LEASES SCOPE/EXCLUSIONS

Transcription

1 LEASES SCOPE/EXCLUSIONS 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. ASPE 3065 Exclusions IAS 17 Exclusions This section does not cover leasing agreements pertaining to the rights to explore for or to exploit natural resources, nor does it apply to licensing agreements for items such as motion pictures, videotapes, plays, manuscripts, patents and copyrights, etc. Operating Lease This Standard shall be applied in accounting for all leases other than: (a) leases to explore for/ use minerals, oil, and similar non-regenerative resources (b) licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights, etc. This Standard shall not be applied as the basis of measurement for: (a) property held by lessees that is accounted for as investment property; (b) investment property provided by lessors under operating leases ; (c) biological assets held by lessees under finance leases ; or (d) biological assets provided by lessors under operating leases (see IAS 41). ACCOUNTING TREATMENT BY A LESSEE ASPE 3065 Classification: Capital or Operating Lease Substantially all of the rewards 1 and risks 2 of ownership have been transferred to the lessee when ONE of the following 3 tests is met: Test #1: Is there a Transfer of Test #2: Is the Lease Test #3: Is the PV of minimum lease Ownership at end of lease term or Term 75% of Economic payments 5 90% of a Bargain Purchase Option 3? Life 4 of the asset? asset s Fair Value? Capital Lease Operating Lease 1 Rewards of ownership: expectation of profits and gain from value appreciation. 2 Risks of ownership: possibilities of losses from idle capacity or obsolescence. 3 Bargain purchase option: allows lessee to purchase leased property for a price sufficiently lower than FV. 4 Economic Life: remaining period during which the property is expected to be economically usable. 5 Minimum Lease payments: Minimum rental payments 6 + guaranteed residual value + penalty for not renewing or extending lease + bargain purchase option. 6 Minimum rental payments: Regular payment to lessor, exc l executory costs (ie. insurance, maintenance, tax). Insufficient Criteria (to be considered by lessees and lessors) The following by themselves are not sufficient evidence of a transfer of risks and rewards: 1. Lessee pays costs incident to ownership (in all leasing agreements, lessee pays for these costs). 2. Lessee has option to purchase asset for lessor s unrecovered investment (no assurance that lessee will exercise). 3. Leased property is special purpose to the lessee ( special purpose is relative and hard to define). IAS 17 Classification: Finance or Operating Lease Substantially all of the benefits and risks of ownership have been transferred to the lessee when ONE of the following 4 tests is met. Test #2: Test #3: Test #1: Is the lease term a major Do PV of minimum lease Is there a transfer of portion of the economic life of payments (excluding executory ownership or a bargain the lease asset? (no costs) cover substantially all of purchase option? (same as quantitative threshold, ASPE the FV of the leased asset (no ASPE) specifically states 75%) quantitative threshold, ASPE specifically states 90%)? Finance lease (called Capital lease under ASPE) Test #4: (additional IFRS test) Are the leased assets of such a specialized nature that only the lessee can use them 1 without P a g e major modifications? (no equivalent test under ASPE)

