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Re-Stating – The 2009-10 Accounts for IFRS – Leasing and Lease Type Arrangements

Re-Stating – The 2009-10 Accounts for IFRS – Leasing and Lease Type Arrangements . Roman Haluszczak, Manager, CIPFA Finance Networks E mail: Roman.Haluszczak@cipfa.org.uk. Leasing and Lease Type Arrangements – Introduction (1).

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Re-Stating – The 2009-10 Accounts for IFRS – Leasing and Lease Type Arrangements

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  1. Re-Stating – The 2009-10 Accounts for IFRS – Leasing and Lease Type Arrangements Roman Haluszczak, Manager, CIPFA Finance Networks E mail: Roman.Haluszczak@cipfa.org.uk

  2. Leasing and Lease Type Arrangements – Introduction (1) Authorities shall account for leases in accordance with IAS 17 Leases, except where interpretations or adaptations to fit the public sector are detailed in the Code. IPSAS 13 Leases is based on IAS 17, and introduces no additional accounting requirements, although it provides additional guidance for public sector bodies. SIC 15 Operating Leases – Incentives, SIC 27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease and IFRIC 4 Determining Whether an Arrangement Contains a Lease are also relevant to accounting for leases. Look at October 2009’s Fan work on leases in our series on the transition balance sheet – Web reference here? Today’s focus is on lease accounting entries for the 2009-10 IFRS Transition – NOT A DETAILED EXAMINATION OF Chapter 4.2 OF THE CIPFA IFRS CODE OR IAS 17 2

  3. Accounting for leases under the IFRS Transition for 2009-10 – Proposed 3 stage -- Headline Processes • Stage 1. Ascertain the leases position for the transition balance sheet as at 1st of April 2009. (Leases taken out before the 1st of April 2009) – Authorities should already have done this • Stage 2. Ascertain the effect of leases taken out before 1st of April 2009 on the Comprehensive Income and Expenditure Statement for 2009\10 and the 2009\10 balance sheet – in both IFRS and GAAP terms – restate the 2009-10 GAAP positions for IFRS – Moving the transition balance sheet position forward by one year • Stage 3. Ascertain the effect of leases taken out after 1st of April 2009 – (During 2009-10) on the Comprehensive Income and Expenditure Statement for 2009\10 and the 2009\10 balance sheet – in both IFRS and GAAP terms – restate the 2009-10 GAAP positions for IFRS – • Leases taken out after 1st of April 2009 – will not affect the 1st of April 2009 IFRS transition balance sheet

  4. SI -454 – 2010 – Mitigation for Lessors under IFRS Transition • 30I.—(1) Where, on or after 1st April 2009, a local authority receives money under an arrangement— • which is in existence on, and is not treated according to proper practices as a finance lease at, 31st March 2010, and (b) all or part of that arrangement will be treated according to proper practices as a finance lease on or after 1st April 2010, the money received under that arrangement may be accounted for in accordance with proper practices applying to that arrangement on 31st March 2010. (2) Where, on or after 1st April 2009, a local authority receives money under an arrangement— • which is in existence on, and is not treated according to proper practices as an operating lease at, 31st March 2010, and (b) all or part of that arrangement will be treated according to proper practices as an operating lease on or after 1st April 2010, The money received under that arrangement may be accounted for in accordance with proper practices applying to that arrangement on 31st March 2010.”. See http://www.legislation.gov.uk/uksi/2010/454/pdfs/uksi_20100454_en.pdf

  5. Operating Lease to Finance Lease (Lessee) Finance Lease to Operating Lease (Lessee) Operating Lease to Finance Lease (Lessor) Finance Lease to Operating Lease (Lessor) Leases – Predicted Likely but not certain GF Scenarios on transition to IFRS Lease Re-Classification Likely GF Effect • Neutral if MRP option 3 is chosen • Neutral if MRP option 3 is chosen • Neutral if SI 454 mitigation chosen • Neutral if SI 454 mitigation chosen

