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- A contract, or part of a contract, that conveys the right to use an asset for a period of time in exchange for consideration.
- A firm may recognise assets it does not own, as long as it is able to control the use.
Leesee: control of the asset
- Obtains substantially all of the economic benefits from the use of the identified asset throughout the period of use; and
- Directs the use of the asset throughout the period of use. The lessee has the ability to change how, and for what purpose, the asset is used during the contractual term.
Lessor vs Lessee
- Lessor: the individual/firm providing the asset and receiving a payment at established dates
- Lessee: the individual/firm acquiring the right to use the asset and having an obligation to pay the lessor at established dates
Lease contracts: key terms
- Lease payments: fixed payments + initial direct costs (excluding service cost component, if any) + (if included in the lease contract) residual value guarantee and/or price of a purchase option.
- Lease term: the period for which a lessee has the right to use the underlying asset, from the commencement date of the contract. Based on expectations about whether lessee likely to exercise an option to extend the lease term
Can the right of use acquired under the lease contract be considered an asset?
- Control: legally enforceable right established by the lease contract.
- Past event: Delivery following signing of the lease contract.
- Future economic benefit: yes
- Should asset be recognised: yes
Can the obligation to make lease payments in the future be considered a liability
- Present obligation: legally enforceable obligation established by the lease contract.
- Past event: delivery following signing of the lease contract.
- Outflow of economic benefits: yes (cash payments)
- Recognise? Yes
All leases are represented in the statement of financial position. Two exceptions:
- 1. Leases with a duration of 12 months of less.
- 2. Leases of low value assets (immaterial) (tablets, phones, laptops, etc)
Implications of new accounting standard
- Some large retailers who lease many retail outlets will need to recognise more leased assets and liabilities.
- Will increase reported debt and assets and this will increase their reported leverage (how much is financed by outside).
- Could have implications for various accounting-based debt covenants (liabilities cannot exceed amount of assets %).
- Means that expenses tend to be higher at the start than at the end.
When to recognise asset
- At the commencement date, a lessee shall recognise a right-of-use asset and a lease liability.
- The date on which a lessor makes an underlying asset available for use by a lessee.
Journal entries for lease payments in arrears
- Interest is 15%,
- Amortise 10% because 10 year lease to reduce the asset amount.
Initial measurement by lessor
- What constitutes a liability for the lessee.
- It’s a receivable for the lessor, which replaces the underlying asset which has been leased to the lessee.
Subsequent measurement for lessor
- What constitutes interest expense for the Lessee- It’s interest revenue for the Lessor
IASB recording for lessors
- From the perspective of the Lessor, leases shall still be classified as either finance leases or operating leases.
- A finance lease is a lease that transfers substantially all of the risks and rewards incidental to ownership of an underlying asset from lessor to lessee.
- An operating lease is a lease that does not transfer substantially all of the risks and rewards of ownership.
- Short-term leases are typically operating leases
- Finance lease—lease receivable recognised
- Operating lease- expensed
Lessor accounting for direct financing leases.
- A lease where the lessor provides the financial resources to acquire the asset.
- Lessor typically acquires the asset, giving the lessor legal title, then enters a lease agreement to lease the asset to the lessee, who subsequently controls the asset.
- No sale is recorded
- Lessor derives income through periodic interest revenue.
- Where risks and rewards of ownership are held by lessee, the lessor substitutes lease receivable for the underlying asset.
Manufacture or dealer lessors
- Where fair value of the property at the inception of the lease differs from its cost to the lessor (manufacturer or dealer)
- Represents a finance lease as:
- Two parts of the transaction
- 1.A sale with a resulting gain (fair value vs cost to dealer/manufacturer)
- 2.A lease transaction that will provide interest revenue over the period of the lease
General format of journal entries for manufacturer or dealer lessors
How to find selling profit for manufacture or dealer lessors
- Selling profit = Sales revenue - Cost of sales
- Sales revenue: = fair value of asset, or if lower, present value of lease payments accruing to the lessor, discounted using a market rate of interest (Para 71a).
Manufacture lessor initial recognition and payments general entries