2 IAS 17 provides additional conditions that may lead to classification as a finance lease: the lessor s losses associated with the cancellation are borne by the lessee (if lessee can cancel the lease) the lessee can continue the lease for a secondary period at a rent substantially lower than market rent gains/losses from FV fluctuation of the residual accrue to the lessee (e.g. a sales rebate approximating sales proceeds at the end of the lease) Lease including Land and Building elements If land ownership will pass to lessee at end of lease term, classify elements separately on lessee s books. Otherwise, assess each element separately, allocating min. lease payments in proportion to relative FVs. If land is immaterial, treat land and building together as a single lease, using building s economic life. N.B.: Separate classification for each element NOT required when classification is investment property (IAS 40) Property interest is a finance lease and the fair value model is used for the asset recognized. Operating Lease Accounting Treatment LESSEE IAS 17 ASPE 3065 Lease Payments Other Recognized as an expense on a straight-line basis over the lease term even if payments are not so, unless another systematic basis is more representative of the benefit received, SIC 15: Costs incurred (including costs in connection with a pre-existing lease) are accounted for in accordance with the applicable standard. Includes costs effectively reimbursed through an incentive agreement. Incentives SIC 15: Incentives may be provided by a lessor to induce a lessee to enter into an agreement. Recognize aggregate benefit as a reduction of rental expense over the lease term. (Straight-line unless another systematic basis is more representative.) Disclosures In addition to IFRS 7: Total future minimum lease payments for noncancellable leases for: <1 year, 1-5 years, and >5 years Total future minimum sublease payments expected to be received for non-cancellable subleases Lease/sublease payments expensed in the period General description of significant leasing arrangements (including basis to determine contingent rent payable, renewal/purchase options, and restrictions) Finance Lease Treatment Same as IAS Upon renegotiation and lease term extension, continue to account as the original lease until the original lease term expires. Difference between payments is related to the term of the lease extension. Payments under a residual value guarantee are included in lease payments when it is likely the guarantee will be required. Lease inducements reduce the lease expense over the lease term. Future minimum lease payments (aggregate and for each of the five succeeding years) Nature of other commitments under the leases Exception: leases with an initial term of a year or less do not require these disclosures LESSEE IAS 17 ASPE 3065 Recognition Amount Discount Rate Allocation of Min Lease Payment Lower of: a) Fair value of leased property; and b) PV of min lease payments If practical, use implicit rate* and if not practical use incremental borrowing rate** Min. lease payments split between the finance charge and the reduction of the outstanding liability. The finance charge is at PV of min lease payments excluding executory costs*** but cannot exceed the fair value of the leased asset Lower of: a) Implicit interest rate; or b) Incremental borrowing rate Lease payments shall be allocated to a reduction of the obligation, interest expense and any related executory costs. The interest 2 P a g e

3 a constant rate based on the outstanding liability expense is calculated by applying the discount rate against the outstanding liability Contingent Rent Expensed Same as IAS 17 Direct**** Cost Costs directly attributable to specific leasing specific guidance activities are added to the asset Depreciation Amount Presentation Disclosures Same as guidance provided under IAS 16 and IAS 38 If lessee will not obtain ownership then depreciate over the shorter of the lease term and useful life Statement of Financial Position Asset Liability Each class of asset, the net carrying amount, reconciliation between the total of future minimum lease payments and their PV. Total of future minimum lease payments, and their present value for each period (<1 yr, 1-5 yrs, and >5 yrs) Contingent rents recognized as an expense Total of future minimum sublease payments expected to be received under non-cancellable subleases General description of significant leasing arrangements (including basis to determine contingent rent payable, renewal/purchase options, and restrictions) Same as guidance provided under 3061 Depreciate over lease term unless there is a term to pass ownership to lessee or a bargain purchase option exists. If either exists, amortize over economic life Present as: Asset separate from assets owned Liabilities separate from other long-term liabilities Lease obligations payable within a year should be classified as current liability Cost Accumulated amortization and amortization method used Interest rate Maturity date Amount outstanding If the leases are secured * implicit rate= the discount rate at inception date that causes the PV of (a) the min. lease payments and (b) the unguaranteed residual value to = the sum of (i) the FV of the asset and (ii) any initial direct costs of the lessor. ** incremental rate = rate would have to pay on a similar lease ***executory costs are costs related to the operation of the leased property (ie. insurance, maintenance cost) ****direct costs = costs directly attributable to negotiating and arranging a lease, (except for manufact./dealer) ACCOUNTING TREATMENT BY A LESSOR ASPE & IFRS Classification: Sales-Type, Direct Financing or Operating Lease From lessor s point-of-view, use the following to determine if the lease transfers substantially all of the risks and rewards of ownership to the lessee: Are any of the Lessee s capital lease criteria met? Is the credit risk associated with the lease normal 1? Operating Lease Are the unreimbursable costs to the lessor estimable? 2 IFRS does not explicitly state sales-type/direct finance lease but the application is similar to ASPE. Sales-Type Lease (ASPE: lessor is manufacturer/dealor) Does Leased Asset Value = Lessor s Book Value? Direct Finance (ASPE: lessor is primarily a financer) 3 P a g e

