Financial Accounting- Leases

                      LEASES (IAS 17)
Learning Outcomes:
        Distinguish between the different types of leases
        Account for an operating lease
        Account for a finance lease
        Explain the advantages of capitalising leased assets
-          Identify the accounting issues involved in leasing assets
Basic Definitions:
         A lease is a contract between two parties: a lessor and a lessee.
         The lessor is the legal owner of the asset
         The lessee rents the asset from the lessor
IAS17 defines a lease as:
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”
IAS17 defines a finance lease as:
A lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred”.
         In a finance lease, the lessee has acquired the risks and rewards of ownership
         Risks of ownership
        Asset breakdown
         Rewards of ownership are those benefits derived from the use of the asset
The following would normally suggest that a lease be classified as a finance lease;
        Present Value of minimum lease payments amounts to substantially all (>90%) of assets fair value
        Lease term is a major part of economic life of asset
        Full ownership of asset transferred to the lessee by end of lease
        Bargain purchase option at end of lease
        Leased asset is of a specialised nature (specific to lessee)

IAS17 defines an operating lease as:
“A lease other than a finance lease”
Accounting Treatment
Operating leases - in the Income statement- recognise as an expense
-          In the statement of financial position- No effect
Finance leases- In the income statement- Recognise leases payments as expenses
-          In the statement of financial position- Recognise finance leased item as an asset and finance lease obligation as a liability.
Effect of capitalisation
Prior to IAS17
         A company could have use of – and generate income from – and asset without disclosing either the asset of lease obligations in the statement of financial position
IAS 17 requires the capitalisation of finance
         This has an impact on key accounting ratios such as gearing, return on assets and ROI.

Advantages of leasing
         It permits flexibility
         It avoids obsolescence
         It gives tax advantages
         It improves cash flow
Disadvantages of leasing
         Capitalising leases can be misleading to the unsophisticated
         The presentation of the legal form of the transaction is sacrificed in favour of the economic substance

No comments: