Substance over form
Information in the financial statements should represent transactions in accordance with their commercial substance not merely their legal form. The accounting for leases is the application of this concept, as the classification of a lease as either a finance lease or an operating lease, depends on the substance of the transactions rather than the legal form of the contract. IAS 17 distinguishes between two types of lease transactions: A finance lease and an Operating lease
A finance lease “is a lease that transfers substantially all the risks and rewards inherent to ownership of the asset”. An operating lease is a lease other than a finance lease. The classification of a lease is crucial, as different accounting, approaches are required for the different types of leases. Question 2
Minimum lease payments are rental payments over the lease term including the amount of any bargain purchase option, premium, and any guaranteed residual value and excluding any rental relating to costs to be met by the lessor and any contingent rentals. Question 3
Minimum lease payments
The interest rate implicit in the lease is the discount rate that, at the inception of the lease, causes the aggregate present value of: a. the minimum lease payments; and
b. the unguaranteed residual value
to be equal to the sum of:
c. the fair value of the leased asset; and
d. any initial direct costs of the lessor.
IAS 17 para 36 requires lessor to recognise assets held under a finance lease in it’s statement of financial position and present them as a receivable at an amount equal to the net investment in the leases.
Classification as a finance lease may have the following adverse impacts on a lessee’s financial statements: Increases non-current assets – reducing ROA ratios
Increases non-current liabilities – adversely affecting debt/equity ratios Depreciation and interest charges may exceed lease payment...
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