4 1 When considering collection risk associated with the lease, compare it to that of similar receivables 2 If costs to lessor are not estimable, the lessor may retain substantial risks associated with the leased asset N.B. A Lease can be a capital lease to the lessee but an operating lease to the lessor and if the lease is an operating lease to the lessee it will always be an operating lease to the lessor Accounting Treatment: Operating Leases LESSOR IAS 17 ASPE 3065 Asset Recorded according to nature of the asset specific guidance Lease Income Recognized in income on a straight-line basis over Same as IAS 17. lease term (even if the payments are not), unless another systematic basis is more representative of benefit pattern. Expenses Added to cost of assets (IAS 17.52) specific guidance Initial Direct Costs Initial direct costs added to carrying amount of leased asset. Recognized as an expense over the lease term on the same basis as the income. Initial direct costs (associated with a specific lease) are deferred and amortized over the lease term in proportion to the recognition of income. Depreciation In accordance with IAS 16 & 38 specific guidance Dealer Lessor recognition of selling profit because an operating specific guidance lease is not the equivalent of a sale Incentives SIC 15: Treated the same as initial direct costs. Recognize aggregate cost of incentives as a reduction of rental income over the lease term. (Straight-line unless another systematic basis is more representative of pattern that the benefit is diminished.) Disclosures In addition to IFRS 7: Total future minimum lease payments for noncancellable leases for each period (<1 yr, 1-5 yrs, and >5 yrs) Total contingent rents recognized as income during the period General description of leasing arrangements Cost of PP&E held for leasing purposes Amount of accumulated amortization of those properties Carrying amount of impaired operating lease receivables Amount of any related allowance for impairment Card Question #1: Company A enters into a 2-year lease with Company B. The first year s monthly payments are $2,000 each and the second year s monthly payments are $1,000 each (total $36,000). What is the journal entry under IAS 17 for the first month for Company A (lessee)? What are the entries for Company B (lessor)? Participation by a Third Party (ASPE ) A lessor can assign lease payments due under an operating lease to a third party. The transaction is accounted for as a secured loan by both parties when: o A guarantee exists that ensures the third party s investment will be recovered. o The third party looks to the seller rather than the property/lease to recover its investment. o The seller retains substantial risks of ownership. When the property is sold, the seller records proceeds of sale as a loan. o The interest rate to be used is that which would otherwise be negotiated for a loan under similar terms and conditions. Until the loan is paid, the seller records lease payments as revenue (even if paid directly to third party) and records as interest expense an appropriate portion of each rental payment with the remainder reducing the amount of the loan. 4 P a g e

