What is a lease?
 A lease is an agreement where a lessor conveys
to a lessee the right to use an asset for an
agreed period of time in return for a payment or a
series of payments
 The lessee does not acquire an asset, merely
the right to use the asset for a period of time
 It may result in the eventual transfer of
ownership – e.g. hire purchase agreement
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Introduction
 NZ IAS 17 governs accounting for leases
 Applies to all lease accounting except:
 Leases to explore for or use minerals, oil, natural gas
and similar non-regenerative assets
 Licensing agreements for items such as motion picture
films, video recordings, plays, manuscripts and
copyrights (para 2)
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Reporting issue
 If the lessee doesn’t own the asset being leased,
should this lack of legal ownership stop the lessee’s
reporting of the asset and the related liability (from
future commitments) in the balance sheet?
An entity may recognise assets it doesn’t own as long as
it is able to control their use
 Do leases transfer control of the asset to the lessee?
This depends on the terms of the lease agreement
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Classification
 NZ IAS 17 recognises the following types of leases:
 Finance
 Operating
 Accounting treatment and disclosures required differ substantially
for finance and operating leases
 Finance lease: transfers substantially all the risks and rewards
incidental to ownership (with or without eventual title transfer) (para
4)
 Operating lease: does not transfer substantially all the risks and
rewards incidental to ownership (para 8) – and is in effect a lease
other than a finance lease (para 4)
 Classification is made at the inception of the lease (para 13)
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Finance Lease
The lease is normally classified as a finance lease if it
has one or more of the following:




The lease is non-cancellable (see definition para 4)
As per para 10:
Ownership is to be transferred at end of lease term
Option to purchase is at much lower than fair value so
certainty of exercising option is reasonably certain
 Lease term covers a major part of the asset’s economic life
 The present value of the minimum lease payments (MLPs)
represents substantially the asset’s fair value
 Leased assets are specialised and only useable by the lessee
See the decision tree on p. 415 of Picker et al.
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Minimum lease payments
Minimum lease payments (MLP) =
Payments over lease term
+ Guaranteed residual value
+ Bargain purchase option
– Contingent rent
– Reimbursement of costs paid by
lessor (executory costs)
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Guaranteed residual value
 At the commencement of the lease, the lessor
estimates the residual value of the asset at the end
of the lease term (based on market conditions).
 Under a finance lease the lessee guarantees that the
lessor will realise at that amount.
 The guarantee may range from 1% to 100% of the
residual value.
 The existence of a guaranteed residual value
indicates that the lessor has transferred risks
associated with movements in the residual value to
the lessee.
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Further definitions…
Bargain purchase option
 A clause in the lease agreement allowing the lessee to purchase the
asset at the end of the lease term for a pre-set amount (which is less
than the expected residual value)
 The option price is normally to be sufficiently lower than expected fair
value so that the exercise of the option is reasonably certain
Contingent rent
 Additional payments arising from increases/decreases in the
schedule lease payments due to the occurrence of particular events
specified in the lease agreement.
 Eg- lease of a photocopier may specify additional payments if the
number of photocopies exceeds a certain amount in a month.
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Present value
 The present value (PV) of MLPs is determined
by applying an appropriate discount rate.
 Discounting is not necessary if the lease
agreement contains one of the following (as the
PV of MLP = FV of the asset in such cases):
 a bargain purchase option; or
 a 100% guaranteed residual value
 The discount rate is based on the interest rate
implicit in the lease.
10
Example
 See Illustrative Example 12.1 p. 418 Picker et al.
for example of lease classification
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Accounting - Lessees
Finance lease
 Lessee recognises:
 an asset (to depreciate)
 liability (reduced by portion of lease
payment representing a reduction in the
principal)
Operating lease
 All lease payments are expensed
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Misclassification
 Divergent accounting treatments provide an incentive to
misclassify leases as operating leases.
 Classification as a finance lease may have the following
adverse impacts on a lessee’s financial statements:
 Increases non-current assets – thus reducing return on asset
ratios.
 Increases non-current liabilities – adversely affecting debt/equity
ratios.
 Depreciation and interest charges may exceed lease payment in
early years of lease – resulting in lower profits.
 NZ IAS 17 is currently being rewritten, but at the moment SIC 27
Evaluating the Substance of Transactions Involving the Legal Form of a
Lease and IFRIC 3 Determining Whether an Arrangement Contains a
Lease give additional guidance to classification
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Finance leases - lessees
 Initially determine and recognise the asset & liability
 There are different treatments prescribed for subsequent




