Leasing

7 Key excerpts on "Leasing"

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  eBook - ePub

  Wiley IFRS 2017

  Interpretation and Application of IFRS Standards

  • (Author)
  • 2017(Publication Date)
  • Wiley

    (Publisher)

  Leasing has long been a popular financing option for the acquisition of business property. During the past few decades, however, the business of Leasing has experienced staggering growth, and much of this volume is reported in the statements of financial position. The tremendous popularity of Leasing is quite understandable, as it offers great flexibility, often coupled with a range of economic advantages over ownership. Thus, with Leasing, a lessee (borrower) is typically able to obtain 100% financing, whereas under a traditional credit purchase arrangement the buyer would generally have to make an initial equity investment. In many jurisdictions, a Leasing arrangement offers tax benefits compared to the purchase option. The lessee is protected to an extent from the risk of obsolescence, although the lease terms will vary based on the extent to which the lessor bears this risk. For the lessor, there will be a regular stream of lease payments, which include interest that often will be at rates above commercial lending rates, and, at the end of the lease term, usually some residual value.

  The accounting for lease transactions involves a number of complexities, which derive partly from the range of alternative structures that are available to the parties. For example, in many cases leases can be configured to allow manipulation of the tax benefits, with other features such as lease term and implied interest rate adjusted to achieve the intended overall economics of the arrangement. Leases can be used to transfer ownership of the leased asset, and they can be used to transfer some or all of the risks normally associated with ownership. The financial reporting challenge is to have the economic substance of the transaction dictate the accounting treatment.

  The accounting for lease transactions is one of the best examples of the application of the principle of substance over form, as set forth in the IASB's Framework

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  eBook - ePub

  Foundations of International Commercial Law

  • Christian Twigg-Flesner(Author)
  • 2021(Publication Date)
  • Routledge

    (Publisher)

  When we speak of “Leasing”, we need to deal with two separate categories of Leasing. First, there are “operating leases”. Here, the person acquiring the goods (the lessee) needs goods for a limited period of time, often for a specific purpose. The owner of those goods (the lessor) will agree to supply the goods in question to the lessee for an agreed period of time, in return for which the lessee will make a payment (whether as a lump-sum or through regular instalments, depending on the duration of the Leasing period). The payments will generally reflect the value to the lessee of being able to use the goods and the profit margin for the lessor. At the end of the Leasing period, the lessee will return the goods to the lessor, who can then lease the same goods again to another lessor. An operating lease is a standard hire agreement and is commonly used where short-term use of goods is all that is needed. Examples include car hire, hiring construction machinery for a period of time, or scaffolding for construction projects.

  The second category is a rather different type of arrangement. This is the finance lease. Rather than the simple two-party arrangement of an operating lease, a finance lease involves three parties: the seller/supplier of the goods in question, a finance company and the person seeking to acquire the goods. Finance leases may be used where the person seeking to acquire the goods does not necessarily wish to become the outright owner of the goods but still wishes to have long-term use of the goods, usually for most of their product life-span. Instead of acquiring those goods directly from the seller/supplier, the goods are sold to a finance company which then enters into a Leasing agreement with the lessee.

  Figure  6.1   Structure of a financial Leasing transaction

  The basic mechanism of a Leasing arrangement is as follows: first, the supplier of the goods and the prospective lessee agree on the goods to be supplied. Then, a finance company – the lessor – agrees to buy the goods from the supplier. The lessor will then enter into a separate contract with the lessee for the supply of the goods in return for regular payments. The lessee may or may not decide to acquire outright ownership at the end of the agreed Leasing period.3

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  eBook - ePub

  Construction Equipment Management for Engineers, Estimators, and Owners, Second Edition

  • Douglas D. Gransberg, Jorge A. Rueda(Authors)
  • 2020(Publication Date)
  • CRC Press

    (Publisher)

  There is an increasing trend toward Leasing as a way to finance construction equipment. It is usually easier to gain financial approval for equipment under a lease program than through conventional purchase financing. In its simplest form, an equipment lease is simply a rental agreement. Rent is paid while the equipment is being used. Once the agreement is over, the equipment is returned to the owner. In a true lease, the lease payments are considered an expense of the lessee. The lessee does not own the equipment, and the equipment is not shown as an asset on financial statements. The most significant factor that affects the rent or lease decision is the duration in which the equipment will be required. Leasing is often considered attractive when the equipment is needed for more than 6 months. Most leases run from 18 to 24 months with large expensive equipment leases running as long as 84 months.

