ADVANCED ACOUNTING 2011 Weeks 12 13

1. ADVANCED ACOUNTING2011Weeks 12 & 13 LEASES IAS 17 and IFRIC 4

2. 2 LEASES STUDY OBJECTIVES LEASES - WHAT TO STUDY: EXAMS AND QE! CLASSIFICATION OF LEASES LEASE ACCOUNTING � RECAP OF THE BASICS DOES AN ARRANGEMENT CONTAIN A LEASE LESSEE ACCOUNTING � FINANCE LEASES SALE AND LEASEBACK � FINANCE LEASES LESSOR ACCOUNTING � FINANCE LEASES INITIAL DIRECT COSTS MANUFACTURER OR DEALER TYPE LESSORS GUARANTEED AND UNGUARANTEED RESIDUAL VALUES

3. 3 1. WHAT TO STUDY: EXAMS AND QE! 1.1 Operating leases will cease to exist under the new IFRS all leases will be capitalised refer definitions of assets and liabilities in conceptual framework 1.2 Ignore following paragraphs dealing with operating leases for all tests and exams in 2011 and QE in 2012: paras 33 -35: Operating leases for lessees; paras 49-57: Operating leases for lessors; paras 15A � 17: Splitting of lease of land and buildings; paras 18-19: Property held under operating leases classified as investment property; and paras 61-63: Sale and operating leaseback 1.3 NB: Classification of leases still relevant � still need to know what a finance lease is!

4. 4 2. CLASSIFICATION OF LEASES 2.1 Finance lease vs operating lease - transfer of substantially all the risks and rewards� 2.2 Examples of situations leading to a finance lease classification 2.3 Indicators of situations leading to a finance lease classification 2.4 Tripartite lease different lessee and lessor classification for example where the lessor benefits from a residual value guarantee by third party 2.5 Subsequent change in classification of a lease ILLUSTRATIVE EXAMPLE 7.2; Chapter 7, page 5

5. 5 3. LEASE ACCOUNTING - THE BASICS OPERATING LEASE (not examinable) LESSEE LESSOR Dr Lease expense 100 Dr Bank / rental debtor 100 Cr Bank / accrual (100) Cr Lease rental income (100) FINANCE LEASE Dr Leasehold asset 1000 Dr Lease receivable 1000 Cr Leasehold liability (1000) Cr Asset (subject to lease) (1000) +Recognise finance cost + depr +Recognise finance income

6. 6 4. DOES AN ARRANGEMENT CONTAIN A LEASE? 4.1 IFRIC 4 examines case where a transaction does not take the legal form of a lease: but conveys the right of use of an asset NB: aim of leasing standards to counter off-balance sheet financing 4.2 Look at substance of arrangement 4.3 Determine whether arrangement: is dependent on the use of a specific asset/assets conveys a right to use the asset ILLUSTRATIVE EXAMPLE 7.3 & 7.4; Chapter 7, page 7

7. 7 5. LESSEE ACCOUNTING - FINANCE LEASES 5.1 Recognise asset/ liability at : fair value of leased property, or if lower the PV of the minimum lease payments (MLPs) 5.2 NB: Definition of MLPs? for a lessee, includes amounts guaranteed by the lessee For a lessor, includes amounts guaranteed to the lessor by the lessee or an unrelated third party 5.3 Subsequent accounting � interest + depreciation Depreciation period - lease term or useful life? 5.4 Arrear vs advance lease payments with advance payment, 1st instalment is entirely capital

8. 8 5. LESSEE ACCOUNTING - FINANCE LEASES 5.5 Interest rate variations 5.6 What about HP agreements? how different to a lease? what is the accounting treatment does IAS 17 apply? 5.7 Tax implications of finance lease VAT � claimable �up-front� for finance leases income taxes - installments, excl VAT, are tax deductible deferred tax arises � asset not capitalised by SARS ILLUSTRATIVE EXAMPLE 7.8; Chapter 7, page 15

9. 9 6. SALE AND LEASEBACK� FINANCE LEASE 6.1 What is a sale and leaseback? involves sale of an asset and then leasing it back reasons why seller/lessee would do this? 6.2 NB: usually an interdependence between the lease payments and the sale price � negotiated as a package may higher than FV sale price + lease payments hence �special� accounting applies 6.3 We deal with seller-lessee�s point of view only. 6.4 First issue: Decide if Finance or Operating leaseback NB Operating leaseback is NOT examinable

