LEASE - OPERATING OR FINANCE? (Part 2)

ACCA P2 考試：LEASE - OPERATING OR FINANCE? (Part 2)

The presence of an option to extend the lease at substantially less than a market rent implies that the lessor expects to achieve its return on investment solely through the lease payments and therefore is content to continue the lease for a secondary period at a nominal rental. This is an indicator of a finance lease. It is reasonable to assume that the lessee will extend the lease in these circumstances. However, an option to extend it at a market rental may indicate that the lessor has not achieved its return on investment through the lease rentals and therefore is relying on a subsequent lease or sale to do so. This is an indicator of an operating lease as there will be no compelling commercial reason why the lessee should extend the agreement. The absence of any option to extend the lease does not provide evidence either way as to an operating or a finance lease and other factors will need to be considered to determine the classification.

In some cases, fluctuations in the fair value of the residual interest in the leased asset are passed back to the lessee. This indicates that the lessee is bearing the residual value risk, and the lessor’s return on investment is effectively fixed.

These indicators provide evidence of a finance lease. If the lease also requires the lessee to make good to the lessor any shortfall between the sale proceeds and a fixed ‘residual’ amount, then again this is evidence of the lessor’s return being fixed. Where the lessor retains the proceeds of the eventual sale of the asset, the lessor is bearing the residual value risk and where the sale proceeds are significant, then this could be evidence of an operating lease.

Issues sometimes arise in lease contracts where an asset is held on a finance lease and then it is all or partially sub- let to another party on identical terms and conditions. This can occur where several entities intend to share leased accommodation and arrange for one entity to lease the whole asset and then sub-let the relevant parts to the others. The issue that arises here is whether the lead entity should recognise the finance leases on a gross basis in its accounts or whether it should net off the transactions in its accounts.

In this case the entity should currently look at the de-recognition requirements of IAS 39, Financial Instruments: Recognition and Measurement. The treatment will depend on the terms of the individual transaction. If the two transactions are separate to the extent that the lead entity is liable to pay its rentals under the head-lease regardless of whether it actually receives its sub-lease rentals, then the de-recognition requirements will not be met and it will need to account for the two leases on a gross basis.

A contingent rent is such amount that is paid as part of lease payments but is not fixed or agreed in advance at the inception of lease rather the amount to be paid is dependent on some future event. However, it is not an interest payment as it is not connected with the passage of time therefore time value of money is not an issue. Contingent rent is commonly connected with an increase or decrease in future sales by the lessee or increase or decrease in the use of asset or inflation or deflation. Under IAS 17, contingent rents are excluded from minimum lease payments and are accounted as expense/income in the period in which they are incurred/earned.

If a lease contains a clean break clause, where the lessee is free to walk away from the lease agreement after a certain time without penalty, then the lease term for accounting purposes will normally be the period between the commencement of the lease and the earliest point at which the break option is exercisable by the lessee. If a lease contains an early termination clause that requires the lessee to make a termination payment to compensate the lessor such that the recovery of the lessor’s remaining investment in the lease was assured, then the termination clause would normally be disregarded in determining the lease term. Similarly the same principle applies, if the lease agreement states that the lease can only be terminated in remote circumstances, with the permission of the lessor or on entering a new lease agreement for the same or equivalent asset.

The IASB is preparing a standard that may clarify and change some of the above aspects of lease accounting. The current models lead to a lack of comparability and undue complexity because of the distinction between finance and operating leases. As a result, many users of financial statements adjust the amounts presented in the statement of financial position to reflect the assets and liabilities arising from operating leases which makes the deliberations of companies regarding classification of leases somewhat a futile exercise.

Written by a member of the Paper P2 examining team.