  Leasing arrangements are a form of finance in which an asset is acquired by a third party, usually a bank, finance company, or dealer, and then leased to the end user for a predetermined period. This arrangement means the Leasing party never actually has title to the asset for the term of the lease, although it has the use of the asset during that time. The usual term of the lease will equal the operating life of the asset, and the repayments will be geared to the cost of the asset spread over that time, plus a profit margin for the lessor. Leasing does not have an impact on a company’s current or debt-to-worth ratios; thus, it provides a more positive financial condition for bonding purposes. Leasing encourages an orderly equipment replacement strategy, minimizing maintenance costs before they become excessive. Leasing also eliminates the need to dispose of used equipment for the lessee.

  Construction equipment Leasing allows additional flexibility to deal with cyclical and regional fluctuations in work level. Many Leasing companies offer seasonal leases called skip leases that allow the user to schedule payments during busiest months, thus reducing cash flow concerns during seasonal periods when work is slow. Step-up leases start with smaller payments that increase over time, allowing the user to generate revenue while initial payments are lower. Deferred payment leases allow the user to defer initial payments until cash flow is started.

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  eBook - ePub

  Applying IFRS for SMEs

  • Bruce Mackenzie, Allan Lombard, Danie Coetsee, Tapiwa Njikizana, Raymond Chamboko(Authors)
  • 2010(Publication Date)
  • Wiley

    (Publisher)

  As the Standard gives no detailed guidance on the application of lease accounting to arrangements containing a lease, an entity may choose to look at the principles in full IFRS. IFRIC 4, Determining Whether an Arrangement Contains a Lease in full IFRS, provides detailed guidance on whether an arrangement contains a lease element.

  The guidance requires that all the following three criteria be met:

  • The ‘purchaser’ has the ability or right to operate the asset or direct others to operate the asset in a manner it determines while obtaining or controlling more than an insignificant amount of the output or other utility of the asset.
  • The ‘purchaser’ has the ability or right to control physical access to the underlying asset while obtaining or controlling more than an insignificant amount of the output or other utility of the asset.
  • Facts and circumstances indicate that it is remote that one or more parties other than the ‘purchaser’ will take more than an insignificant amount of the output or other utility that will be produced or generated by the asset during the term of the arrangement, and the price that the ‘purchaser’ will pay 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.

  DEFINITION OF A LEASE

  A lease is an agreement whereby the lessor conveys to the lessee in return for a pa yment or series of payments the right to use an asset for an agreed period of time.

  CLASSIFICATION OF LEASES

  Leases are classified as either finance or operating leases. The key difference is that with a finance lease, the lease substantially transfers all the risks and rewards incidental to ownership of the asset from the lessor to the lessee. Should the contract not substantially transfer all the risks and rewards incidental to ownership, then the lease is accounted for as an operating lease.

  The difference in the accounting for an operating versus a finance lease is that with a finance lease, the asset is derecognized from the lessor's statement of financial position. For an operating lease, the asset remains on the lessor's statement of financial position. This accounting is discussed in greater detail further in the chapter. Exhibits 18.1 and 18.2

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  eBook - ePub

  International Financial Reporting Standards (IFRS) Workbook and Guide

  Practical insights, Case studies, Multiple-choice questions, Illustrations

  • Abbas A. Mirza, Graham Holt, Magnus Orrell(Authors)
  • 2010(Publication Date)
  • Wiley

    (Publisher)

  4.4 It is evident from these descriptions that a large degree of judgment has to be exercised in classifying leases; many lease agreements are likely to demonstrate only a few of the situations listed, some of which are more persuasive than others. In all cases, the substance of the transaction needs to be properly analyzed and understood. Emphasis is placed on the risks that the lessor retains more than the benefits of ownership of the asset. If there is little or no related risk, then the agreement is likely to be a finance lease. If the lessor suffers the risk associated with a movement in the market price of the asset or the use of the asset, then the lease is usually an operating lease.

  4.5 The purpose of the lease arrangement may help the classification. If there is an option to cancel, and the lessee is likely to exercise such an option, then the lease is likely to be an operating lease.

  4.6 Classifications of leases are to be made at the inception of the lease. The inception of a lease is the earlier of the agreement date and the date of the commitment by the parties to the principal provisions of the lease. If the lease terms are subsequently altered to such a degree that the lease would have had a different classification at it inception, a new lease is deemed to have been entered into. Changes in estimates such as the residual value of an asset are not deemed to be a change in classification.

