Financial Accounting I (FAC4861/3) Rendani Muthelo 16 December 2015

Transcription

1 Financial Accounting I (FAC4861/3) Rendani Muthelo 16 December 2015

2 Leases

3 Objective and scope The objective of IAS17 Leases is to prescribe, for lessees and lessors, the appropriate accounting policies and disclosure to apply in relation to lease (:1) IAS17 shall be applied in accounting for all leases other than licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights However, IAS17 shall not be applied as the basis of measurement for investment property provided by lessors under operating leases (see IAS40) (:2) 3

4 Definitions 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 A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of asset. Title may or may not eventually be transferred. An operating lease is a lease other than a finance lease Economic life is either: (a) The period over which an asset is expected to be economically usable by one or more users; or (b) The number of production or similar units expected to be obtained from the asset by one of more users Useful life is the estimated remaining period over which the economic benefits embodied in the asset are expected to be consumed 4

5 Definitions Minimum lease payments are 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 the guaranteed residual value Guaranteed residual value is: (a) For a lessee, that part of the residual value that is guaranteed by the lessee or a party related to the lessee; and (b) For a lessor, that part of the residual value that is guaranteed by the lessee or by a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee Unguaranteed residual value is that portion of the residual value, the realisation of which by the lessor is not assured or guaranteed by a party related to the lessor 5

6 Definitions The definitions below apply only to a lessor Gross investment in the lease is the aggregate of the minimum lease payments receivable by the lessor under a finance lease and any unguaranteed residual value accruing to the lessor Net investment in the lease is the gross investment in the lease discounted at the interest rate implicit in the lease Unearned finance income is the difference between the gross investment in the lease and the net investment in the lease 6

7 Definitions The interest rate implicit in the lease is the discount rate that causes the aggregate present value of (a) the minimum leases payments and (b) the unguaranteed residual value to be equal to the sum of (i) the fair value of the leased asset and (ii) any initial direct costs incurred by a lessor, that is a not a manufacturer or dealer The lessee s incremental borrowing rate of interest is the rate of interest the lessee would have to pay on a similar lease, or if that is not determinable, the rate that the lessee would incur to borrow over a similar term, and with a similar security, the funds necessary to purchase the asset Initial direct costs may include commission, legal fees and internal costs that are incremental and directly attributable to negotiating and arranging a lease. They exclude general overheads such as those incurred by a sales and marketing team 7

8 Classification of leases A lease is classified as a finance lease if its 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 (:8) Indicators of situations to be considered in the classification contained in paragraphs 10 and 11- self-study (:10 - :11) 8

9 Arrangement containing a lease IFRIC4 Determining whether an arrangement contains a lease An entity may enter into an arrangement that does not take the legal form of a lease but conveys a right to use an asset in return for a payment or series of payments, e.g. take-or-pay contracts, in which the purchaser (the user of the asset) must make specified payments regardless of whether they take delivery of the contracted products or services IFRIC4 provides guidance for determining whether such arrangements are, or contain, leases that should be accounted for in accordance with IAS17 (IFRIC4:1-2) 9

10 Substance of the arrangement Determining whether an arrangement is, or contains, a lease shall be based on the substance of the arrangement and requires an assessment of whether: (a) fulfilment of the arrangement is dependent on the use of a specific asset or assets (the asset); and (b) the arrangement conveys a right to use the asset (IFRIC4:6) 10

11 Use of a specific asset A specific asset is subject to a lease if the fulfilment of the arrangement is dependent on the use of such asset However, if the supplier (the party conveying the right to use the asset) has the right and ability to provide goods or services using other assets not specified in the arrangement, then fulfilment is not dependent on the specified asset and the arrangement does not contain a lease - even if a specific asset is explicitly identified in an arrangement A warranty obligation that permits or requires the substitution of the same or similar assets when the specified asset is not operating properly does not preclude lease treatment An asset has been implicitly specified if the supplier owns or leases only one asset with which to fulfil the obligation and it is not economically feasible for the supplier to perform its obligation through the use of alternative assets (IFRIC4:7-8) 11

12 Conveys a right to use the asset An arrangement conveys the right to use the asset if it conveys to the purchaser (lessee) the right to control the use of the underlying asset The right to control the use of the underlying asset is conveyed if the purchaser has the ability to obtain or control more than an insignificant amount of the output or other utility of the asset and any of the following conditions is met: (a) The purchaser has the ability or right to operate the asset or direct others to operate the asset in a manner it determines; (b) The purchaser has the ability or right to control physical access to the underlying asset; or (c) The price for the output is neither contractually fixed per unit of output nor equal to the current market price per unit of output as of the time of delivery of the output (:9) 12

