Accounting for Leases
Source: Solutions Manual t/a Australian Financial Accounting 7/e by Craig Deegan
11.1 Within AASB 117 a lease is defined as:
an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.
11.2 We should capitalise a lease transaction (meaning that the leased asset and lease liability will be placed on the statement of financial position) when substantially all the risks and rewards of ownership pass to the lessee, and the lease payments are deemed to be material. AASB 117 describes the risks and rewards of ownership as follows:
Risks include the possibilities of ...view middle of the document...
11. Indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease are:
(a) if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee;
(b) gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for example, in the form of a rent rebate equalling most of the sales proceeds at the end of the lease); and
(c) the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.
12. The examples and indicators in paragraphs 10 and 11 are not always conclusive. If it is clear from other features of the lease that the lease does not transfer substantially all risks and rewards incidental to ownership, the lease is classified as an operating lease. For example, this may be the case if ownership of the asset transfers at the end of the lease for a variable payment equal to its then fair value, or if there are contingent rents, as a result of which the lessee does not have substantially all such risks and rewards.
11.3 If the lease is considered to be a finance lease (also referred to as a capital lease or a financial lease), the amount to be initially capitalised by the lessee for the asset and liability is the fair value of the leased property, or if lower, the present value of the minimum lease payments as determined at the inception of the lease.
Minimum lease payments are defined at paragraph 4 of AASB 117 as:
The payments over the lease term that the lessee is or can be required to make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor, together with:
(a) for a lessee, any amounts guaranteed by the lessee or by a party related to the lessee; or
(b) for a lessor, any residual value guaranteed to the lessor by:
(i) the lessee;
(ii) a party related to the lessee; or
(iii) a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.
However, if the lessee has an option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised, the minimum lease payments comprise the minimum payments payable over the lease term to the expected date of exercise of this purchase option and the payment required to exercise it.
As the last part of the above requirement indicates, for a lessee, the minimum lease payments include any bargain purchase option, even though the lessee might not be contractually obliged to exercise the option to buy the asset.
The discount rate to be used in computing the present value of the minimum lease payments (and hence, the amount to be included in the statement of financial position for the leased asset and lease liability...