IAS 17 LEASES (Key Notes)
Definition of lease types:
Finance lease-lease
that transfers substantially all the risks and rewards to the lessee
Operating lease-any other lease
Indicators of
Finance Lease
The
main indicator is that the lease term is for the major part of the useful
economic life of the asset. And the indicators are:
-
at the beginning of the lease, the present value of the
minimum lease payments is approximately equal to the fair value of the asset
-
The lease transfers ownership of the asset to the lessee by
the end of lease term
-
The lessee has the option to buy the asset at a price
expected to be lower than fair value at the time the option is exercised
-
The lease asset is of specialized nature
Substance over
form
Accounts
are generally required to reflect commercial substance (reflects the financial reality of the transaction) rather than
legal form (legal reality of the
transaction).
IAS
17 deals with the accounting for finance lease which follow the definition of
an asset in the IASB Framework for the Preparation and Presentation of
Financial Statements: “an asset is a resource controlled by the entity as a result
of the past events and from which future economic benefits are expected to flow
the entity”. Ownership is not necessary, control is the essential feature.
IAS 17 thus argues that an asset leased under
a finance lease must be recorded as an asset and corresponding liability in the
lessee’s accounting records.
ACCOUNTING ENTRIES
A. Finance Lease
01.
At the beginning of the
lease
Dr. Non-Current
Asset
Cr. Finance
Lease Liability
Initial recording-
NCA: at the fair value (or, if lower, the present value of the
minimum lease payment)
Finance Lease Liability: liability for finance
leases spilt between current liabilities and non-current liabilities
02.
At the end of each period of
the lease
Dr. Depreciation
expenses (Income Statement)
Cr. Non-current
Asset-accumulated depreciation
(NCA should be
depreciated over the shorter of the useful life and the lease term)
03.
As each rental paid
Dr. Interest
Expenses (Income Statement)
Cr. Finance
Lease Liability
(with the
finance charge)
Dr. Finance
Lease Liability
Cr. Bank/Cash
(with the rental
payment)
B. Operating Lease
Only rental payment under
operating leases are charged to the income statement on straight-line-basis
over the term of the lease
Note: If a finance lease asset is
incorrectly treated as an operating lease it will have the following effects on
the financial statements:
- assets
understated so Return on capital employed will be overstated
- liabilities
understated so gearing understated
-
little effect on income statement (profit will be overstated)