  6. Lessee Accounting – Operating lease to Finance lease– Stage 1 is in the Delegate pack

  7. CIPFA IFRS Code on Accounting for Leases – 2009-10 IFRS Re-statement • Lessee Accounting – Operating lease to finance lease –identify and reverse out the previous GF operating lease transactions • At the commencement of the lease a fair value of the asset and an associated liability will need to be estimated. • Payments made between the commencement of the lease and 31 March 2010 shall be apportioned between the finance (interest) charge and the repayment of the liability (principle). • Depreciation ( And/or Re-valuation) of the assets acquired under the lease will need to be charged from the commencement of the lease until 31 March 2010. This should be in accordance with an authority's depreciation policies. • The General Fund shall be charged with MRP / Loans Fund Charges payable from the commencement of the lease until 31 March 2010. – • Intended General Fund neutral effect – See the following slides

  8. Option 3 – Asset Life Annuity Method for MRP on finance leases coming Balance Sheet • MRP will be calculated as the principal element for the year of the annuity required to repay over the asset life the amount of capital expenditure financed by borrowing or credit arrangements. The authority should use an appropriate interest rate to calculate the amount. (PMT function in Excel) • In the case of finance leases, the MRP requirement would be regarded as met by a charge equal to the element of the rent/charge that goes to write down the balance sheet liability. • Assets coming on balance sheet What is your MRP policy? • Latest MRP statutory guidance – please see http://www.communities.gov.uk/localgovernment/localgovernmentfinance/capitalfinance/capfinguidconsultdocs/

  9. Lessee Accounting – Operating lease to Finance lease Suggested Accounting Entries

  10. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessee – Historic SORP Position – Stage 2 – 2009\10 Entries (A)

  11. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessee – IFRS Position – – Stage 2 – 2009\10 Entries (B)

  12. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessee – IFRS Position VS Historic SORP Position –Draft Reconciling Journal – Stage 2 – 2009\10 Entries (C) Closing Balance under SORP + reconciling journal = Closing Balance under IFRS = Transition Balance sheet (Stage 1) + 1 year on (Stage 2)

  13. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessee – Historic SORP Position – Stage 3 – Leases commencing in 2009\10 Entries (A)

  14. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessee – IFRS Position – Stage 3 – Leases commencing in 2009\10 Entries (A)

  15. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessee –IFRS Position VS Historic SORP Position – Draft Reconciling Journal – Stage 3 – 2009\10 Entries (C) Closing Balance under SORP + reconciling journal = Closing Balance under IFRS Transition Balance sheet (Stage 1) + 1 year on (Stage 2) + New entries in 2009\10 (Stage 3)

  16. Lessor Accounting and Recognition – Operating lease to Finance lease Suggested Accounting Entries

  17. CIPFA IFRS Code on Accounting for Leases – 2009-10 IFRS Re-statement • Lessor Accounting – Operating lease to finance lease • Identify all the transactions associated with the operating lease up until its commencement and write them out • At the commencement of the lease de-recognise the physical asset and in its place recognise a long term debtor which will now equal the net investment in the lease • For each new finance lease, authorities will need, from its commencement, to separate the lease income they receive into a finance income element ( usually interest) and a repayment of principal element (Capital receipt) • The repayment of principal element of each payment shall be applied to reduce the balance on the long-term debtor, and is ultimately classed as a capital receipt. BUT – • In England and Wales, SI 454 – 2010 gives authorities the option not to classify the repayment of the principal element they receive as a capital receipt for leases entered into on or before 31 March 2010, but to retain it in the General Fund as income.

  18. Draft CIPFA IFRS Code on Accounting for Leases – 2009-10 IFRS Re-statement – Part 1 • Lessor Accounting – Operating lease to finance lease – Suggested Initial Accounting Entries • Credit I+E and debit long term debtor with the equivalent value of the net investment in the lease – • For disposal of the operating lease asset -- credit PPE and debit the I+E with the operating asset carrying amount– Any surplus or deficit on disposal is transferred from the GF to the Capital Adjustment Account. • When repayments are made, the interest element is credited to the I&E. The principal element is credited to the long-term debtor, reducing the amount outstanding (or eliminating it in the case of the deferred receipt). 