5 Income types Initial direct costs Residual Value Capital/Finance Lease Accounting Treatment: IAS 17 Manufacturer or Dealer Finance income shall be based on a pattern reflecting a constant rate of return Profit or loss is in accordance with the policy followed by the entity for outright sales. If artificially low rates of interest are quoted, then use the market rate of interest. Profit or loss (at commencement, same as for outright sale) = PV min lease payments computed at a market rate Less: Cost or carrying value of the leased property o Less: Unguaranteed residual value Initial direct costs are included in the initial measurement of the finance lease receivable and reduce the amount of income recognised over the lease term. Reviewed regularly. If reduction in value: Change accounting using new estimate The reduction in net investment is charged to income Other Finance income shall be based on a pattern reflecting a constant rate of return Included in the initial measurement of finance lease receivable through the implicit interest rate. Reduces the amount of finance income recognized over the lease Same as manufacturer or dealer Presentation Shown as receivable equal to the net investment Same as manufacturer or dealer Disclosures In addition to IFRS 7: Same as manufacturer or dealer Reconciliation between gross investment and the PV of receivables Total contingent rents recognized as income during the period General description of leasing arrangements Gross investment and the PV of min lease payments for each period (<1 yr, 1-5 yrs, and >5 yrs) Capital/Finance Lease Accounting Treatment: ASPE Direct Financing Sales-Type Lessor Role Financial intermediate between manufacturer or dealer and a lessee Manufacturer or dealer effectively selling a product to lessee Income Types Finance income is recognized using the implicit rate after recognizing an equal amount of finance income to offset initial direct costs incurred in the period Finance Income = Total min lease payments net of any executory costs and related profit included therein; Profit or loss is recognized at time of transaction. Profit or Loss = PV of minimum lease payment net of executory costs and related profit therein; computed o Plus: Any unguaranteed residual value at the interest rate implicit in Less: cost or carrying value, if different, of leased property the lease Less: cost or carrying value, if different, of leased property Finance Income = Total min lease payments net of any executory costs and related profit included therein; o Plus: Any unguaranteed residual value Less: The aggregate present values Initial and Net of the balances: Same as Direct Financing 5 P a g e

6 Continuing Investment with Income Tax Factors: a) minimum lease payments receivable less any executory costs and related profit therein; b) the unguaranteed residual value of the lease property accruing to the lessor; c) unearned finance income, after deducting initial direct costs, remaining to be allocated to income over the lease term; d) the investment tax credit remaining to be allocated to income over the lease term; and e) future income taxes as a result of the lease, when predictable with reasonable assurance Above (w/o Tax) Same as a)-c) from above Same as Direct Financing Initial Direct Expensed as incurred and portion of unearned income is Expensed at inception of lease Costs recognized Residual Value Reviewed annually, and an upward adjustment is not made. Same as Direct Financing If decline: change accounting using new estimate reduction in net investment charged to income Presentation Net investment is shown separate from other assets. Net Same as Direct Financing investment includes: a) min. lease payments receivable less executory costs and related profit included therein; b) Plus: any unguaranteed residual value of the leased property; c) Less: unearned finance income remaining Investment tax credit is either: a) Deducted in computing the net investment; or b) Shown as deferred credit Net investment shall be segregated between current and long-term portions in a classified balance sheet Disclosures Net investment and implicit interest rate Same as Direct Financing IFRS Treatment: SALE AND LEASEBACK TRANSACTIONS A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset. The lease payment and the sale price are usually interdependent because they are negotiated as a package. 6 P a g e

7 Disclosures: Provisions of the agreement or terms of the sale and leaseback transactions ASPE Treatment: When there is interdependence between the sales and lease terms and inability to separate the sales and lease, it is a sale-leaseback transaction. Exception: When the leaseback is only a portion of the asset sold or only for a portion of the useful life (i.e. one floor of a tower, or lease is three years of a ten year useful life), it may be possible to separate the accounting aspects of the sale and the lease. Disclosure: significant guidance provided LEASE CLASSIFICATION CHANGES Lease classification made at inception of the lease Changes in estimates (economic life/residual value of leased asset) do not result in a new classification Changes in provisions, renewal/extension considered a new lease and may result in new classification ASPE: Additional guidance Point-of-view Classification Change Treatment Lessee Capital to Operating Asset and related obligation removed from books Net adjustment goes to NI for the period Lessor Sales-type/Direct financing to Operating Net investment removed from books; lease asset recorded at Lower of: Original Cost, Present FV or Present carrying amount Net adjustment goes to NI for the period IMPAIRMENT OF LEASE RECEIVABLES IAS 17: In accordance with IAS 36. ASPE 3065: Similar to ASPE 3856 If there is an indication that the lease receivables are impaired, the carrying amount is reduced (directly or by the use of an allowance account) to the highest of: (a) PV of future cash flows (discounted using current market rate of interest), (b) Amount realizable by selling the lease at the beginning of the period, (c) Amount realizable by exercising the rights to the property net of costs The impairment can be reversed in the future if conditions change up to the original carrying value. The reversal is recognized in net income in the period it occurs. IFRIC 4: DETERMINING WHETHER AN ARRANGEMENT CONTAINS A LEASE When to use IFRIC 4? When an entity enters into an arrangement of transaction(s) not in the legal form of a lease but it conveys a right to use an asset for a series of payments. (Excludes: public-to-private service concession arrangements) 7 P a g e