10. 10 6. SALE AND LEASEBACK� FINANCE LEASE 6.5 In a finance leaseback, the lessor in substance provides finance to the lessee with the asset as security 6.6 For a sale and finance leaseback: NO profit/loss on sale recognised immediately it is deferred and amortised over the lease term ILLUSTRATIVE EXAMPLE 7.12; Chapter 7, page 24 6.7 Tax implications of sale and finance leaseback current tax implications deferred tax implications Vat implications

11. 11 7. LESSOR ACCOUNTING - FINANCE LEASE 7.1 Financier-type lessor lessor is simply the financier and not seller / manufacturer of the asset 7.2 Present lease as receivable at amount equal to net investment in lease 7.3 Recognise finance income no depreciation by lessor remove leased asset from books 7.4 Tax implications for lessor VAT implications Income tax Deferred tax

12. 12 7. LESSOR ACCOUNTING - FINANCE LEASE EXAMPLE 1 Fair value of asset leased R1000; and Finance charges = R200 Draft journal entries on first day of the lease for lessor using: 1. �gross investment in lease� method; and 2. �net investment in lease� method Solution: Part 1 Part 2 Dr Gross investment in lease 1 200 - Dr Net Investment in lease - 1 000 Cr Unearned finance income (200) - Cr Asset (1 000) (1 000) ILLUSTRATIVE EXAMPLE 7.19 & 7.20; Chapter 7, page 39/45

13. 13 8. INITIAL DIRECT COSTS 8.1 Are incremental costs that are: directly attributable to negotiating / arranging a lease except such costs of manufacturer / dealer lessor 8.2 IDC of lessee - for a finance lease capitalised to leased asset ILLUSTRATIVE EXAMPLE 7.9; Chapter 7, page 19 8.3 IDC of lessor - for a financier-type lessor Included in lease receivable; NB definition of implicit interest rate ILLUSTRATIVE EXAMPLE 7.17; Chapter 7, page 37

14. 14 8. INITIAL DIRECT COSTS 8.4 IDC of lessor - For a manufacture/dealer-type lessor recognise as an expense when selling profit is recognised, as they relate to earning the selling profit, ie. excluded from definition of initial direct costs. ILLUSTRATIVE EXAMPLE 7.18; Chapter 7, page 38

15. 15 9. MANUFACTURER OR DEALER-TYPE LESSORS 9.1 A finance lease by manufacturer /dealer lessor gives rise to: profit or loss on sale of asset as in a �normal� sale, and finance income over the lease term 9.2 Treat as a sale � recognise revenue 9.3 Present lease as receivable (net investment in lease) 9.4 Sales revenue = fair value of asset, or if lower PV of MLPs 9.5 Where artificially low interest rates quoted�? use market interest rates stops profit manipulation

16. 16 9. MANUFACTURER OR DEALER-TYPE LESSORS EXAMPLE 2 Lessor sells vehicle costing 70 000 for 100 000 payable in one year�s time at 2% interest. Market rate is 15%. Solution: 2% 15% Selling price 100 000 88 695 Finance charges 2 000 13 305 102 000 102 000 COS 70 000 70 000 Immediate profit 30 000 18 695 (X) (v) ILLUSTRATIVE EXAMPLE 7.21; Chapter 7, page 46

17. 17 10. GUARANTEED AND UNGUARANTEED RESIDUAL VALUES LESSEE�S POINT OF VIEW: 10.1 Guaranteed residual value (GRV) from a lessee�s point of view: residual value guaranteed by lessee to lessor akin to a final instalment to lessor 10.2 NB: GRV included in the definition of MLP�s forms part of leasehold liability forms part of the amortisation table & is the last instalment 10.3 The lessee ignores unguaranteed residual values only relevant to the lessor

18. 18 10. GUARANTEED AND UNGUARANTEED RESIDUAL VALUES LESSOR�S POINT OF VIEW: 10.4 Guaranteed residual value from a lessor�s point of view: residual value guaranteed by lessee to lessor; or residual value guaranteed by a third party to the lessor as with lessee, is akin to a final instalment to lessor 10.5 Unguaranteed residual value (URV) is akin to determination by lessor of �residual value� for PPE 10.6 Both GRV and URV included in gross investment in lease ILLUSTRATIVE EXAMPLE 7.22; Chapter 7, page 48 ILLUSTRATIVE EXAMPLE 7.23; Chapter 7, page 49