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IFRS Types of lease-finance or operating lease

IFRS Types of lease-finance or operating lease

IFRS Types of lease-finance or operating lease:The terms of a lease arrangement determine how a lease is classified and the resulting income statement recognition. When the terms of a lease effectively transfer control of the underlying asset, the lease represents an in substance financed purchase (sale) of an asset and the lease is classified as a finance lease by the lessee and a sales-type lease by the lessor. When a lease does not effectively transfer control of the underlying asset to the lessee, but the lessor obtains a guarantee for the value of the asset from a third party, the lessor would classify a lease as a direct financing lease. All other leases are classified as operating leases. See LG 7 for information on leveraged leases, a specific model applicable to certain direct financing leases. Leveraged leases were eliminated in the new standard, but the standard grandfathered leveraged leases that exist at the adoption date of the new standard.

IFRS Types of lease-finance or operating lease

IFRS Types of lease-finance or operating lease

IFRS Types of lease-finance or operating lease

For many reporting entities, leasing is an important way to obtain access to property. It allows lessees to finance the use of necessary assets, often simplifies the disposal of used property, and reduces a lessee’s exposure to the risks inherent in asset ownership. Leasing guidance (before the issuance of ASU 2016-02) required lessees to classify leases as either capital or operating leases. Lessees recognised assets and obligations related to capital leases; expenses associated with capital leases were recognised by amortising the leased asset and recognising interest expense on the lease obligation. Many lease arrangements were classified as operating leases, under which lessees would not recognise lease assets or liabilities on their balance sheet, but rather would recognise lease payments as expense on a straight line basis over the lease term.

IFRS Types of lease-finance or operating lease

The leasing guidance was often criticised for not providing users the information necessary to understand a reporting entity’s leasing activities, primarily because it did not provide users with a comprehensive understanding of the costs of property essential to a reporting entity’s operations and how those costs were funded. Users frequently analysed information from a reporting entity’s lease-related disclosures to compare that reporting entity’s performance with other companies. The user community and regulators frequently called for changes to the accounting requirements that would require lessees to recognise assets and liabilities associated with leases. In 2008, the FASB and IASB (collectively, the “boards”) initiated a joint project to develop a new standard to account for leases. Although many of the perceived problems with the previous leasing guidance related to a lessee’s accounting for operating leases, the boards thought it beneficial to reflect on lease accounting holistically, and to consider lessor accounting while concurrently developing a proposal on revenue recognition (ASC 606, Revenue from Contracts with Customers, which was issued in May 2014).

IFRS Types of lease-finance or operating lease

The FASB issued ASU 2016-02 (the “leasing standard” or “ASC 842”) in February 2016. Although the project began as a joint project, the boards diverged in some key areas. Most significantly, the boards did not agree on whether all leases should be accounted for using the same model. After significant deliberation, the IASB decided that lessees should apply a single model to all leases, which is reflected in IFRS 16, Leases, released in January 2016. The FASB decided that lessees should apply a dual model. Under the FASB model, lessees will classify a lease as either a finance lease or an operating lease, while a lessor will classify a lease as either a sales-type, direct financing, or operating lease. Under the FASB model, a lessee should classify a lease based on whether the arrangement is effectively a purchase of the underlying asset. Leases that transfer control of the underlying asset to a lessee are classified as finance leases (and as a sales-type lease for the lessor); lessees will classify all other leases as operating leases. In an operating lease, a lessee obtains control of only the use the underlying asset, but not the underlying asset itself.

IFRS Types of lease-finance or operating lease

A lease may meet the lessee finance lease criteria even when control of the underlying asset is not transferred to the lessee (e.g., when the lessor obtains a residual value guarantee from a party other than the lessee). Such leases should be classified as a direct finance lease by the lessor and as an operating lease by the lessee. See LG 3 for information on the dual model adopted by the FASB. The dual model does not affect a lessee’s initial recognition of assets and liabilities on its balance sheet, but differentiates how a lessee should recognise lease expense in the income statement. The accounting for lessors is largely unchanged under the FASB and IASB models. The following table includes a description of some of the most significant differences between the guidance in ASC 842 and IFRS 16.

IFRS Types of lease-finance or operating lease

Finance lease Operating lease
  1. Record a right-of-use asset and a lease liability.
  2. Interest expense is determined using the effective interest method. Amortization is recorded on the right-of-use asset (usually on a straight-line basis). The periodic expense at the beginning of the lease term will generally be greater than the corresponding cash payments, but will decline over the lease term as the lease liability is reduced
  3. Interest and amortization expense should generally be presented separately in the income statement
  4. The right-of-use asset is tested for impairment in accordance with ASC 360

 

  1. Record a right-of-use asset and a lease liability
  2. Lease expense is recorded on a straight-line basis over the lease term by adding interest expense determined using the effective interest method to the amortization of the right-of-use asset. Unlike a finance lease, amortization of the right-of-use asset is calculated as the difference between the straight-line expense and the interest expense on the lease liability for a given period
  3. Lease expense is presented as a single line item in operating expense in the income statement
  4. The right-of-use asset is tested for impairment in accordance with ASC 360


IFRS Types of lease-finance or operating lease

Sales-type lease Direct financing leaseDirect financing lease
  1. The underlying asset is derecognized and the net investment in the lease (the sum of the present value of the future lease payments and unguaranteed residual value) is recorded.
  2. The net investment in the lease is increased by interest income and decreased by payments collected.
  3. Selling profit or loss is recorded at lease commencement .
  4. Interest income is recorded based on the effective rate of interest in the lease
  1. The underlying asset is derecognized and the net investment in the lease (the sum of the present value of the future lease payments and unguaranteed residual value) is recorded.
  2. The net investment in the lease is increased by interest income and decreased by payments collected.
  3. Selling profit is deferred and selling loss is recorded at lease commencement .
  4. Interest income is recorded based on the effective rate of interest in the lease
  1. The underlying asset remains on the balance sheet
  2. The underlying asset continues to be depreciated over its useful life, which could extend beyond the lease term.
  3. Lease revenue and depreciation expense are presented on a gross basis in the income statement.


IFRS Types of lease-finance or operating lease

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