1 / 63

Leases March 8, 2011

Leases March 8, 2011. Jody Grewal , Kieng Iv, Lisa Ryerson, May Leung. AGENDA. Lessee (Classification, Accounting, Disclosures) Lessor (Classification, Accounting, Disclosures) Sales and Leaseback Impairment Classification Changes IFRIC 4/ SIC 27 Exposure Draft

claire
Download Presentation

Leases March 8, 2011

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. LeasesMarch 8, 2011 Jody Grewal, Kieng Iv, Lisa Ryerson, May Leung

  2. AGENDA • Lessee (Classification, Accounting, Disclosures) • Lessor (Classification, Accounting, Disclosures) • Sales and Leaseback • Impairment • Classification Changes • IFRIC 4/ SIC 27 • Exposure Draft • Financial Statements Example

  3. LEASE DEFINITION 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. (IFRS) Lease is the conveyance, by a lessor to a lessee, of the right to use a tangible asset, usually for a specified period of time in return for rent. (ASPE)

  4. LESSEE PERSPECTIVE

  5. Lessee Classification:Capital or Operating Lease (ASPE 3065) Substantially all of the rewards and risks of ownership have been transferred to the lessee when ONE of the following 3 tests is met: • Test #1: Ownership test – Is there a transfer of ownership at the end of the lease term or a bargain purchase option? • Test #2: Economic life test – Is the lease term ≥75% of the leased asset’s economic life? • Test #3: Fair Value test - Is the PV of the minimum lease payments ≥90% of the leased asset’s fair value? • “Yes” to any of the above: Capital Lease • “No” to all of the above: Operating Lease

  6. Lessee Classification:Capital or Operating Lease (ASPE 3065) (cont’d) Explanation of terms: • Rewards of ownership: expectation of profits and gain from appreciation of value of the leased asset • Risks of ownership: possibilities of losses from idle capacity or obsolescence of the leased asset • Bargain purchase option: allows lessee to purchase leased property for a price sufficiently lower than FV • Economic Life: remaining period during which the property is expected to be economically usable • Minimum Lease payments: Minimum rental payments+ Guaranteed residual value + Penalty for not renewing or extending lease + Bargain purchase option • Minimum rental payments: Regular payment to lessor, excluding executory costs (insurance, maintenance, tax)

  7. Lessee Classification:Finance or Operating Lease (IAS 17) Substantially all of the rewards and risks of ownership have been transferred to the lessee when ONE of the following 4 tests is met: • Test #1: Ownership test – Is there a transfer of ownership at the end of the lease term or a bargain purchase option? (same as ASPE) • Test #2: Economic life test – Is the lease term a Major Portion of the leased asset’s economic life? (no quantitative threshold, ASPE specifically states at least 75%) • Test #3: Fair Value test – Dothe PV of the minimum lease payments cover substantially all of the FV of the leased asset? (no quantitative threshold, ASPE specifically states at least 90%) • Test #4 (additional IFRS test): Specialized asset test – Are the leased assets of such a specialized nature that only the lessee can use them without major modifications? (no equivalent ASPE test) • “Yes” to any of the above: Finance Lease (Capital under ASPE) • “No” to all of the above: Operating Lease

  8. Lessee: Operating Lease Treatment

  9. Lessee: Operating Lease Treatment

  10. Lessee: Operating Lease Treatment

  11. Lessee: Capital and Finance Lease Treatment

  12. Lessee: Capital and Finance Lease Treatment

  13. Lessee: Capital and Finance Lease Treatment

  14. Lessee: Capital and Finance Lease Treatment

  15. Card Question #1 ABC Corp leased a truck with an economic life of 7 years on January 1, 2010 from Truck Corp. The yearly rental is $5,582.62 due at the start of the year, for 3 years and the fair value of the truck is $20,000. There is no purchase option but the residual value at the end of the lease (guaranteed) is $7,000. 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%. How should the lease be classified by the lessee (ABC Corp) under IFRS? Test #1 – Ownership test: No, since there is no transfer of title and no bargain purchase option Test #2 – Economic life test: No, since the lease term is 3 years and the truck’s economic life is 7 years, which not a major portion (not even half) Test #3 – FV test / Recovery of investment test: Yes, since the minimum lease payments’ PV is substantially all of the FV of the leased asset. (see next slide)