  4.7 Leases of land, if title is not transferred, are classified as operating leases, as land has an indefinite economic life and a significant reward of land ownership is its outright ownership and title to its realizable value. If the title to the land is not expected to pass to the lessee, then the risks and rewards of ownership have not substantially passed, and an operating lease is created for the land. Leases of land and buildings need to be treated separately, as often the land lease is an operating lease and the building lease, a finance lease.

  4.8

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  eBook - ePub

  Financial Reporting under IFRS

  A Topic Based Approach

  • Wolfgang Dick, Franck Missonier-Piera(Authors)
  • 2011(Publication Date)
  • Wiley

    (Publisher)

  The distinction between these two types of agreement is very important. In the case of a finance lease agreement, the leased item is considered as an acquisition by the lessee. However, it is not yet paid for when it is first entered on the balance sheet since payment will be made in instalments over the lease period. Consequently, a financial debt is recorded on the lessee’s balance sheet. The lessor, on the other hand, must consider the item as sold, remove it from his balance sheet, and recognize a sale on his income statement, all the while maintaining legal ownership of the item in question. Since the sale has not yet been paid by the lessee, it is recorded as a receivable on the lessor’s balance sheet.

  Figure 6.3 Lease agreements.

  After we present the scope of lease agreements, we will look at the criteria used to differentiate operating leases from finance-lease agreements. Finally, we will examine the effects on the balance sheet and income statement of restating an operating lease as a finance-lease agreement (IAS 17).

  6.2.1 The Scope of Lease Agreements

  A lease agreement transfers the right of use for an asset from the lessor to the lessee for a given amount of time in exchange for payment.

  A lease agreement involves the following elements (IAS 17):

  • The lessor transfers the right of use for an asset to the lessee. • This right is granted for a set period of time. • In exchange, the lessee pays the lessor an agreed amount.

  During the lease period, the lessee assumes the same financial rights and obligations for the rented item as an owner, except that these rights are limited in time. The agreement does not need to be in the form of a standardized legal contract. Chapter 2 mentions an example of a sales agreement with a buyback clause that, financially speaking, more closely resembles a lease agreement than a sale. Service contracts are another example of this since they often include lease agreements as an important component.

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  eBook - ePub

  Interpretation and Application of UK GAAP

  For Accounting Periods Commencing On or After 1 January 2015

  • Steven Collings(Author)
  • 2015(Publication Date)
  • Wiley

    (Publisher)

  Chapter 20 Leases

  1. Introduction
  2. Finance Leases
  3. Operating Leases
  4. Manufacturer/Dealer Lessors
  5. Sale and Leaseback Transactions
  6. Potential Changes to Lease Accounting
  7. Small Companies

  Introduction

  Leases serve a commercial purpose for many businesses; however, they have proved to be somewhat problematic for the accountancy profession due to the subjective nature of how they can be financially represented and the ability to manipulate transactions to achieve a desired outcome (usually to achieve ‘off-balance sheet finance’). There has been an ongoing project with the International Accounting Standards Board and the US Financial Accounting Standards Board to overhaul the ways in which leases are accounted for, which is covered later in the chapter.

  Leasing is dealt with in Section 20 Leases of FRS 102. At the outset, this particular section confirms that Section 20 does not deal with the following types of Leasing transactions:

  • Leases granted to a lessee to enable them to explore for or use minerals, oil, natural gas and similar non-regenerative resources (Section 34 Specialised Activities deals with these issues).
  • Licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights (Section 18 Intangible Assets other than Goodwill deals with these issues).
  • Measurement of property, plant and equipment held by lessees, which are accounted for as investment property and measurement of investment property provided by lessors under operating leases (see Section 16 Investment Property).
  • Measurement of biological assets held by lessees under finance leases and biological assets provided by lessors under operating leases (see Section 34 Specialised Activities).
  • Leases that could lead to a loss to the lessor or the lessee as a result of non-typical contractual terms.

  FRS 102 uses a ‘risks and rewards’ approach to lease classification. In other words, if the risks and rewards of ownership of the asset subjected to the lease remain with the lessor, the lease is deemed to be an operating lease, whereas if the risks and rewards pass from the lessor to the lessee, the lease is deemed to be a finance lease.

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