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					   Leases


      IAS 17
     IFRIC 4

IFRS Innsikt 2012
      September 2012
What will you learn?
By completing this module,
you will be able to:         1)   Explain the definition of a lease
                             2)   Describe the criteria for classifying
                                  leases as operating or finance
                             3)   Explain the accounting treatment
                                  for operating leases and finance
                                  leases
                             4)   Describe the accounting for a sale
                                  and leaseback transaction
                             5)   Evaluate the quality of disclosures



                                                        IFRS Baseline 2012 – Leases 2
Agenda



The basic framework
Arrangements containing a lease
Real estate leases
Accounting for operating leases
Accounting for finance leases
Sale and leaseback
The closing




                                  IFRS Baseline 2012 – Leases 3
IAS 17/IFRIC 4, 12/SIC 15, 27, 29                          RL § 5-11/NRS 14
 • More agreements covered                        • Fewer agreements covered
     •   IFRIC 4 Agreements that do not not            •   IFRIC 4 – it is accepted in use→
         take the legal form of a lease                    practice?…

 • Classification                                 • Classification
     •   ”Stricter” practice?                          •   Not as ”strict” practice?

 • Present value calculation– implicit            • Present value calculation – free choice
   interest rate (preferred)                        between the “implicit interest rate” and
                                                    the “incremental borrowing rate”.

 • Acquisition cost - fair value or, if lower,    • Acquisition cost - the PV of the
   the PV of the minimum lease payments             minimum lease payments

 • Operating leases that include                  • Does not address the issue– Treated
   investment property may be treated as            as operating lease
   financial with subsequent
   measurement at fair value
 • Land and building – classification of          • NRS 14 – No such requirement?
   each element separately
                                             Classification
                                          Sale and leaseback
                                                                             IFRS Baseline 2012 – Leases 4
Scope

This Standard shall be applied in accounting for all leases
other than:
a) leases to explore for or use minerals, oil, natural gas and
    similar non-regenerative resources; and
b) licensing agreements for such items as motion picture
    films, video recordings, plays, manuscripts, patents and
    copyrights.

However, this Standard shall not be applied as the basis of
measurement for:
a) property held by lessees that is accounted for as
   investment property (see IAS 40 Investment Property);
b) investment property provided by lessors under operating
   leases (see IAS 40);
c) biological assets held by lessees under finance leases
   (see IAS 41 Agriculture); or
d) biological assets provided by lessors under operating
   leases (see IAS 41).
                                                                 IFRS Baseline 2012 – Leases 5
Definition of a lease




                                         L$
  Transfers right to
    use an asset




                               Payment
   Agreement that transfers
   right to use an asset for   In return for payment
    agreed amount of time




                                          IFRS Baseline 2012 – Leases 6
Classification (IAS 17, 7 – 19)


       The overriding principle                Substance over form
                                                    (IAS 17, 10)


                                          Have substantially all risks
                                         and rewards of ownership of
            The key question            leased asset been transferred
                                                 to the lessee?
                                              (IAS 17, 10 and 11)

                                          no                           yes

                                    Operating Lease         Finance Lease


         Timing of classification               Inception of lease
                                                    (IAS 17, 13)



                                                                   IFRS Baseline 2012 – Leases 7
Indicators of a finance lease (IAS 17, 10)

               Ownership transfers at end of lease?                 yes

                                no

                     Bargain purchase option?                       yes




                                                                            Finance lease
                                no

                Lease for majority of economic life?                yes

                                no
      Present value of minimum lease payments equals at least
                                                                    yes
            substantially all of fair value of leased asset?
                                no

                    Lease assets specialised?                       yes

                                no

                 Additional indicators (continues…)
                                                                IFRS Baseline 2012 – Leases 8
More indicators of a finance lease (IAS 17, 11)

                               no
              Cancellation losses borne by lessee?               yes




                                                                         Finance lease
                               no
        Changes in fair value of residual borne by lessee?       yes

                               no
                 Bargain lease renewal option?                   yes

                               no
                        Operating lease




                                                             IFRS Baseline 2012 – Leases 9
Assessment and reassessment (IAS 17, 13)

     Assessment                  Reassessment




     When entering
   into arrangement       Change in contractual terms
                        (unless only extension / renewal)


                           or                        or
                                               Change in
                       Substantial              whether
                       change made     or      fulfilment
                         to asset             depends on
                                             specified asset



                                                 IFRS Baseline 2012 – Leases 10
Minimum lease payments and other definitions
(IAS 17, 4 (definitions))

    Include
    Non-cancellable lease payments
    Guaranteed residual value
    Purchase option if reasonably
    certain of exercise
    Lease payments under bargain
    renewal option

    Exclude
    Contingent rent
    Cost for services
    Taxes if paid by and reimbursed to
    the lessor


