Leasing

Pre-lesson
 Go through summary notes for lease under AFA
Lease (IAS 17)
 2 types of leases
1. Finance lease
2. Operating lease
 Substance over form
 Commercial substance of a transaction should be reflected in the
financial statements rather than the legal form in order to represent
transaction faithfully.
Types of lease
Finance Lease
 Risk & rewards of ownership transferred from lessor to lessee
 How ?
1. Ownership of assets transfers to lessee by end of lease term
2. Option to purchase the assets at such a price that its reasonably certain from
outset the option will be exercise
3. Lease term the major part of the economic life of the assets
4. At inception of lease the PV of min lease payments amount to at lease
substantially all the FV of the leased assets
5. Leased assets a specialised nature that only the lessee can use them without
major modification
 Other criteria
 If cancellation losses borne by lessee
 Fluctuation in FV at end of lease borne by lessee
 Option to extend lease for a secondary period at below market rent
Lease term for Finance lease

 Lease term can be divided into 2 periods

1. Primary period- usually non-cancellable period
 Protects the lessor to ensure loan is repaid to him/her
2. Secondary period- extended period of lease –option given to
lessee
 Usually nominal amount (since lessee has repaid the loan amount in
primary period
 Sufficient to just cover lessor’s administrative cost
 Protects the lessee (lessee has acquired the ownership of asset without
legal title)
 This period counted as part of lease term if lessee certain to exercise this
option to extend lease
 If lessee wishes to terminate the lease at this moment, equip will be sold
and substantially all the sale proceeds goes to lessee.
Acc’ing Treatment for Finance Lease

 Assets held : treated as NCA

 Lower of FV or PV of min lease payments at inception
 Initial deposit is part of cost of NCA
 Depreciated over the shorter of lease term or asset’s useful life
 Payables : split into current (payable within 12 months) and non-
current lease liabilities
 Finance Lease
 3 methods but ICAEW allocate interest/finance cost using the
following method
1. Actuarial method (follows AFA)

 Total Interest/finance cost calculated as follows:

Total Lease Payments X
Less : Initial cost of asset (X)
Total finance charge X
Disclosure

 To disclose either
1. Gross basis
2. Net basis
 Refer to worked example P298 & interactive qn 3 P300
Operating Lease

 Disclosure : non-cancellable operating lease, to show in

commitment notes.
 Refer to interactive qn 6 p304
 Land & Building

Lease of land & building where lease payment is combined as

one
 One can be finance, another as operating lease
 How then to split the MLP?
 Proportionate to the fair value of leasehold interest
 If can’t split, treat everything as finance lease
 If land value is immaterial, treat entire amount as buildings
 Refer to interactive qn8
Sales & leaseback Finance lease
If CA> FV prior to sale, the assets should be written down to FV
b4 sales & loss recognised as an impairment loss.
Refer to interactive qn 9
Sales & Leaseback Operating Lease
If Sale Price = FV (selling at market value)
 profit or loss recognised immediately
If sale price < FV (selling at a loss, compared to market)
 For profit, recognise immediately
 For loss, recognise immediately unless lease rentals are below
market rentals in which case, it should be deferred & amortised
over lease period.
If sale price >FV (above market gain)
 “normal” gain –recognised immediately
 “above market” gain –deferred & amortised
Try interactive qn 10.
Steps (Sales & leaseback operating lease)

1. Compare CA >FV  Impairment loss & adjust CA

2. Calculate gain/loss by SP-CA
3. Identify the scenario & account for it accordingly.
 Refer to previous slide.
Discussion questions

 Question bank p38 Q24 info (2)

 Do 24.1(a) & (b) for info (2). (4marks in total)
 Question bank p43 Q28. How does info (2) affect the 1)
Financial position, 2)profit and loss statement 3)Cash flow
statement?
 Question bank p82 Q59.1 for info 2
 Question bank p19 Q10.1 for info 2-how does it affect b/s &
p/l?
 …Dec 2016 Mock Exam 2 Q3

Spannick plc leases its Head Office from a property investment company,
Fortwell plc. The inception of the current lease was 1 October 2011. The
lease term is 20 years, which corresponds to the remaining useful life of
the building. Spannick plc paid an initial deposit of £20,000 and was
required to pay £50,000 on 30 September each year, commencing on 30
September 2012. Both the initial deposit and the payment made on 30
September 2012 have been charged to rental expense in profit or loss.
The market price of the building on 1 October 2011 was £750,000. The
interest rate implicit in the lease is 4% and the present value of the
minimum lease payments is £700,000.