8 Topic A: whether the arrangement meets the definition of a lease in accordance to IAS 17 Is fulfillment of the arrangement dependent on use of specific asset(s)? t Lease Lease Does it convey right to use asset? One of: Right to operate in desired manner and control more than insignificant amount of output Right to control physical asset and controls more than insignificant amount of output Other parties cannot take more than an insignificant amount of output during term and price paid by purchaser per unit is not fixed or equal to market price Topic B: when assessment or reassessment of arrangement should be made to determine if it is a lease Assessment date should be the same as IAS 17. A reassessment after the inception of the arrangement is made only if any one of the following conditions is met (using facts as of date of assessment): There is a change in the contractual terms, unless the change only renews or extends the arrangement. A renewal option is exercised or an extension is agreed on if previously not in lease term. There is a change in the determination of whether fulfillment is dependent on a specified asset. There is a substantial change to the asset Topic C: how payments for the lease should be separated from other elements. Payments for the lease and other elements of the arrangement are to be separated on the basis of their relative fair values. The minimum lease payments for lease can be calculated by: Is it practical to separate payments for lease and other elements? Estimate lease payments with leases with comparable assets, OR Estimate other elements with comparable arrangements and deduct from total If finance Lease: recognize an asset and a liability at an amount equal to the fair value of the underlying asset. The liability is to be reduced as payments are made and an imputed finance charge on the liability recognized using the purchaser's incremental borrowing rate of interest. If operating Lease: treat all payments under the arrangement as lease payments but -disclose those payments separately from minimum lease payments of other arrangements that do not include payments for non-lease elements, and -state that the disclosed payments also include payments for non-lease elements in the arrangement. SIC 27: EVALUATING THE SUBSTANCE OF TRANSACTIONS INVOLVING THE LEGAL FORM OF A LEASE When to use: When an entity entered into a transaction or an arrangement with unrelated party/parties (an Investor) that involves the legal form of a lease, SIC 27 will provide guidance on: (a) how to determine whether a series of transactions is linked and should be accounted for as one transaction; (b) whether the arrangement meets the definition of a lease under IAS 17; and, if not, (i) whether a separate investment account and lease payment obligations that might exist represent assets and liabilities of the entity (ii) how the entity should account for other obligations resulting from the arrangement; and (iii) how the entity should account for a fee it might receive from an Investor. 8 P a g e