  19. CIPFA IFRS Code on Accounting for Leases – 2009-10 IFRS Re-statement – Part 2 • Lessor Accounting – Operating lease to finance lease – Suggested Further Accounting Entries • Credit Capital Receipts Deferred and debit the CAA with the equivalent value of the net investment in the lease – • Other equivalent entry is - Debit Capital Receipts Deferred and Credit the General Fund with the annual amount allocated to repay the long term debtor • The above entries recognise revenue income and are in line with SI 454 – 2010 • Over time the balance on Capital Receipts Deferred will be fed into the I + E account and will be used up • For leases signed after 31st of March 2010 – this choice will no longer be available and consequently accounting will need to be done in line with the CIPFA IFRS Code

  20. Operating Lease to Finance lease – Suggested Accounting Entries – Lessor – Historic SORP Transactions - Stage 1 Transition Balance Sheet • PPE – Let us assume that on the 1st of April 2006 – the authority acquired an asset for £1m and paid for it in cash – Accounting Entries - Credit cash £1m and debit fixed asset £1m. • In 2006-07 and 2007-08 the depreciation charge was £20k per annum whilst in 2008-09 in increased to £24k per annum due to a revaluation. The total depreciation charge over the period was therefore £64k – Accounting entries – Credit PPE £64k and Debit CAA £64k • In the three financial years in question MRP was respectively; £40k, £38k and £37k – Accounting entries – Debit GF £115k and Credit CAA £115k • Operational Lease income received in 2007/08 and 2008/09 was £53k per annum – Accounting Entries – Credit I + E (GF) £106k and Debit cash £106k • The revaluation adjustment at the end of 2007/08 totalled £200k – Accounting Entries – Debit PPE £200k and Credit RR £200k • Depreciation adjustment – excess of CV depreciation over HC depreciation in 2008-09 was £4k - Accounting Entries – Debit RR £4k and Credit CAA £4k

  21. Operating Lease to Finance lease– Suggested Accounting Entries – Lessor – IFRS Transactions - Stage 1 Transition Balance Sheet (A) • Assumption – The Authority does a retrospective analysis of this lease, back its commencement date of – 1st of April 2007 • Decision – After undertaking an analysis the authority decided that on the balance of risks and rewards this asset should have been leased out to a third party from the 1st of April 2007 on the basis of a finance lease and not an operating lease • Up until the 31st of March 2007 – Accounting entries under the Historic SORP Position and the IFRS position were the same – ( See previous slide) • At the 31st of March 2007 – the historic SORP accounts related balances for the asset were as follows:

  22. Operating Lease to Finance lease– Suggested Accounting Entries – Lessor – IFRS Transactions - Stage 1 Transition Balance Sheet (B) • Operating lease asset must be translated into a finance lease debtor at 1st of April 2007 – This is accounted for as a disposal • Accounting Disposal Entries in 2007\08 • Disposal of operating leased asset by finance lease • Credit Fixed asset £980k and debit GF £980k being the write out of the carrying amount of the asset which was being leased to a third party under an operating lease • Credit GF by £1,000k and debit debtors £1,000k being the recognition of the long term debtor now being created for finance lease principal income (net investment in the lease) • Profit on disposal = £20k – Debit GF £20k and Credit CAA - £20k -- Any profit\loss on this deal would be debit\credit GF and debit\credit CAA • SI 454 issues – Credit Capital Receipt Deferred £1,000k and debit CAA £1,000k – This will be utilised later on

  23. Operating Lease to Finance lease– Suggested Accounting Entries – Lessor – IFRS Transactions - Stage 1 Transition Balance Sheet (C) • Summary of Accounting Disposal Entries on 1st of April 2007 (within 2007\08) including final position on disposal (re-classification) of the operating lease asset by finance lease

