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Topic 7 - Liabilities and Leasing - Notes

This document outlines the key learning outcomes and content covered in a topic on accounting for liabilities and leases according to IFRS 16. The topic discusses the benefits of leasing, distinguishes between operating and finance leases, and explains how to account for various lease types in the books of lessees and lessors. It addresses operating leases, finance leases, sale-and-leaseback transactions, and leases where the lessor is a dealer or manufacturer. The goal is for students to understand and apply the accounting treatment for different kinds of leases according to IFRS 16.

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Vanshika Tilak
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33 views24 pages

Topic 7 - Liabilities and Leasing - Notes

This document outlines the key learning outcomes and content covered in a topic on accounting for liabilities and leases according to IFRS 16. The topic discusses the benefits of leasing, distinguishes between operating and finance leases, and explains how to account for various lease types in the books of lessees and lessors. It addresses operating leases, finance leases, sale-and-leaseback transactions, and leases where the lessor is a dealer or manufacturer. The goal is for students to understand and apply the accounting treatment for different kinds of leases according to IFRS 16.

Uploaded by

Vanshika Tilak
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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AF210

Topic 7
Accounting for Liabilities & Leases
(IFRS 16)

Presented by:
Mr. Selvin Prasad
(Bcom, PGCTT, PGDCRM, Mcom, PhD in
progress)
The University of the South Pacific, Fiji
Learning Outcomes
On completion of this topic, you should be able to
1. Discuss the benefits of leasing
2. Distinguish between operating and finance leases
3. Account for operating leases in the books of the lessee
and lessor
4. Determine the implicit interest rate for a finance lease
5. Account for finance leases in the books of the lessee and
lessor
6. Account for a sale and lease-back in the books of the
lessee and lessor
7. Account for a finance lease where the lessor is a dealer
and/or manufacturer
LO 1

Benefits of Leasing

Pay to use an item over one or more periods,


rather than purchasing it outright
LO 1
Benefits
1. Cash Flows
 Periodic lease payments reduce pressure on cash
reserves
 Outright purchases require a large outflow upfront
2. Flexibility
 Lease term may be less than asset’s useful life
 Lessee may be able to purchase asset for a bargain
price at the end of the lease term
3. Technical Support
 Lessee may benefit from asset maintenance by the
lessor during the lease term
LO 2

Two types of Leases

Leases were previously covered by


IAS 17 which has recently been
replaced by IFRS 16.
LO 2
Differential Treatment
Lessees and lessors are subject to different guidelines.
1.For lessees, IFRS 16 provides a single lessee
accounting model,
 Required to recognise assets and liabilities for all
leases unless the lease term is 12 months or less
or the underlying asset has a low value.
2.However, lessors continue to classify leases as
operating or finance
 IFRS 16’s approach to lessor accounting is
substantially unchanged from IAS 17.
LO 2

Classification (for Lessors only)

Are risks & rewards of ownership substantially


transferred to lessee?
Yes classify as finance lease
No classify as operating lease
LO 2
Risks
Who (lessor or lessee) loses out if:

1.The lease is cancelled


 E.g. does the lessee still have to meet the lease
payments?
2.The asset is idle
 Due to bad weather, lack of customers, technical
problems etc?
3.The asset becomes technically obsolete
LO 2
Rewards
Examples

1.Who makes decisions about utilising the asset? (issue


of control )
2.Who uses the asset for the majority of its useful life?
(issue of future economic benefits)
3.Who owns the asset at the end of the lease term?
LO 2

Problems with IAS 17


Some items met the definition of assets and liabilities
but did not appear on the Balance Sheet
 Incentives to misclassify leases as operating leases
 Classification as a finance lease may have adverse
impacts on a lessee’s financial statements e.g.
1.Increases non-current assets
i.e. reducing ROA ratios
– Increases non-current liabilities
i.e. adversely affecting debt/equity ratios
– Depreciation and interest charges may exceed
lease payment in early years of lease
i.e. resulting in lower profits
LO 3

Accounting for Operating Leases

Refer to Lecture Examples


LO 3

Accounting & Disclosure


Lessor Lessee
Balance  Recognise the  Not recognized (i.e.
Sheet underlying asset and liability
Asset remain (off balance
 Capitalise sheet)
initial direct  In the notes,
costs (IDC) disclose
commitments over
lease term
Profit &  Lease Revenue  Lease Expense
Loss  Depreciation
Statement
LO 4

Implicit Rate of Interest

For Finance Leases


LO 4
Measurement at Inception
Initially measure the lease at the lower of
1. Fair Value; and
2. Present Value of Minimum Lease Repayments (MLR)
MLR includes
1. Annual lease repayments
 Subtract executory costs
 e.g. repairs and maintenance paid by lessor and
recouped from lessee
2. % of residual value guaranteed by lessee
 Lessor includes both guaranteed & unguaranteed
residual
3. Bargain purchase option
LO 4
Implicit Interest Rate
This is the interest rate which equates 1 and 2
Plus
1 Present Value of MLR i.e. Present Value of
annual repayments Unguaranteed Residual
excluding executory costs
Residual value
guaranteed by lessee
Bargain purchase price

2 Fair Value Initial direct costs of the


lessor e.g. commissions,
legal fees and
documentation costs
LO 5

Accounting for Finance Leases

Refer to Lecture examples


LO 5

Accounting & Disclosure


Lessor Lessee
Balance Lease Receivable  Right to Use Asset
Sheet  Lease Liability
In the notes, disclose
commitments
over lease term
Profit & Loss Interest Revenue  Interest Expense
Statement  Depreciation

Faithfully represent underlying economic reality


A leased asset is controlled by the lessee, not the lessor
LO 6

Sale and Lease-back

Refer to Lecture Examples


LO 6
Rationale
The owner of an asset may
 Still need to use the asset; and simultaneously
 Need cash urgently

In such a scenario, the owner may seek a financier who


will
 Buy the asset from the owner, usually at fair value
 Lease it back to the owner, probably for the
remainder of its useful life
 Make a return by charging interest
LO 6

Accounting Treatment
1. Classification
 Apply the same test as for other leases
 Refer to IFRS 16

2. Gain on sale
 The seller/lessee classifies this as a deferred gain
 The gain is amortised over the lease term, because
the sale is part of the lease arrangement
LO 7

Lessor Dealers/Manufacturers

Refer to Lecture Examples


LO 7

Rationale
Dealers or manufacturers

1. Their primary business is to sell certain items e.g.


vehicles, machines, office equipment which may be
 Manufactured internally; or
 Purchased from another supplier

2. In addition, they may also offer finance arrangements


to customers
 e.g. vehicle dealers
LO 7

Accounting Treatment
1. Classification
Apply the same test as for other leases
 refer to IFRS 16

2. Recognise
a)Revenue based on Fair Value
b)Lease Receivable based on lower of Fair Value and
Present Value
c)Reduction in Inventory, based on Cost
d)Cost of Sales, based on remainder/difference
AF210

Topic 7
Accounting for Liabilities & Leases
(IFRS 16)

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