9th February 2015
Contents of lecture
• IAS 17 Leases
• Assignment briefing
• Elliott & Elliott: Chapter 9 “Financial reporting – evolution of global standards”
• Melville: Chapter 9 “Leases”
IAS 17 Leases
Account for operating and finance leases entered into by a lessee in accordance with the requirements of International Accounting
Acquisition of non-current assets
Non-current assets can be acquired by:
• Purchase by cash or on standard credit terms;
• Purchase for non-cash consideration;
• Purchase, borrowing to finance;
• Extended credit – instalment payments, hire purchase;
• Lease – in legal terms, a hire of the asset from the owner.
Leases – possible accounting methods
• Account for all payments as an expense – the payments made under the terms of the lease to acquire rights over the asset
• Acknowledge the existence of the liability to pay future rentals and create an asset for the rights acquired
• Acknowledge that leases differ in nature and treat some as an expense and some as assets
The Accounting Problem
• Assets hired under certain types of lease bare all the characteristics of a non-current asset but in strict legal form are a rental payment.
• If treated in accordance with legal form they would not appear on the balance sheet as a liability or asset.
• Users of financial statements would not be aware of the liability or of the existence of the non-current assets.
• This would distort performance measures.
IAS 17 – Leases
• IAS 17 requires that the concept of substance over form should be applied to ensure that:
1. liabilities under a lease are recognised appropriately;
2. a non-current asset is recognised where the item leased has the characteristics of a non-current asset.
IAS 17: Definitions - Lease
An arrangement whereby a lessor conveys to the lessee in return for a series of payments the right to use an asset for an agreed period of time.
Ownership still with Types of lease
IAS 17 distinguishes two types of lease:
1. Finance lease – a lease which transfers substantially all the risks and rewards incidental to ownership.
2. Operating lease – a lease other than a finance lease.
Indications that a lease is a finance lease
• Present value of lease payments is substantially equal to the asset’s fair value
• Ownership is transferred at the end of the primary lease period
• Lessee has the option to purchase the asset at a price expected to be sufficiently lower than the asset’s fair value on the date that the option is exercised, so as to make it reasonably certain as from the inception of the lease (i.e., the start of the lease) that this option will be exercised
• Lease period is for the major part of the economic life of the asset • Assets are so specialised that only the lessee can use them
Accounting treatment: operating leases
• Lease payments under an operating lease shall be recognised as an expense on a straight-line basis over the lease term unless • another systematic basis is more representative of the time pattern of the user’s benefit.
Operating leases - Example
• A Plc enters into a 5 year operating lease on 1st April 2014 to occupy a factory.
• Under the terms of the lease, £120,000 is payable on the commencement of the lease on 1st April 2014.
• £120,000 is then payable each year for 4 years commencing
1st April 2015.
• Show the ledger account for rental payments and Income
Statement & Balance Sheet extracts for the years ended 31st
December 2014 and 2015
Operating leases - ledger account
Operating leases solution: financial statement extracts
• Finance leases are initially recognised as assets & liabilities at the fair value of leased asset (or, if lower, the present value of the minimum lease payments)