Requirements : Explain the required IFRS accounting treatment of the

issue above, preparing relevant calculations and discussing the impact,
where appropriate, on the statement of profit or loss, statement of
comprehensive income and statement of financial position . (6marks)
Self attempt questions

 Question bank p22 Q11 for info 3-how does it affect b/s &
p/l?
 Question bank p27 Q14 for info 5-how does it affect b/s &
p/l?
 Intangible Assets
Chapter 5
18
Intangible
19 Assets

Two main Intangible Assets

1. Goodwill from business combinations – IFRS3
2. Other Intangible Assets – IAS 38
 20 Goodwill

Goodwill = the excess of the value of a business over the

sum of its identifiable net assets
1. Internally generated goodwill – eg. good relationship
between business and it’s customers
 Should not be recognised as an asset
2. Purchased goodwill (IFRS 3) – when a business is
acquired
 No amortization but impairment review
 21 Intangible Assets – IAS 38
Intangible Assets = no physical substance
=> Definition
1. Identifiable and
 Separable; or
 Arise from contractual or other legal rights

2. Under the control of the entity

 Able to enjoy the future economic benefits from the asset
 Able to prevent access of others to those benefits,
eg. Control over technical knowledge or know-how only exists if it is
protected by legally enforceable rights – patent
Customer list that can be traded
A talented employee is not an intangible asset.
IA
22 Recognition

Recognition criteria
1. Probably future economic benefits
2. Cost can be measured reliably
1. Internally generated asset
 Measurement: at cost

2. Acquired IA (eg under business combination)

 Measurement: FV
 Assume to meet recognition criteria
 Cost comprise
 Purchase price, inc non-refundable tax & duties
IA
23
 Any directly attributable cost – labor, legal & cost of testing

Expenditure on IA
 Treat as expense unless :
 Part of cost of an asset which meets the recognition criteria
 Arise in a biz combination
 Eg of expenditure to be treated as exp :
 Start up cost
 Cost of introducing new product
 Training
 Advertising and general OH cost
 Business relocation & reorganisation cost
 Refer to worked example p229
 Subsequent expenditure on IA –rarely recognised!
Internally
24 generated IA
 Expenditure incurred in the research phase should be
expensed as incurred
 Expenditure incurred in the development phase should be
recognised as an IA
 IAS 38 prohibits recognition of the following internally
generated IA
 internally generated brands
 Mastheads
 Publishing titles
 Customer lists
 25
R&D
 R-Expensed off as insufficient certainty that research will
generate future economic benefits
 D-recognised as IA if ALL the following criteria are met:
1. Technical feasibility of completing the IA so that it will be available
for use/sale
2. Intention to complete the IA and use/sell
3. The ability to use/sell the IA
4. Able to provide evidence that IA will generate future economic
benefits. Eg. Demonstrate existence of a market for the IA,
demonstrate the usefulness of the IA
5. The availability of adequate technical, financial resources etc to
complete the development & use/sell it
6. Expenditure on development can be measured reliably
26 R&D
 Cost of IA is the sum of expenditure incurred from the date
when the IA asset first meet the recognition criteria.
 Earlier cost to expense off

 Refer worked example P232

Measurement of IA after recognition
27
 Cost model
 Revaluation model
Measurement
28 of IA after recognition

 Revaluation model- used when there is a active market available,

however, usually N/A as they(patent, copyrights) have unique sale
value and not comparable/homogenous with other similar IA.
 Interactive qn p237
 Impairment (similar to Asset)
 Recoverable amount < CA
 Amortization
 Start when asset available for use
 Should reflect the pattern in which the asset’s future economic benefits are
consumed
 Disposal-refer to worked example P235
 Disclosure- refer to mock exam in next slide
 29 In class discussion

 Question bank p39 Q25 (3)