9 When to treat series of transactions as one transaction: Treated as one transaction when: A series of transactions that involve the legal form of a lease is linked and the overall economic effect cannot be understood without reference to the series of transactions as a whole. If one transaction: Accounting needs to reflect the substance of the arrangement and all aspects needs to be evaluated, with weight given to those aspects that have an economic effect. Indicators that individually demonstrate that an arrangement may not involve a lease under IAS 17 include: (a) entity retains all the risks and rewards incident to ownership of an underlying asset and same rights as before; (b) the primary reason is to achieve a particular tax result, and not for the right to use an asset; and (c) an option is included on terms that make its exercise almost certain. Indicators that collectively (more than one) demonstrate that a separate investment account and lease payment obligations do not meet the definitions of an asset and a liability and shall not be recognized by the Entity include: (a) entity not able to control the investment account for own objectives and not obligated to pay lease payments; (b) the entity has only a remote risk of reimbursing the entire amount of any fee received; (c) other than the initial cash flows at inception of the arrangement, the only cash flows expected under the arrangement are the lease payments that are satisfied solely from funds withdrawn from the separate investment account established with the initial cash flows. Indicators that individually demonstrate that recognition of the entire fee as income when received, if received at the beginning of the arrangement, is inappropriate include: (a) obligations either to perform or to refrain from certain significant activities are conditions of earning the fee, and therefore execution of a legally binding arrangement is not the most significant act; (b) limitations are put on the use of the asset that have the practical effect of restricting the use of the asset; (c) the possibility of reimbursing any amount the fee and paying some additional amount is not remote. The fee is to be presented in the statement of comprehensive income based on its economic substance and nature. Disclosure: An entity shall disclose the following in each period that an arrangement exists: (a) a description of the arrangement including: (i) the underlying asset and any restrictions on its use; (ii) the life and other significant terms of the arrangement; (iii) the transactions that are linked together, including any options; and (b) the accounting treatment applied to any fee received, the amount recognized as income in the period, and the line item of the statement of comprehensive income in which it is included. Each arrangement needs to be disclosed separately or in aggregate for each class of arrangement EXPOSURE DRAFT: LEASES Existing models require classification into finance or operating lease, leading to lack of comparability due to clear distinction between the two. In the future, guidance is moving towards all leases being classified as capital/finance. Main Proposal: Lessee: recognize asset representing rights to use leased term and liability to make payments. Lessor: recognize its right to receive lease payments and would either i) recognize a lease liability while continuing to recognize the underlying asset or ii) derecognize the rights in the underlying asset. Assets and liabilities are recognized as the longest possible lease term that is more likely than unlikely, using an expected outcome technique to reflect the lease payments, and updated when there are changes in facts that make it significantly different from prior period. Changes for Lessees: If they currently account for it as operating leases (recognize under the current period), they will be required to recognize the assets and liabilities under proposal. Changes for Lessor: accounting is very different - will be either derecognized or recognize asset and liability for underlying asset 9 P a g e

10 Card Question #2 & 3: ABC Corp leased a truck with an economic life of 7 years on January 1, 2010 from Truck Corp. The yearly rental is $5, due at the start of the year, for 3 years. There is no purchase option. The truck has been designed specifically for the use of the lessee. The incremental borrowing rate of the lessee is 10%, and the implicit rate of the lessor is 12%. Card Question #2: How should the lease be classified by ABC Corp (lessee) under IFRS? Test 1: Test 2: Test 3: Test 4: What is the entry to record the lease by ABC Corp (lessee) on Jan 1, 2010? Card Question #3: In addition to the facts in Card Question #2, assume that the credit risk of the lease is normal, unreimbursable costs to the lessor are $1,345 and the truck is sitting on the lessor s books at $15,000. How should Truck Corp. (lessor) classify the lease under ASPE? Test 1: Test 2: Test 3: Test 4: What are the entries to record the lease on Truck Corp. s (lessor) books? Supplementary Illustration: Using the same information as above, how would the lessee account for the lease until the second payment? (Other than initial entry) Payment *paid on Jan 1 Interest Expense Difference Obligation 1-Jan-10 $ 20, Jan-10 $5, $ - $ 5, $ 14, Dec-10 $5, $ 1, $ 3, $ 10, Dec-11 $5, $ 1, $ 4, $ 6, Dec-12 $ 7, $ $ 6, $ 0.00 January 1, 2010 Lease Obligation under Capital Lease Cash December 31, 2010 Interest Expense Lease Obligation under Capital Lease Lease Payable Depreciation Expense 4333* Acc'd Depreciation 4333* January 1, 2011 Lease Payable Cash * ($20, ) 3 year lease term = $3333 Question based on facts from Illustration 4.5 Chapter 12 of Kieso et al. (2003) Intermediate Accounting II. 10 P a g e