13 Taxation in leases - VAT VAT input/output is based on the cash selling price of the asset (i.e. it is not based on the present value of the minimum lease payments) Unless otherwise stated, the lease payments (including the residual values) are generally inclusive of VAT VAT input is levied on initial direct costs and is payable immediately by the entity (i.e. it is not included in the lease instalments) For finance leases, VAT input/output is financed over the lease term and is included in the finance liability/net investment in a lease. Therefore, lease instalments payable/receivable shall include a VAT portion. The VAT portion is determined as the proportion of the lease instalment paid to the total lease instalments (including the guaranteed residual value) over the period of the lease term bears to the total VAT input/output 13

14 Taxation in leases Income tax For finance leases, the lease instalments are deductible/taxable for income tax purposes. However, the VAT portion included in the lease instalment is not deductible/taxable for tax purposes. As a result, this amount will become the tax base of the lease liability/net investment in a lease For finance leases, the allowances on a leased asset are granted to lessor because of the legal ownership over the asset. However, according to IN47 the allowance granted to a lessor on a leased asset must be based on the cost of the asset (i.e. its selling price) less residual value as specified in the lease agreement For operating leases, the lease payments/receipts, excluding of VAT, are deductible/taxable for tax purposes 14

15 Lessee accounting: Finance leases Initial recognition At the commencement of the lease term, lessees shall recognise finance leases as assets and liabilities at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments 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 not available, the lessee s incremental borrowing rate shall be used Any initial direct costs of the lessee are added to the amount recognised as an asset (e.g. legal costs in relating to drafting of lease agreements) (:20) 15

16 Lessee accounting: Finance leases Subsequent measurement Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability Contingent rents shall be charged as expenses in the periods in which they are incurred A finance lease gives rise to depreciation expense for depreciable assets as well as finance expense The depreciation policy for depreciable leased assets shall be consistent with that for depreciable assets that are owned and recognised in accordance with IAS16 and IAS38 If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset shall be fully depreciated over the shorter of the lease term and its useful life IAS36 is applied to determine impairment losses on leased assets (:25 - :27) 16

17 LE1: Interest rate implicit in the lease CA Ltd is a lessee and SA Ltd is the lessor. Ignore VAT. Cost of an asset: R800,000 Annual lease payments (in arrears): R220,000 Guaranteed residual value: R120,000 Unguaranteed residual value: R50,000 Lease term: 5 years REQUIRED: (PV=R800,000;PMT=-R220,000;FV=?[ ];N=5) i (rate implicit in the lease) =? CA Ltd: Present value of the minimum lease payments (i[ ];PMT=-R220,000;FV=?[ ];N=5) PV=? 17

18 LE2: Finance lease - lessee CA Ltd is a gas heater distributor and has a financial year end of 31 December. On 1 January 2014, CA Ltd entered into a finance lease agreement as a lessee. The details relating to the lease are provided below: Cash selling price (excl. VAT): R800,000 Annual lease payments (in arrears): R228,000 Guaranteed residual value: R136,800 Unguaranteed residual value: Undeterminable Lessee s incremental rate of borrowing: 17% p.a. Initial direct costs (incl. VAT): R4,560 Lease term: 5 years / Useful life: 6 years At lease inception, it was reasonably certain that ownership of the asset will transfer to CA Ltd at the end of the lease term. REQUIRED: Prepare all the necessary journal entries to be processed in the year ended 31 December Include deferred tax related entries. 18

19 LE2SS: Finance lease - lessee 19

21 LE3: Finance lease - lessee CA Ltd is a gas heater distributor and has a financial year end of 31 December. On 1 January 2014, CA Ltd entered into a finance lease agreement as a lessee. The details relating to the lease are provided : Cash selling price (excl. VAT): R800,000 Annual lease payments (in arrears): R228,000 Guaranteed residual value: R136,800 Unguaranteed residual value: R57,000 Initial direct costs (inc. VAT): R4,560 Lease term: 5 years / Useful life: 6 years At lease inception, it was not reasonably certain that ownership of the asset will transfer to CA Ltd at the end of the lease term. REQUIRED: Calculate the carrying amount of the asset on 31 December

23 Lessee accounting: Operating leases Lease payments (excluding costs for services such as insurance and maintenance) under an operating lease shall be recognised as an expense on a straight-line basis over the lease term even if the payments are not on that basis (:33 - :34) SIC-15 Operating leases incentives / IE (PART B2) In negotiating a new or renewed operating lease, the lessor may provide incentives for the lessee to enter into the agreement (e.g. upfront cash payments, reimbursement of relocation costs, reduced rentals, etc.) The lessee shall recognise the aggregate benefit of incentives as a reduction of rental expense over the lease term on a straight-line basis Costs incurred by the lessee, including costs in connection with a preexisting lease shall be accounted for by the lessee in the traditional manner (i.e. expensed when incurred) (:5 - :6) 23

