TOPIC 4 - IAS 17 LEASES -...

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CPA P2 Advanced Corporate Reporting 1 © Cenit Online 2015 TOPIC 4 - IAS 17 – LEASES

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TOPIC 4 - IAS 17 – LEASES

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5 Indicators of A Finance Lease

1. A finance lease is presumed if the lease term is for all or substantially all of the assets

useful life.

N.B. The Lease term is the non cancellable period for which the lessee has contracted to lease

the asset together with any further terms for which the lessee has the option to continue to

lease the asset

2. A finance lease is presumed if the lease transfers ownership of the asset to the lessee

by the end of the lease term (thus hire purchase transactions qualify)

3. The lessee has the option to purchase the asset at the end of the lease term and the

purchase price is sufficiently below market value, that it makes it highly probable that

the lessee will purchase the asset outright

4. The leased asset could be used by another party, other than the lessee, but only with

significant modifications being made - indicates the leased asset is specifically for the

current lessee

5. The present value of the minimum lease payments is equal to all or substantially all of

the fair value of the leased asset at the inception of the lease – (So in other words, in

todays money, the lease payments are equal or nearly equal to the purchase cost of

the leased asset)

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DEPOSITS PAID

Where the lessee has paid a deposit to the lessor before the lease commences, the deposit is

used to reduce the amount of the lease liablity i.e. reduce the amount of lease finance

advanced – deposits are deemed to be all capital

The Double Entry for a deposit is

Cr Bank

Dr Finance Lease Obligation

In questions, where the initial payment is different in amount to the annual rentals, this is

generally taken to be an indicator of a deposit paid – See “Branch” question !!

FINANCE LEASE IN ADVANCE

Main Points

Rental is paid on first day

The first rental is deemed to be all capital

An accrual will be made for finance costs

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In Year 2, the amount of capital repaid will be the lease rental less accrued interest

from Year 1 paid in Year 2 i.e. paid as part of Year 2 rental

FINANCE LEASE IN ARREARS

Rental is paid on Last day

Rentals are deemed to be composed of Interest and Capital

No Interest Accrual

FINANCE LEASE PAID IN ARREARS EXAMPLE

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FINANCE LEASE PAID IN ARREARS EXAMPLE

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Leases of Land & Buildings

Under IAS 17, the land and buildings element would be dealt with seperately. The lease of

the land is an operating lease, as land has an indefinite useful economic life. The lease on the

buildings is assessed on its own merits. The lease payments are split in proportion to the fair

values of the respective assets

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SUM OF THE DIGITS METHOD OF ALLOCATING INTEREST

ON A FINANCE LEASE An means of allocating the Finance Charge over the term of a finance lease

Approximates to the actuarial method

More interest expensed in the early part of the lease and less towards the end

Procedure

The digit 1 is assigned to the final instalment, 2 to the penultimate instalment and so

on (This applies for a Finance Lease in Arrears. For a Finance Lease paid in Advance,

the Digit 0 is applied to the Final Instalment )

Add the digits

Calculate the interest charge included in each instalment by taking the total finance

cost and multiplying by the following fraction

Digit Applicable to the Instalment

Sum of the Digits

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Example of Sum of the Digits Method

Account for the above lease using the sum of the Digits as a means of allocating the finance

charge

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Solution

Finance Cost

Allocation

Total Finance

Expense

(5000) * 4 –

€15,850 =

€4150

Instalment Digit Finance Expense

Allocation

1 4 4/10 * 4150 = 1660 2 3 3/10 * 4150 = 1245 3 2 2/10 * 4150 = 830 4 1 1/10 * 4150 = 415 10 4150

Finance Lease (In

Arrears)Table

Date Opening Capital

Obligation

Interest Rental Closing Capital

Obligation

Yr 1 15,850 1660 -5000 12,510

Yr 2 12,510 1245 -5000 8,755

Yr 3 8755 830 -5000 4,585

Yr 4 4585 415 -5000 -

Statement of Profit or Loss Extract for the Year End Yr 1 Finance Cost 1,660

Depreciation (15,850/4) 3,963

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Statement of Financial Position Extracts As at 31/12/Yr 1 Assets

Non Current

Assets Held Under

Finance Lease

(15,850 – 3,963) 11,887

Non Current Liabilities

Finance Lease

Obligation

8755

Current Liabilities

Finance Lease

Obligation

(15850+1660-5000 -

8755)

3755

Bank 5000

Retained Egs -5623

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LESSOR ACCOUNTING

Finance Lease

Mirror image of lessee accounting

Amount Due from Lessee

Recognised to give a

constant periodic rate of

return .Approximation may

be made (i.e. Sum of Digits)

Credit against

Investment in Finance

Lease

Operating Lease - Record as a long term asset and

depreciate over useful life, record income on a straight

line basis over the lease term.

