There are different types of leases depending on what sort of lease arrangement is in place. Here we’ll take a look at some of the things you should know.
What is a lease?
A lease is 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. IAS 17 Leases is the relevant International Financial Reporting Standard for this.
Two types of lease
When studying ACCA F7 Financial Reporting, you’ll need to be familar with both types of leases. These are:
- Operating Lease
- Finance Lease
What you need to know about leases for F7 Financial Reporting
The ACCA F7 Financial Reporting (International) syllabus outlines four key areas for leases:
- You should know and be able to explain why the legal form of a lease could mislead the users of financial statements.
- You should be able to describe and show how to determine a lease type (operating or finance)
- You should be able to talk about the effects of a finance lease being mis-treated as an operating lease.
- You should also be able to account for both types of leases in the accounts of the lessee.
A Finance Leases is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset is a finance lease. Title may or may not eventually be transferred.
FINANCE LEASE (individually or combination)
- The lease transfers ownership of the asset to the lessee by the end of the lease term.
- The lessee has a bargain purchase option and it is certain at the date of inception that the option will be exercised.
- The lease term is for the major part of the economic life of the asset even if title is not transferred.
- At the inception of the lease the present value of the minimum lease payments amounts to substantially all of the fair value of the leased asset; and
- The leased assets are of such a specialised nature that only the lessee can use them without major modifications.
- Gains or losses from the fluctuation in the fair value of the residual accrue to the lessee; and
- The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.
- If the lease can cancel the lease, the lessor’s associated losses are borne by the lessee.
Finance Leases Accounting Treatment – Lessee
- Recognises a leased asset on the Statement of Financial Position at the lower of the fair value of the leased asset and present value of lease payments.
- PV Discount rate is the implicit rate in the lease.
- Liability recognised.
- Lease payments made are apportioned between finance charges and reduction of liability.
- The finance charge allocation is allocated to a period to produce a constant rate of interest over the period.
An Operating Leases is a lease other than a finance lease.
Operating Leases Accounting Treatment – Lessee
- Treats contract as an executory contract.
- Does not recognise leased asset on the Statement of Financial Position
- Recognises lease expense on a straight line basis over the lease term.
- A lessee may classify a property interest held under an operating lease as an investment property. If this is done, then that interest is accounted for as if it were a finance lease.
- Lessors and lessees recognise incentives granted to a lessee under an operating lease as a reduction in lease rental income or expense over the lease term.
- A lease of land generally will be classified as an operating lease unless title transfers to the lessee.
- A lease of land and building should be treated as two separate leases, a lease of the land and a lease of the building, and the two leases may be classified differently.
- A series of linked transactions in the legal form of a lease should be accounted for based on the substance of the arrangement; the substance may be that the series of transactions is not a lease.
- Special requirements apply to manufacturer or dealer lessors granting finance leases.