24 LE4: Operating lease - lessee CA Ltd is a lessee and has a financial year end of 31 December. Operating lease #1 On 1 January 2012, CA Ltd entered into a three year operating lease with an annual payment of R300,000 and a 10% per annum escalation clause. Lease instalments are payable in arrears on 31 December each year. Operating lease #2 On 1 January 2013, CA Ltd entered into a four year operating lease. In order to incentivise CA Ltd, the lessor reimbursed CA Ltd s relocation costs amounting to R10,000. The annual lease payment is R40,000 payable on 31 December each year. Annual escalation rate is 10% per annum. REQUIRED: Process all the journal entries for year ended 31 December Ignore VAT but include deferred tax related entries 24

25 LE4SS: Operating lease - lessee 25

26 LE4SS: Operating lease - lessee 26

27 LE5: Onerous contract vs impairment CA Ltd is a lessee and has a financial year end of 31 December Operating lease On 1 January 2012, CA Ltd entered into a five year operating lease with an annual payments of R300,000. On 31 December 2013, CA Ltd wished to exit the lease. The following were its options relating to the lease: CA Ltd may sublease the asset for the remaining term at an amount of R220,000. The appropriate discount rate was 12% p.a. CA Ltd may pay the termination penalty of R515,000. Finance lease On 1 January 2012, CA Ltd entered into a five year finance lease with annual payments of R300,000. On 31 December 2013, CA Ltd wished to exit the lease. The interest rate implicit in the lease was 20% p.a. The recoverable amount of the asset was R500,000 as at 31 December REQUIRED: Prepare all the necessary journal entries in 2012 and

28 LE5SS: Onerous contract vs impairment 28

29 Lessor accounting: Finance leases Initial recognition Lessors shall recognise assets held under a financial lease as a receivable at an amount equal to the investment in the lease (:36) For a lease other than those involving manufacturers and dealer lessors (e.g. banks), indirect costs are included in the initial measurement of the receivable and reduce the amount of income recognised over the lease term (i.e. the rate implicit in the lease will incorporate as defined) However, the indirect costs for manufacturers are recognised as an expense when the selling profit is recognised and therefore these costs are not taken into account in the determining the rate implicit in the lease (:38) 29

30 Lessor accounting: Finance leases Subsequent measurement Manufacturer or dealer lessors shall account for the transaction as an outright sale and recognise selling profit or loss (:42) The sales revenue recognised is the fair value of the asset or, if lower, the present value of the minimum lease payments accruing to the lessor, computed at a market rate of interest The cost of sale recognised is the cost, or carrying amount if different, or the leased property less the present value of the unguaranteed residual value (:44) If artificially low rates of interest are quoted (for instance, to attract customers), the sales revenue (consequently the selling profit) shall be restricted to that which would apply if a market rate of interest were charged (:42) 30

31 Lessor accounting: Finance leases Subsequent measurement If there has been a reduction in the estimated unguaranteed residual value, the income allocation over the lease term is revised and any reduction in respect of amounts accrued is recognised immediately (:41) The finance income is recognised based on the effective interest rate method (i.e. based on the amortisation of the lease receivable) using the market rate Lease payments, excluding costs for the services, are applied against the gross investment in the lease (i.e. principal and the unearned finance income) (:40) Costs incurred by manufacturer or dealer lessors in connection and arranging a lease shall be recognised as an expense when the selling profit is recognised (:42) 31

32 LE6: Finance lease - lessor CA Ltd is a gas heater manufacturer and has a financial year end of 31 December. CA Ltd is a lessor. Details relating to the lease are below: Initial direct costs (incl. VAT): R4,560 Cost price (excl. VAT): R640,000 Gross margin: 25% on cost price Annual lease payments (in arrears): R228,000 Guaranteed residual value: R136,800 Unguaranteed residual value: R57,000 Market rate: 15% p.a. Lease term: 5 years REQUIRED: Determine the appropriate rate to use in order to determine revenue 32

33 LE6SS: Finance lease - lessor 33

34 LE7: Finance lease - lessor CA Ltd is a financing house which specialises in the distribution of gas heaters and has a financial year end of 31 December. CA Ltd is a lessor. Details relating to the lease are below: Inception date: 1 January 2012 Initial direct costs (incl. VAT): R4,560 Cost price (excl. VAT): R640,000 Gross margin: 25% on cost price Annual lease payments (in arrears): R228,000 Guaranteed residual value: R136,800 Unguaranteed residual value: R57,000 Market rate: 15% p.a. Lease term: 5 years REQUIRED: Determine the appropriate rate to use in order to determine revenue 34