Net Investment in Finance

Lease

Finance Income

Lease Rentals Received

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IAS 17 – Finance Lease Paid In Advance – Class Question & Answer

A lease rental of €20 million was paid on 1 April 2009. It is the first of 5 annual payments in

advance for the rental of an item of equipment that has a cash purchase price of €80 million.

The auditors have advised that this is a finance lease and have calculated the implicit rate in

the lease as 12% per annum. Leased assets should be depreciated on a straight line basis over

the life of the lease.

(a) Show the effect on the Statement of Profit or Loss and Statement of Financial Position

for 31 March 2010

(b) Calculate the interest charge for the remaining years of the lease

Solution

1. The cash price of the leased plant of €80 million should be capitalised and included as

plant and equipment. As the lease has a 5 year life, straight line depreciation for the

year to 31 March 2010 will be 20% of €80 million = €16 million

Leasing Table - Lease Paid in Advance (i.e. on First Day of Period)

Year Opening

Capital

Obligation

Rental Remaining

Capital

Obligation

Interest

Accrual

(12%)

31.3.10 1 80,000 (20,000) 60,000 7200

31.3.11 2 60,000 (20,000) 47,200 5664

31.3.12 3 47,200 (20,000) 32,864 3,944

31.3.13 4 32,864 (20,000) 16,808 3192

31.3.14 5 16,808 (20,000) - -

Notes:

1. First Rental is deemed to be all capital

2. Interest for each year is calculated on the “Remaining Capital Obligation”

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3. The Interest Accrual in the current year is paid from the Rental of the following year

with the balance of the rental representing capital repayment

Statement of Profit or Loss Extract for Y/e 31.3.10

Finance Charge 7,200

Depreciation 16,000

Statement of Financial Position Extract as at 31.3.10

Assets

Non Current Assets

Plant (80-16) 64,000

Equity & Liabilities

Non Current Liabilities

Finance Lease Obligation 47,200

Current Liabilities

Finance Lease Obligation (12800+7200) 20,000

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Sale and leaseback transactions

In a sale and leaseback transaction, an asset is sold by a vendor and then the same asset is

leased back to the same vendor.

The lease payment and the sale price are usually interdependent because they are negotiated

as a package. The accounting treatment of a sale and leaseback transaction depends upon the

type of lease involved.

If the leaseback is a finance lease, the transaction is a means whereby the lessor provides

finance to the lessee, with the asset as security (i.e.in substance, it is a financing transaction

not a sale transaction.) For this reason it is not appropriate to regard an excess of sales

proceeds over the carrying amount as income (i.e. Gain on Disposal). Such excess is deferred

and amortised over the lease term.

So because the entity still has the risks and rewards of ownership of the asset via a finance

lease, the gain on disposal is not immediately realised. It gets realised as the finance lease

term progresses. Such excess is deferred and amortised over the lease term in the financial

statements of the lessee/seller.

Journals for a Sale and Leaseback Transaction where a finance Lease is created

1.

Dr Bank

Cr Assets

Cr Deferred Gain on Disposal

Being sales proceeds on disposal

2.

Dr Asset Held under Finance Lease

Cr Finance Lease Obligation

Being creation of Finance Lease Liability

3.

Dr Deferred Gain on Disposal (SOFP)

Cr Gain on Disposal (SOPL)

Being amortisation of Deferred Gain over Lease Term

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4. Account for Finance Lease as Normal – Interest, Capital Repaid, Split of Outstanding

Obligation between Current Liabilities and Non Current Liabilities and Depreciate the

Leased Asset

If the leaseback is an operating lease, and the lease payments and the sale price

are at fair value, there has in effect been a normal sale transaction and any profit or

loss is recognised immediately.

Dr Bank

Cr PPE

Cr/Dr Gain/Loss on Disposal (SOPL)

The remaining operating lease payments will be recognised on a straight line basis in the

SOPL.

Where the sale price is below fair value, any profit or loss should be recognised

immediately except that if the apparent loss is compensated by future lease payments at

below market price it should to that extent, be deferred and amortised over the period for

which the asset is expected to be used

If the sale price is above fair value, the excess over fair value should be deferred and

amortised over the period which the asset is expected to be used

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Criticisms of IAS 17 Leases

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Past Exam Questions

–CPA P1

Past Exam Questions

– CPA P2

Q3 (3) Apr 14 Q (A) April 2015

Q5 Apr 13 Q1 August 2014

Q4 Aug 11 Q (A) April 2014

Q3 Apr 11

Q (B) Aug 13

Q (a) Aug 12

Q1 Aug 11 – Issue 8

Q3 Apr 11

Q1 Apr 11 note (vi)