  24. Operating Lease to Finance lease– Suggested Accounting Entries – Lessor – IFRS Transactions - Stage 1 Transition Balance Sheet (D) • Further Accounting Entries in 2007\08 and beyond post disposal • Taking the position on disposal as a starting point • In 2007-08 and 2008-09 MRP will be £38k and £37k respectively – Accounting entries – Debit GF £75k and Credit CAA £75k • In 2007-08 and 2008-09 finance lease income will be £53k per annum with £3k of this being of a capital nature - - Accounting entries will be Credit GF £100k Credit outstanding debtor £6k and debit cash £106k • Si 454 adjustments recognising revenue income – equivalent to the capital elements – Debit Capital Receipts Deferred £6k and Credit GF £6k

  25. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessor – IFRS Position VS Historic SORP Position – Draft Reconciling Journal – Stage 1 Transition Balance Sheet Closing Balance under SORP + reconciling journal = Closing Balance under IFRS

  26. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessor – Historic SORP Position – Stage 2 – 2009\10 Entries (A)

  27. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessor – IFRS Position – – Stage 2 – 2009\10 Entries (B)

  28. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessor – IFRS Position VS Historic SORP Position – Draft Reconciling Journal – Stage 2 – 2009\10 Entries (C) Closing Balance under SORP + reconciling journal = Closing Balance under IFRS - Transition Balance sheet (Stage 1) + 1 year on (Stage 2)

  29. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessor – Historic SORP Position – Stage 3 – Leases commencing in 2009\10 Entries (A)

  30. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessor – IFRS Position – Stage 3 – Leases commencing in 2009\10 Entries (B)

  31. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessor – IFRS Position VS Historic SORP Position – Draft Reconciling Journal – Stage 3 – 2009\10 Entries (C) Closing Balance under SORP + reconciling journal = Closing Balance under IFRS Transition Balance sheet (Stage 1) + 1 year on (Stage 2) + New entries in 2009\10 (Stage 3)

  32. Further Help and worked examples • Please see CIPFA’s transition guidance at: http://www.cipfa.org.uk/pt/cipfalasaac/transition_guidance.cfm • Focus on chapter 4.2 - there is text and also a number of lease transition scenarios which have been presented in spread sheet format. • Simplified and amended versions of these have been used in this presentation • There are some CIPFA spreadsheets relating to IFRIC 4 – IFRIC 4 has been considered in our delegate information pack. • Please examine the above in further depth to get a better understanding of the entries and approaches

  33. Re-Stating – The 2009-10 Accounts for IFRS – Leasing and Lease Type Arrangements-Delegate Information Only 33

  34. Lease Re-Classification Requirements The requirements of the Code in respect of lease classification are different to those of the SORP. Authorities will therefore need to review their lease arrangements to determine whether or not leases need to be reclassified. Leases classified as operating leases under the SORP may be classified as finance leases under the Code, and leases classified as finance leases under the SORP may be classified as operating leases under the Code. Such reclassifications may occur where the authority is acting as a lessee and as a lessor. Hopefully these issues have been addressed in you authority 34

  35. Lease Re-Classification – Main reasons (1) Where a lease is a lease of property, the land and buildings elements are considered separately for the purpose of lease classification under the CIPFA IFRS Code. Under the SORP, both elements would have been considered together. The likely effect of this requirement is that, for some property leases formerly classified as finance leases under the SORP, the land element will be reclassified as an operating lease; For some property leases formerly classified as operating leases under the SORP, the buildings element will be reclassified as a finance lease. Chapter 4.2.2.9 of the CIPFA IFRS Code needs to be read and understood by practitioners Separation of the lease between land and buildings elements takes place at the inception of the lease 35

  36. Lease Re-Classification – Main reasons (2) Definition of a finance lease under the SORP- “A finance lease is one that transfers substantially all of the risks and rewards of ownership of a fixed asset to the lessee. It should be presumed that such a transfer of risks and rewards occurs if at the inception of a lease the present value of the minimum lease payments including any initial payment amounts to substantially all (normally 90% or more) of the fair value of the leased asset. The present value should be calculated by using the interest rate implicit in the lease.” The equivalent test under the Code (following IAS 17 and IPSAS 13) does not include any guidance regarding the meaning of ‘substantially all of the fair value’; the ‘90% test’ in the SORP no longer applies. 36

