Leases

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  • Leases
    • An agreement whereby the lessor conveys to lessee the right to use an asset for an agreed period of in return for a payment or a series of payments
      • Maybe more than 2 th parties (companies leasing  a car
        • Motor dealer
        • Finance Company
        • Company leasing the car
    • Difference between leasing and buying
      • Buying
        • Pay cash for item upfront - may need to incur debt to pay installments?
        • Legal ownership
        • Responsibility for servicing, maintenance and insurance
        • Indefinite timescale
      • Leasing
        • Pay cash in installments to lessor (spread over time)
        • No legal ownership
        • Servicing, maintenance and insurance may be covered by lessor
        • Fixed period of lease
    • Old = IAS 17 - 2 types of leasing: Finance and Operating
      • Finance lease: transfers substantially all the risks and rewards of ownership of an asset to a lessee
        • Capitalized in the lessee's account
        • recorded as an ASSET
        • recorded as the obligation for future payment as a liability
      • Operating lease: any other lease.
        • EXPENSE the annual payments as a rental in the INCOME STATEMENT
      • Recognizing exemptions as an EXPENSE through P&L
        • Lease with a term of 12 months or less with a no purchase option
        • leases where the underlying asset has a low value when new (computers or small office furniture)
    • IFRS 16
      • Latest development IFRS 16
        • eliminates off-balance sheet accounting (operating vs financial distinction removed)
        • Changes income statement presentation and timing of income and expense recognition -  depending on a new lease classification
        • introduces a new model for lessor accounting
        • Requires more extensive disclosures
      • Recognizing exemptions as an EXPENSE through P&L
        • Lease with a term of 12 months or less with a no purchase option
        • leases where the underlying asset has a low value when new (computers or small office furniture)
      • Capitlisation
        • when commencing a lease, a lessee recognises a right of use and a lease liability
        • The lease liability is initially measured at the present value of the lease payments payable over LT.
          • Discounted at the rate implicit in the lease if that can be readily determined.
          • If that rate cannot be determined, the lessee shall use their incremental borrowing rate.
        • The right of use asset is initially measured at the amount of the liability plus any initial direct costs incurred by the lessee. (Total cost)
    • Implicit interest rate
      • The rate of interest that causes the present value of: the lease payments and the non- guaranteed       residual value
        • It equals the sum of: the fair value of the underlying asset and any initial direct costs of the lessor
      • The "Internal Rate of Return"
        • R1 + (NPV1 x [R2 - R1]/ [NPV1 - NPV2])
    • Treatment
      • Step 1: Capitalised Lease Liability at PV of payments, and right of use asset value of lease liability + direct cost
        • Step 2: Depreciate the ROUA every period causing P&L expense
          • Step 3: Calculate the annual finance charge as the implicit interest rate * the liability balance for the year. This increases the liability and causes an EXPENSE in P&L
            • Step 4: The lease payment reduces the liability, if this is at the start of the year then it is deducted before the interest calculation. If at the end of the year it is deducted after calc.

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