                                         IFRS Baseline 2012 – Leases 11
Agenda



The basic framework
Arrangements containing a lease
Real estate leases
Accounting for operating leases
Accounting for finance leases
Sale and leaseback
The closing




                                  IFRS Baseline 2012 – Leases 12
Arrangements containing a lease (IFRIC 4 - factors (1))

          Use of a specific          Specification may be
          asset or assets          embedded in arrangement
                  &
                                      Explicit or implicit




      Conveys a right to use the
         asset (next slide)




                                                     IFRS Baseline 2012 – Leases 13
Arrangements containing a lease (IFRS 4 - factors (2))

      Use of a specific asset or
       assets (previous slide)
                  &
                                    Ability / right to operate / direct
                                       another to operate while
                                       obtaining > insignificant
                                            amount of output

                                   Ability / right to control physical
      Conveys a right to use the
                                       access while obtaining >
               asset
                                    insignificant amount of output

                                   Remote that one or more parties
                                    will take > insignificant amount
                                    of the output and output is not
                                     contractually fixed per unit or
                                     equal to current market price

                                                           IFRS Baseline 2012 – Leases 14
Agenda



The basic framework
Arrangements containing a lease
Real estate leases
Accounting for operating leases
Accounting for finance leases
Sale and leaseback
The closing




                                  IFRS Baseline 2012 – Leases 15
Classification of real estate leases

 Lease of both land and building:   Land lease may be classified as a
 requires classification of each      finance lease if substantially all
 element                             risks and rewards transferred to
                                                                lessee




 Minimum lease payments                       If reliable allocation not
 allocated to land and buildings       possible, treat both as finance
 based on relative fair values of         lease unless clear that both
 leasehold interests                   elements are operating leases




                                                        IFRS Baseline 2012 – Leases 16
Real estate leases as investment property


                                                        Lessee elects to
                             Lessee elects to
   Property meets                                       account for the
                              use fair value
    definition of                                       operating lease
                       &        model for         &
     investment                                           interest as
                               investment
       property                                           investment
                                 property
                                                            property



     ♦ Recognise and measure property interest and liability initially
                      as if it were a finance lease
      ♦ Subsequently measure asset under IAS 40 fair value model
                and liability as finance lease obligation
            ♦ Continue to account as finance lease even if it
                    ceases to be investment property

                                                             IFRS Baseline 2012 – Leases 17
Agenda



The basic framework
Real estate leases
Accounting for operating leases
Accounting for finance leases
Sale and leaseback
Arrangements containing a lease
Know your journals
Disclosure
The closing

                                  IFRS Baseline 2012 – Leases 18
Accounting for operating leases


             Lessee                   Lessor




                                  ♦ Leased asset
         Prepaid / accrued
       lease rental payable   ♦ Accrued/deferred lease
                                   rental receivable




                              ♦ Depreciation expense
       Lease rental expense
          (straight line)      ♦ Lease rental income
                                    (straight line)



                                               IFRS Baseline 2012 – Leases 19
Other considerations: Operating leases


                                   Spread on straight-line basis
    Uneven lease payment profile
                                   Statement of financial position
                                   reflects deferral / prepayment



          Lease incentives         Spread on straight-line basis



        Annuity depreciation               Not permitted




                                                       IFRS Baseline 2012 – Leases 20
Agenda



The basic framework
Arrangements containing a lease
Real estate leases
Accounting for operating leases
Accounting for finance leases
Sale and leaseback
The closing




                                  IFRS Baseline 2012 – Leases 21
Accounting for finance leases


               Lessee                       Lessor




           ♦ Leased asset                 Receivable
     ♦ Liability (present value of   (present value of gross
       minimum lease payments)            investment)




           ♦ Depreciation               ♦ Profit on sale
         ♦ Finance expense            ♦ Finance income



                                                     IFRS Baseline 2012 – Leases 22
Other considerations: Finance leases

                                            Depreciate asset
           Initially record asset and
                                             over shorter of:
                liability at lower of:
 Lessee




                                              ♦ Lease term
          ♦ Present value of minimum
                 lease payments            ♦ Useful life (unless
                                         reasonably certain lessee
                 ♦ Fair value
                                           will obtain ownership)




           Finance income / expense
 Lessor




           calculated using effective
          interest method (using rate
                implicit in lease)




                                                   IFRS Baseline 2012 – Leases 23
Manufacturers / dealers as lessors

                                    According to policy for
                                        outright sales
    Recognise sales revenue at
     commencement of lease        Revenue = lower of fair value
                                 and present value of minimum
                                        lease payments


                                  Difference between carrying
                                  amount of leased asset and
     Recognise costs of sales
                                 present value of unguaranteed
                                         residual value

                                     Expense when selling
        Initial direct costs
                                       profit recognised



                                                    IFRS Baseline 2012 – Leases 24
Agenda



The basic framework
Arrangements containing a lease
Real estate leases
Accounting for operating leases
Accounting for finance leases
Sale and leaseback
The closing




                                  IFRS Baseline 2012 – Leases 25
Sale and leaseback transactions


                     Lila-Tech sells building to Buildings Inc




                          Buildings Inc leases the building
                                  back to Lila-Tech



                Is it a finance leaseback or
                 an operating leaseback?