  37. MRP Approaches – Informing members – • If an authority brings a finance lease onto its balance sheet it will need to pay a principal element to reduce the liability • The intended effect of the MRP guidance is to try to ensure that the combined impact of the new finance charge and MRP for on-balance finance leases will have a neutral effect on the GF • An authority will have to make a conscious decision to adopt the annuity MRP method for on balance sheet finance leases and will need to inform its members through its MRP reporting mechanism. • Alternative methods of estimating principal other than the annuity MRP approach are possible but will probably need to pass a “prudence” requirement (consult with your auditors) • Authorities won’t necessarily know the amount of MRP transfer required, it would be prudent if they agreed establish this principle as soon as possible with their members • MRP policy can be selected so as to equate MRP to future principal repayments • Please see SI No 454 2010 – especially mitigation for lessors

  38. CIPFA IFRS Code on Accounting for Leases – Lessee – Possible lease Agreements (1) • IFRIC 4 -- Determining Whether an Arrangement contains a lease or not. Chapter 4.2.2.25 onwards of the CIPFA Code) • An entity may enter into an arrangement, comprising a transaction or a series of related transactions, that does not take the legal form of a lease but conveys a right to use a specific asset (eg an item of property, plant or equipment) in return for a payment or series of payments. E.g. (the supplier) may convey such a right to use an asset to another entity (the purchaser), often together with related services, including: outsourcing arrangements (eg the outsourcing of the data processing functions of an entity) rights to networks capacity • Determining whether an arrangement is, or contains, a lease shall be based on the substance of the arrangement and requires an assessment of whether: • Fulfillment of the arrangement is dependent on the use of a specific asset or assets (the asset); and • The arrangement conveys a right to use the asset.

  39. CIPFA IFRS Code on Accounting for Leases – Lessee – Possible lease Agreements (2) • Chapter 10.1.1.9 of the CIPFA Code considers any exemptions from IFRS – In terms of IFRIC 4 an Authority must: (1) Examine the facts and circumstances of possible lease agreements existing as at the 1st of April 2009 (2) In the light of (1) above determine to what degree (if at all) the CIPFA Code, IAS 17 and IFRIC 4 might apply (3) Undertake a retrospective analysis of the lease if required going back to its inception and commencement dates (4) Utilise the approaches which have been discussed in this presentation Example: “Microwave communication dishes used solely to enable a Police Force to communicate – provided within a service contract.”

  40. CIPFA IFRS Code on Accounting for Leases – Lessee – Possible lease Agreements (3) • Assessing or re-assessing whether the arrangement contains a lease after the inception of the arrangement shall be made only if any one of the following conditions is met: (a) There is a change in the contractual terms, unless the change only renews or extends the arrangement. (b) A renewal option is exercised or an extension is agreed to by the parties to the arrangement, unless the term of the renewal or extension had initially been included in the lease term in accordance with paragraph 4 of IAS 17. A renewal or extension of the arrangement that does not include modification of any of the terms in the original arrangement before the end of the term of the original arrangement shall be evaluated under paragraphs 6–9 only with respect to the renewal or extension period. (c) There is a change in the determination of whether fulfillment is dependent on a specified asset. (d) There is a substantial change to the asset, for example a substantial physical change to property, plant or equipment. 

  41. CIPFA IFRS Code on Accounting for Leases – Measurement of Investment Properties • Influence of Section 4.4 of the Code – (IAS 40 Investment Assets) • Separate measurement of the land and buildings elements is not required when the lessee’s interest in both land and buildings is classified as an investment property in accordance with IAS 40 and the fair value( lease interest) model is adopted (As required by section 4.4 of the Code) • In accordance with IAS 40, it is possible for a lessee to classify a property interest held under an operating lease as an investment property. • If the above is true, the property interest is accounted for as if it were a finance lease and, in addition, the fair value of the lease interest (As per the code) is used for the asset recognised.

