Published On:Sunday 25 December 2011
Posted by Muhammad Atif Saeed
Leases IAS 17
International Financial Reporting Standards (IFRS)
Leases (IAS17)
A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership.
Classification depends on the substance of the transaction rather than the form of the contract. Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are:
b) the lessee has the 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.
c) the lease term is for the major part of the economic life of the asset even if title is not transferred.
d) at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.
e) the leased assets are of such a specialized nature that only the lessee can use them without major modifications.
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)
c) the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.
The examples and indicators (above) are not always conclusive. If it is clear from other features that the lease does not transfer substantially all risks and rewards incidental to ownership, the lease is classified as an operating lease.
Differences in terminology
| | IFRS | US GAAP |
| For Lessor | Operating lease | Operating lease |
| | Finance lease | Direct Financing Lease |
| | Finance lease | Sales-type lease |
| | Finance lease | Leveraged lease |
| For Lessee | Operating lease | Operating lease |
| | Finance lease | Capital lease |
INITIAL DIRECT COSTS
| Type of Lease | Accounting Treatment for Initial Direct Costs |
| Operating | Recorded as an asset and amortized over the lease term* |
| Direct Financing (US) Finance (IFRS) | Recorded as part of investment in lease and amortized over lease term by reducing interest revenue (find new implicit rate)* |
| Sales-type Lease (US) Finance if lessor is manufacturer or dealer (IFRS) | Immediately recognized as cost of goods sold (reduces profit or increases loss on sale of leased asset) |
What interest rate to use:
| IFRS | US GAAP |
| — “The discount rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee’s incremental borrowing rate shall be used. | — Lessors always use the interest rate implicit in the lease — The lessee uses the LOWER of the implicit interest rate and their own incremental borrowing rate |