  16. Card Question #1 (cont’d)Test #3 Rental payments $5,582.62 PV factor for an annuity due, 3 years at 12% x2.69 PV of rental payments 15,017.54 PV of guaranteed residual value:$7K(PVF n=3, y=12%) = $7K(0.71178) = 4,982.46 PV of minimum lease payments 20,000 FV of lease asset 20,000 Test #4 (not necessary because Test #3 is passed) – Specialization test: Yes, the truck has been designed specifically for ABC Corp, who will not have to make major modifications to it Conclusion? Finance lease What is the entry to record the lease by ABC Corp (lessee) on Jan 1, 2010? • Dr. Leased Asset – Truck 20,000 • Cr. Obligation under Finance Lease 20,000

  17. LESSOR PERSPECTIVE

  18. Lessor Classification:Sales-Type, Direct Financing or Operating lease (ASPE & IFRS) From the lessor’s point of view, use the following tests to determine if the lease transfers substantially all of the benefits and risks of ownership to the lessee: • Test #1: Are any of the lessee’s capital lease criteria met? • Test #2: Is the credit risk associated with the lease normal? • Test #3: Are the unreimbursable costs to the lessor estimable? “No” to any of the above results in Operating Lease classification “Yes” to all three of the above leads to Test #4: • Test #4: Does the leased asset value equal the lessor’s book value? If “yes”, classification is direct finance lease, If “no”, classify as sales-type lease

  19. Lessor Classification:Sales-Type, Direct Financing or Operating lease (ASPE & IFRS) (cont’d) Test #2 guidance: When considering collection risk associated with the lease, compare it to that of similar receivables Test #3 guidance: 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 • N.B. A Lease that is an operating lease to the lessee will always be an operating lease to the lessor (fails Test #1)

  20. Lessor Classification:Sales-Type, Direct Financing or Operating lease (ASPE & IFRS) ASPE & IFRS differences Test #4 Guidance: ASPE specifies that if the lessor is a manufacturer/dealor and tests #1-3 are met, classification is likely a Sales-Type ASPE specifies that if the lessor is primarily involved in financing activities and tests #1-3 are met, classification is likely Direct Financing IFRS focuses on the economic substance of the lease, rather than ‘bright lines’ or specific guidance

  21. Classification: Issues for both Lessees & Lessors • 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

  22. Lessor: Operating Lease Treatment

  23. Lessor: Operating Lease Treatment

  24. Lessor: Operating Lease Treatment

  25. Card Question 2 • Company A enters into a 2- year lease with Company B • Payments: • Yr 1: $2,000/month • Yr 2: $1,000/month • Total = $36,000 • What are the journal entries under IFRS for the first month? • For Company A • For Company B

  26. Card Question 2 LESSEE: Dr. Rent expense $1,500 Dr.Prepaid rent $500 Cr. Cash $2,000 LESSOR: Dr.Cash $2,000 Cr. Rent revenue $1,500 Cr. Unearned rent revenue $500

  27. Lessor: Third-Party ParticipationASPE 3065.57-.60 • A lessor can assign lease payments to a 3rd party • Transaction is accounted for as a secured loan by both parties when: • Guarantee exists that ensures 3rd party’s investment will be recovered • 3rd party looks to lessor to recover (rather than the property) • Lessor retains substantial risks of ownership

  28. LESSOR: Third-Party ParticipationASPE 3065.57-.60 • When the property is sold, lessor records proceeds of sale as a loan • Interest rate is that of a similar loan under such conditions • Until the loan is paid, lessor records: • Lease payments as revenue • Interest expense as an appropriate portion of each rental payment with the remainder reducing the amount of the loan