  42. Re-Stating – The 2009-10 Accounts for IFRS – Operating Lease to Finance lease Lessee – Stage 1 Transition Balance sheet 42

  43. Operating Lease to finance Lease – Suggested Accounting Entries – Lessee – Historic SORP Transactions Description- Stage 1 – Transition balance sheet • Assumption – Initially the authority assumed that the lease was an operating lease commencing on the 1st of April 2005 – with payments being made on the 31st of March each year totalling £40k per annum. • As at the 31st of March 2009 – the authority paid out operational leasing charges of £40k per annum for 4 years – totalling £160k • The annual accounting entries were credit cash £40k and debit GF £40k • As at the 31st of March 2009 the cumulative entries for these historic actual transactions totalled £160k – Accounting Entries - credit to cash of £160k and debit to the GF of £160k • These formed the Historic SORP transactions position up until the 31st of March 2009 – • Subsequent analysis of this lease determined that it should have been accounted for as a finance lease not an operating lease

  44. Operating Lease to finance Lease – Suggested Accounting Entries – Lessee – IFRS Transactions Description- Stage 1 – Transition Balance sheet(A) • Assumption – The Authority does a retrospective analysis of the lease back to its commencement date of – 1st of April 2005 and decides that on the balance of risks and rewards the lease is now a finance lease with an initial recognition fair value of £1m asset and £1m liability on the 1st of April 2005. • Action – Record the accounting entries as if the lease had always been a finance lease • Accounting Entries - Debit PPE £1m and credit the other long term liability £1m • Action – add in MRP Charges as follows; 2005/06 - £25k,2006/07 -£26k,2007/08 -£27k and 2008-09 £28k – totalling £106k for the 4 years – Equal to the principal repayment charges • Accounting Entries MRP over 4 years – Debit GF £106k and Credit CAA £106k • Action calculated interest elements on the £1m liability were 2005/06 £15k,2006/07 -£14k,2007/08 -£13k and 2008-09 £12k – totalling £54k for the 4 years • Accounting Entries over 4 years – credit cash £54k and debit GF £54k

  45. Operating Lease to finance Lease – Suggested Accounting Entries – Lessee – IFRS Transactions Description -- Stage 1 – Transition Balance sheet(B) • Action – Estimate -- annual inputed principal repayments (reducing balance) of the liability were: 2005/06 - £25k,2006/07 -£26k,2007/08 -£27k and 2008-09 £28k – totalling £106k for the 4 years – Equal to MRP charges • Accounting entries for principal over 4 years – credit cash £106k and debit liability £106k • Action – Annual depreciation charges on the new asset were: 2005/06 - £20k,2006/07 -£20k,2007/08 -£20k and 2008-09 £21k – totalling £81k for the 4 years • Accounting Entries - Depreciation over 4 years – Credit Fixed Assets £81k and debit CAA £81k – No effect on the GF • Asset re-valued by £200k in 2008-09 – Accounting Entries - Debit Fixed Asset and Credit RR by £200k

  46. Operating Lease to finance Lease – Suggested Accounting Entries – Lessee – IFRS Transactions -- Stage 1 – Transition Balance sheet – Observations on the examples • The MRP charges over the 4 years = £106k = the principal repayment charges over the 4 year – reflects the choice of MRP methodology whereby MRP = the principal repayment on the liability for the new asset which has been recorded on the balance sheet • The principal and interest charges repaid on the liability for the new asset which has been introduced onto the balance sheet = the figure for the previous annual operational lease payment, namely £40k per annum • The above are important assumptions which ensure a neutral GF effect. – Realistic here? • Very important issue here – SI No 454 2010 does not allow any mitigation for lessee authorities moving from operating to finance leases or finance leases to operating leases

  47. Operating Lease to finance Lease – Suggested Accounting Entries – For the Lessee – IFRS Position VS Historic SORP Position – Draft Reconciling Journal – Stage 1 Transition Balance Sheet Closing Balance under SORP + reconciling journal = Closing Balance under IFRS

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