, any excess of sale proceeds need not immediately be recognized as income in the financial statements of the seller-lessee. If such an excess is recognized, it should be deferred and amortized over the lease term.

If a sale and leaseback transaction results in an operating lease

  1. If it is evident that the transaction is established at fair value, any profit or loss should be recognized immediately.

  2. If sale price is not established at fair value

    1. If sale price is below fair value, any profit or loss should be recognized immediately, except that when a loss is to be compensated by below fair market future rentals, the loss should be deferred and amortized in proportion to the rental payments over the period the asset is expected to be used.

    2. If the sale price is above fair value, the excess over fair value should be deferred and amortized over the period for which the asset is expected to be used.

IAS 17 stipulates that in case of operating leases, if at the time of the sale and leaseback transaction the fair value is less than the carrying amount of the leased asset, the difference between the fair value and the carrying amount should immediately be recognized.

However, in case the sale and leaseback result in a finance lease, no such adjustment is considered necessary unless there has been an impairment in value, in which case the carrying value should be reduced to the recoverable amount in accordance with the provisions of IAS 16.

Other leasing guidance and expected changes to lease accounting.

SIC 27, issued and effective in 2001, addresses arrangements between an enterprise and an investor that involve the legal form of a lease. SIC 27 establishes that the accounting for such arrangements is in all instances to reflect the substance of the relationship. All aspects of the arrangement are to be evaluated to determine its substance, with particular emphasis on those that have an economic effect. To assist in doing this, SIC 27 identifies certain indicators that may demonstrate that an arrangement might not involve a lease under IAS 17. For example, a series of linked transactions that in substance do not transfer control over the asset, and which keep the right to receive the benefits of ownership with the transferor, would not be a lease. Also, transactions arranged for specific objectives, such as the transfer of tax attributes, would generally not be accounted for as leases.

SIC 27 deals most specifically with those arrangements that have characteristics of leases coupled with corollary subleases, whereby the lessor is the sublessee and the lessee is the sublessor, which may also involve a purchase option. The financing party (the lessee-sublessor) is often guaranteed a certain economic return on such transactions, further revealing that the substance might in fact be that of a secured borrowing rather than a series of lease arrangements. Since nominal lease and sublease payments will net to zero, the exchange of funds is often limited to the fee given by the property owner to the party providing financing; tax advantages are often the principal objective of these transactions. Accounting questions arising from the transactions include recognition of fees received by the financing party; the presentation of separate investment and sublease payment obligation accounts as an asset and a liability, respectively; and the accounting for resulting obligations.

SIC 27 imposes a substance over form solution to this problem. Accordingly, when an arrangement is found to not meet the definition of a lease, a separate investment account and a lease payment obligation would not meet the definitions of an asset and a liability, and should not be recognized by the entity. It presents certain indicators which imply that a given arrangement is not a lease (e.g., when the right to use the property for a given term is not in fact transferred to the nominal lessee) and that lease accounting cannot be applied.

The interpretation provides that the fee paid to the financing provider should be recognized in accordance with IAS 18. Fees received in advance would generally be deferred and recognized over the lease term when future performance is required in order to retain the fee, when limitations are placed on the use of the underlying asset, or when the nonremote likelihood of early termination would necessitate some fee repayment.

The interpretation also identifies certain factors that would suggest that other obligations of an arrangement, including any guarantees provided and obligations incurred upon early termination, should be accounted for under either IAS 37 (contingent liabilities) or IAS 39 (financial obligations), depending on the terms.

The IASB has recently proposed as part of its Improvements Project several changes to IAS 17. Pending the Board's more far-reaching reexamination of lease accounting, these changes would clarify that when a lease of both land and buildings is classified, the lease is to be split into two elements (i.e., the lease of land and the lease of buildings) with the former generally classified as an operating lease, and the latter classified as an operating or finance lease by applying the conditions in IAS 17. The amendment would also eliminate the choice of how a lessor accounts for initial direct costs incurred in negotiating a lease by requiring that such costs that are incremental and directly attributable to the lease are to be capitalized and allocated over the lease term.

Additional guidance.

Sale-leaseback transactions can be rather complex, and the guidance offered by IAS 17 is limited. Therefore, to provide further insight into this common type of financing arrangement, additional commentary is offered, based on the rules and interpretations under US GAAP, which do not constitute authoritative guidance but which may offer certain insights in developing accounting responses to such circumstances. See Appendix A.




Wiley Ias 2003(c) Interpretation and Application of International Accounting Standards
WILEY IAS 2003: Interpretation and Application of International Accounting Standards
ISBN: 0471227366
EAN: 2147483647
Year: 2005
Pages: 147

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