Download Leases - Endunamoo School Of Accounting

Financial Accounting I (FAC4861/3)
Rendani Muthelo | 16 December 2015
Leases
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
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
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
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
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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
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
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
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
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)
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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)
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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
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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
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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)
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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)
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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=?
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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 2014. Include deferred tax related entries.
18
LE2SS: Finance lease - lessee
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LE2SS: Finance lease - lessee
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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 2014
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LE3SS: Finance lease - lessee
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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)
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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 2013.
Ignore VAT but include deferred tax related entries
24
LE4SS: Operating lease - lessee
25
LE4SS: Operating lease - lessee
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LE5: Onerous contract vs impairment
CA Ltd is a lessee and has a financial year end of 31 December 2013.
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 2013.
REQUIRED: Prepare all the necessary journal entries in 2012 and 2013
27
LE5SS: Onerous contract vs impairment
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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)
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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)
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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)
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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
LE6SS: Finance lease - lessor
33
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
LE7SS: Finance lease - lessor
35
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 2014. Include VAT and deferred tax related entries.
36
LE8SS: Finance lease - lessor
37
LE8SS: Finance lease - lessor
38
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
2014.
REQUIRED:
• Process the journal entry to process the change in estimate in the
financial records of CA Ltd for the year ended 31 December 2014.
39
LE9SS: Change in residual value
40
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
LE10: Operating lease - lessor
CA Ltd is a lessor and has a financial year ending 31 December 2013.
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 2013.
Ignore VAT but include deferred tax related entries.
42
LE10SS: Operating lease - lessor
43
LE10SS: Operating lease - lessor
44
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
LE11SS: Sale and finance lease back
46
LE11SS: Sale and finance lease back
47
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
LE12: Sale and operating lease back
On 1 April 2015, CA Ltd sold a plant for R130,000 on sale
operating lease back basis. The lease term was agreed to be
years from that date. The carrying amount of the plant
R100,000 and fair value of the plant was R90,000. The year
of CA Ltd is 31 December.
and
four
was
end
REQUIRED:
Prepare journal entries to account for the above transaction in
the financial records of CA Ltd. Ignore tax.
49
LE12SS: Sale and operating lease back
50
Thank you
Presenter’s details
[email protected]
+2782 869 3299
ECC Administrator
Livhuwani Muthelo
[email protected]
[email protected]
+2711 056 6359
+2784 282 3299
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