  29. Lessor –Finance Lease

  30. Lessor –Finance Lease

  31. Lessor – Direct Financing and Sales-type Lease

  32. Lessor – Direct Financing and Sales-type Lease

  33. Lessor – Direct Financing and Sales-type Lease

  34. 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. classify the lease under ASPE? Test 1: Are any of the Lessee’s capital lease criteria met? • Yes, based on card question #1 answer Test 2:Is the credit risk associated with the lease normal? • Yes, the credit risk of the lease is normal Test 3: Are the unreimbursable costs to the lessor estimable? • Yes, unreimbursable costs to the lessor are $1,345 Test 4: Does Leased Asset Value = Lessor’s Book Value? • No, Book Value is $15,000 and the Fair Value is $20,000 according to Card Question #2 Conclusion? Sales-Type Lease

  35. Card Question #3 (cont’d) What are the entries to record the lease on Truck Corp.’s books? • Dr. Lease Payments receivable 23,747.86* • Dr. Cost of Goods Sold 15,000 • Cr. Inventory-Truck 15,000 • Cr. Sales 20,000 • Cr. Unearned interest income 3,747.86 *(3*5,582.62+7,000)

  36. Sale and Leaseback Transaction – IAS 17 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 Disclosures: Provisions of agreement or terms of sale leaseback agreement

  37. Sale and Leaseback Transaction – ASPE 3065 When there is interdependence between the sales and lease terms and inability to separate the sale and lease, it is a sale-leaseback transaction. Exception: When the leaseback is of a portion remaining use of the property sold, it may be possible to separate the accounting aspects of the sale and the lease. (i.e. one floor of an tower, or lease is three years of a ten year useful life). Disclosure:No guidance provided

  38. Impairment of Lease Receivables IAS 17: • In accordance with IAS 36 ASPE 3065: • Indication of impairment? • Carrying amount reduced to the greater of: • PV of future cash flows • Amount realizable by selling the lease at the beginning of the period • Amount realizable by exercising rights to the property (net of costs to exercise those rights) • Impairment can be reversed if circumstances change • Recognized in net income

  39. IFRIC 4: Determining Whether An Arrangement Contains a Lease

  40. Is fulfillment of the arrangement dependent on use of specific asset(s)? Yes No No • 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 Not Lease Yes Lease Does the Arrangement Contain a Lease?

  41. When should assessment/reassessment take place? 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 to by the parties, (where renewal/extension was not included in lease term. A renewal/extension of the arrangement with no modification of terms shall be evaluated under Topic A only with respect to the renewal or extension period. • There is a change in the determination of whether fulfillment is dependent on a specified asset. • There is a substantial change to the asset

  42. Is it practical to separate payments for lease and other elements? No Yes 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. How Should Payments Be Accounted For?

  43. SIC 27 Interpretation: Evaluating the substance of transactions involving the legal form of a lease • 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.

  44. Whether it is a 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.

  45. Is Arrangement a Lease? 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 enjoys substantially the same rights to its use as before the arrangement; • (b) the primary reason for the arrangement is to achieve a particular tax result, and not to convey the right to use an asset; and • (c) an option is included on terms that make its exercise almost certain

  46. If not a Lease: Indicators that collectively 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 recognised by the Entity include: • Entity not able to control the investment account for own objectives and is not obligated to pay the lease payments. • the Entity has only a remote risk of reimbursing the entire amount of any fee received from an Investor and possibly paying some additional amount, or, when a fee has not been received, only a remote risk of paying an amount under other obligations and • (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.

  47. If not a Lease: 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 ability to use the asset; • c)the possibility of reimbursing any amount the fee and paying some additional amount is not remote. • The fee shall be presented in the statement of comprehensive income based on its economic substance and nature.

  48. Exposure Draft: 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

  49. REAL EXAMPLES OF FINANCIAL STATEMENTS WESTJET • Quarterly Report : http://www.westjet.com/pdf/investorMedia/financialReports/westjet-2010-q3-financial-statements.pdf • Annual Report 2009 : http://www.westjet.com/pdf/investorMedia/financialReports/WestJet2009AR_financialReport.pdf

  50. No. Under ASPE, this condition alone is not sufficient evidence that substantially all the benefits and risks of ownership have been transferred to the lessee, because, in all leasing agreements, lessee either directly or indirectly pays for these costs. The Terms of the Lease Are Right! LESSEE VS LESSOR

More Related