measurement of assets & liabilities
For assets, determine
 Depreciation
 any impairment
For liabilities:
Calculate
 reduction of the lease liability
 interest expense incurred
Expense
 contingent rent
 lessor costs
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Initial Recognition
 Initially determine and recognise a lease asset &
liability
 Recorded at the lower of the Future Value (FV) of
the asset and the Present Value (PV) of MLP (para
20)
 Note re Useful life
If the lessee intends returning the asset at the end of the lease
period the useful life will be the term of the lease.
Where the lessee intends to purchase the asset at the end of the
lease term, the useful life will be the economic life of the asset 15
Journal Entries
Journal entries for year ended 30 June 2014 – Tauranga Ltd
Dr
Leased asset
85,457
Cr
Lease liability
85,457
Recognition of the leased asset at lower of FV and PV of
MLP
Dr
Dr
Lease liability
22,000
Prepaid executory costs
1,900
Cr
Cash
23,900
Payment in advance of first annual lease payment
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Subsequent measurement
For assets, determine:
 depreciation (over the useful life of the asset to the
entity)
 any impairment
 For liabilities, lease payment to be allocated
between:




reduction of the lease liability
interest expense incurred
reimbursement of lessor costs (if applicable)
contingent rent (if applicable)
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First year end entries…
Journal entries at 30 June 2015 – Tauranga Ltd
Dr
Executory costs
Cr
Prepaid executory costs
Expensing prepaid executory costs
1,900
1,900
Dr
Dr
Dr
Lease liability
17,558
Interest expense
4,442
Prepaid executory costs
1,900
Cr
Cash
23,900
Payment in advance of second annual lease payment
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Depreciation
Depreciation charge at 30 June 2015:
Dr
Depreciation expense
19,489
Cr
Accumulated depreciation
19,489
Annual depreciation charge
 ($85,457 - $7,500 guaranteed residual value) = $77,957
depreciable amount.
 $77,957/ 4 yrs = $19,489
N.B
Depreciation is over the lease term as Tauranga Ltd
intends on returning the asset to Gisborne Ltd at the
end of the lease term
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Disclosures - Lessees
 Carrying amount of each class of leased asset
as at balance date
 Reconciliation between total future MLP at
balance sheet date and present value
 Total MLP at balance date and future value for
periods under 1 year, 1–5 years and over 5 years
 Contingent rents expensed
 Sublease details
 Material leasing arrangements (para 31)
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Operating leases
 All ownership risks/rewards to lessor
 Treated as rental agreements so that:
 Lessees
 Lease payments are expensed on a straight line basis
over the term of the lease (para 33).
 Disclosures
 See para 35 for lessee disclosures
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Sale & leaseback transactions
 Involves the sale of an asset that is then leased back from the





purchaser for all or part of the remaining economic life of the
asset. (para 58)
Used to generate immediate cash flow while retaining asset
use.
Lease component of the transaction is accounted for in the
same way as normal lease transactions.
The ‘sale’ component transaction differs, depending on
whether it is classified as a finance or operating lease.
Under a finance lease the lessee’s gain/(loss) from the sale of
the asset is deferred and amortised over the term of the lease.
Under an operating lease the lessee’s gain/(loss) is:
 recognised immediately if ‘sale’ is calculated at fair value
 excess/reduced gains/(losses) are deferred and amortised over the
term of the lease
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