36 LE8: Finance lease - lessor CA Ltd is a gas heater manufacturer and has a financial year end of 31 December. CA Ltd is a lessor. On 1 January 2014, CA Ltd entered into the following lease arrangement: Initial direct costs (incl. VAT): R4,560 Cost price (excl. VAT): R640,000 Gross margin: 25% on cost price Annual lease payments (in arrears): R228,000 Guaranteed residual value: R136,800 Unguaranteed residual value: R57,000 Market rate: 15% p.a. Interest implicit in the lease: 13.5% p.a. Lease term: 5 years REQUIRED: Prepare all the necessary journal entries for the year ended 31 December Include VAT and deferred tax related entries. 36

39 LE9: Change in residual value Consider the same facts as in LE8. However, the estimate of the unguaranteed residual value decreased to R40,000 on 31 December REQUIRED: Process the journal entry to process the change in estimate in the financial records of CA Ltd for the year ended 31 December

40 LE9SS: Change in residual value 40

41 Lessor accounting: Operating leases Lessors shall present assets subject to operating leases according to the nature of the asset (:49) Lease income (excluding costs for services such as depreciation, insurance and maintenance) under an operating lease shall be recognised as an expense on a straight-line basis over the lease term even if the receipts are not on that basis (:51) Initial direct costs incurred by the lessors in negotiating and arranging an operating lease shall be added to the carrying amount of the leased asset and recognised as an expense over the lease term on the same basis as the lease income (:52) SIC-15 Operating leases incentives / IE (PART B2) The lessor shall recognise the aggregate cost of incentives as a reduction of rental income over the lease term on a straight-line basis (:4) 41

42 LE10: Operating lease - lessor CA Ltd is a lessor and has a financial year ending 31 December Details relating to the leases are below: Operating lease #1 On 1 January 2012, CA Ltd entered into a three year operating lease with an annual payment of R300,000 and a 10% p.a. escalation clause. Lease instalments are payable on 31 December each year. Operating lease #2 On 1 January 2013, CA Ltd entered into a four year operating lease. In order to incentivise the lessee, CA Ltd reimbursed the lessee s relocation costs amounting to R10,000. The annual lease payment is R40,000. Annual escalation rate is 10% p.a. REQUIRED: Process all the journal entries for year ended 31 December Ignore VAT but include deferred tax related entries. 42

43 LE10SS: Operating lease - lessor 43

44 LE10SS: Operating lease - lessor 44

45 LE10: Sale and finance lease back CA Ltd is a lessee and has a financial year end of 31 December. CA Ltd entered into a sale and finance lease arrangement. Details of the agreement and the asset are provided below: Leased asset Acquisition date: 1 January 2012 Original cost (base cost): R400,000 Wear & Tear: S12C on new asset Useful life: 5 years Lease arrangement Inception date: 1 January 2013 Selling price: R500,000 Fair value of the asset: R480,000 Lease term: 4 years Interest rate implicit in the lease: 11.5% p.a. REQUIRED: Prepare ALL journal entries, including tax related entries. Ignore VAT. 45

46 LE11SS: Sale and finance lease back 46

47 LE11SS: Sale and finance lease back 47

48 Sale and operating lease back If the transaction is established at fair value, any profit or loss shall be recognised immediately If the sale price is below fair value any profit or loss shall be recognised immediately if the loss is compensated for by future lease payments at below market price, it shall be deferred and amortised in proportion to the lease payments over the lease term If the sales is above fair value, the excess over the fair value shall be deferred and amortised over the lease term. Any excess of fair value over carrying amount is recognised immediately If the fair value is less than the carrying amount, a loss equal to the amount of the difference between the carrying amount and the fair value shall be recognised immediately (:61 :63) 48

49 LE12: Sale and operating lease back On 1 April 2015, CA Ltd sold a plant for R130,000 on sale and operating lease back basis. The lease term was agreed to be four years from that date. The carrying amount of the plant was R100,000 and fair value of the plant was R90,000. The year end of CA Ltd is 31 December. REQUIRED: Prepare journal entries to account for the above transaction in the financial records of CA Ltd. Ignore tax. 49

50 LE12SS: Sale and operating lease back 50

51 Thank you Presenter s details rendani.muthelo@endunamoo.co.za ECC Administrator Livhuwani Muthelo admin@endunamoo.co.za ecc@endunamoo.co.za