 Determine the amount that should be expensed off, the amount that
should be capitalised.
 Question bank p23 Q12 for info 2-how does it affect b/s &
p/l?
 Question bank p27 Q14 for info 2-how does it affect b/s &
p/l?
 Question bank p80 Q57, attempt 57.1 for info 3
 2017 Jan Mock Exam Q2
In the30previous financial year Prime plc had commenced work on the development
of a new type of microprocessor. In the period up to 31 March 2006 research costs
of £76,000 had been incurred and written off. In April 2006 it became clear that the
project met the relevant criteria for capitalisation of development expenditure in
accordance with IAS 38, Intangible Assets. In the period from April 2006 to 30
September 2006, when production began, development costs of £220,000 were
incurred. Sales in the six months to 31 March 2007 have totalled £250,000 and
projected sales for the next two years are £520,000 and £480,000 respectively. After
that the technology will have been superseded. Prime plc is also producing and
selling a solar-powered torch for which it needed a component made in China. An
import licence for the component was granted on 1 April 2005. The licence cost
£140,000 and expires on 31 March 2009.
 31
2017 Jan Mock Exam Q2

Requirement
Prepare the intangible assets note in respect of the information above for the year
ended 31 March 2007
2017 Jan Mock Exam Ans Q2
32
Practice
33 2016 June Paper Qn 2.2
The draft financial statements include research and development expenditure of
£390,500 within intangible assets. Luigi’s working papers show that this all related to
the development of a new waterproof fabric, which was assessed as being
commercially viable on 31 March 2015. The development of the fabric was
completed on 31 August 2015, and the first fabric was delivered to customers on 1
September 2015. The amount capitalised is made up as follows:

Research costs £ 100,000

Development costs incurred prior to 31 March 2015 £ 55,500
Development costs incurred from 1 April 2015 to 31 August 2015 £225,000
Marketing costs £10,000
£390,500

No amortisation has been charged on this amount. The fabric technology is estimated
to have a three-year life before it is superseded by superior products.
Practice
34 2016 June Paper Qn 2.2

Required
1. Explain the required IFRS financial reporting treatment of
above issue in the finanical statements of Naples plc for the
yr ended 31 Dec 2015. Prepare all relevant calculations & set
out the required adjustments in the form of journal entries.
(7.5marks)
2. Describe the differences between IFRS & UK GAAP in
respect to the financial reporting treatment of issue above.
(2.5marks)
 Answer : 2016 June Paper 2.2
35

Research and development expenditure In accordance with IAS 38, Intangible

Assets, all expenditure that arises in the research phase should be recognised as
an expense when incurred because there is insufficient certainty that the
expenditure will generate future economic benefit. Development costs must be
capitalised only once the IAS 38 criteria are met.
Therefore the costs of £55,500 incurred before the project was assessed as being
commercially viable should not have been capitalised. The marketing costs
should not have been capitalised because they cannot be directly attributed to
producing or preparing the asset for its intended use. The cost of the intangible
asset should therefore be reduced by £165,500 (390,500 – 225,000), leaving a
carrying amount of £225,000. To correct this the journal entries should be:

Dr Profit or loss account £ 165,500

Cr Intangible assets – cost £ 165,500
An36intangible asset with a finite useful life, as here, should be
amortised over its expected useful life. Luigi should therefore have
charged amortisation for four months of the current year, over an
expected three-year useful life, a charge of £25,000 (225,000 x
4/36). The journal entries should have been:

Dr Amortisation charge £ 25,000

Cr Intangible assets – accumulated amortisation £ 25,000

The carrying amount of intangible assets at 31 December 2015 will

therefore reduce by £190,500 (165,500 + 25,000)/will be £200,000
(225,000 – 25,000).
 Q4
Exam
Mock
Mar
2015
37

Required
1.Explain the required IFRS financial reporting treatment of above issue. Prepare all relevant
calculations where relevant. (4marks)
Ans
38 : 2016 Mock Exam Q4
The technical and commercial success of this new product was
proven on 31 March 2007, so the £240,000 expenditure incurred
after that date should be deducted from operating expenses and
recognised as a development cost intangible asset. The asset
should be amortised from 1 October 2007 when the product was
launched on to the market. Its useful life is estimated at six years,
so amortisation should be at the rate of £40,000 per annum and
£20,000 in the year to 31 March 2008. The net effect on profit is
an increase of £220,000 (240,000 – 20,000), of which £132,000
(60%) is attributable to the owners of Warren and the remainder
to the non-controlling interest in this subsidiary
Self
39 attempt questions

 Leases P313 Q6, 8-11

 IA P241 Q1-7