                                                        IFRS Baseline 2012 – Leases 26
Operating leaseback profit or loss recognition

                                     Recognise in profit or
          Sale price = FV
                                       loss immediately


                                     Defer and amortise
          Sale price > FV              excess over FV
                                    over asset’s useful life


           Sale price < FV
      and, in case of a loss, not    Recognise in profit or
    compensated by future below-       loss immediately
       market lease payments

          Sale price < FV
      and, in case of a loss, is    Defer and amortise loss
    compensated by future below-    over asset’s useful life
       market lease payments
                                                    IFRS Baseline 2012 – Leases 27
Finance leaseback profit or loss recognition

                             Defer and amortise profit
         Gain on sale
                                 over lease term


                              Loss not recognised,
         Loss on sale          but asset subject to
                               impairment testing




                                              IFRS Baseline 2012 – Leases 28
A question for you: Sale and leaseback (1)

♦ Lila-Industrial sells a machine (carrying amount
  L$ 11 million) to Lila-Pharma for its fair value of
  L$ 20 million. Lila-Industrial leases it back for 10 years
  at lease payments of L$ 2.7 million per year
♦ At the transaction date, the expected value of the
  machine at the end of the lease term is L$ 12 million
♦ At the end of the10 years, Lila-Industrial can repurchase
  the machine for L$ 3 million
♦ Lila-Industrial derecognised the asset and recorded a
  profit on sale of L$ 9 million
♦ The present value of minimum rental payments is
  L$ 18.5 million and the present value of repurchase
  option is L$ 1.5 million
What adjustments should Lila-Industrial prepare?
                                                               IFRS Baseline 2012 – Leases 29
A question for you: Sale and leaseback (2)

Same facts as in Sale and leaseback 1, except:
♦ Annual lease payments are L$ 2.1 million and the
  present value of the lease payments is L$ 14.4 million
♦ The repurchase price at the end of the 10 years under
  the purchase option is L$ 11.5 million and the present
  value of the purchase option is L$ 5.6 million
What adjustments should Lila-Industrial prepare?




                                                           IFRS Baseline 2012 – Leases 30
Agenda



The basic framework
Real estate leases
Accounting for operating leases
Accounting for finance leases
Sale and leaseback
Arrangements containing a lease
The closing




                                  IFRS Baseline 2012 – Leases 31
Which statements are true?

        A lease is classified as an operating lease if the lease term is
                < 75% of the asset’s estimated economic life

        A lease is classified as an operating lease if the present value
      of the minimum lease payments is < 90% of the asset’s fair value

     A lease is classified as an operating lease if the present value of the
     minimum lease payments is < 90% of the asset’s fair value and the
          lease term is < 75% of the asset’s estimated economic life

       A lease is classified as an operating lease if the lease does not
         transfer substantially all the risks and rewards of ownership
                          from the lessor to the lessee




                                                                  IFRS Baseline 2012 – Leases 33
Which statements are true in respect of operating
leases?
        At inception the lessee recognises an asset and liability for
             the present value of the minimum lease payments

        At inception the lessee recognises an asset and liability for
                  the entire fair value of the leased asset

       At inception the lessee does not recognise an asset or liability
                          related to the leased asset

        At inception the lessee recognises an asset based upon the
         percentage of expected usage times the asset’s fair value




                                                                IFRS Baseline 2012 – Leases 34
Which statements are true?

       Minimum lease payments include guaranteed residual value


           Minimum lease payments include contingent rents

          Minimum lease payments include taxes paid by and
                      reimbursed to the lessor

          Minimum lease payments include all renewal periods




                                                          IFRS Baseline 2012 – Leases 35
Which statements are true?

               Transfer of ownership at the end of the lease
                   is an indicator of an operating lease

               Transfer of ownership at the end of the lease
                     is an indicator of a finance lease

                Lease for the majority of the economic life
                  is an indicator of an operating lease

       No bargain purchase option is an indicator of a finance lease




                                                               IFRS Baseline 2012 – Leases 36
1) A lease is classified as either an
   operating lease or a finance lease
2) Classification depends on whether
   substantially all of the risks and
   rewards have been transferred
3) No bright lines
4) Classification is made at inception
5) Under a sale and leaseback, how
   the leaseback is classified drives
   the accounting (i.e. operating or
   finance leaseback)


                       IFRS Baseline 2012 – Leases 37

				
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