1. Was the junior accountant’s analysis correct? Why or why not?
No, the junior accountant’s analysis is not correct in classifying the lease as an operating lease in accordance with IFRS. Whether or not a lease is classified as a finance or an operating lease depends on if all of the benefits as well as risks of ownership have been shifted from the lessor to the lessee.
According to IAS 17-10(d), a lease must be classified as a finance if either “the lease term is for the major portion of the asset’s economic life” or “at the inception of the lease the present value of the minimum payment amounts to at least substantially all of the fair value of the lease asset.” With regards to this case, the term of the lease is equal to 75% of the equipment’s useful life. Also, the present value of the annual payments would equal $263,716 with the fair value of asset only being $265,000, which makes the present value of the minimum lease payment 99.5% of the fair value of the leased asset. With these criteria being met it satisfies the requirements of IAS 17 and would therefore be classified as a finance lease
2. Was the senior accountant’s analysis correct? Why or why not?
The senior accountant’s analysis is correct according to IAS 17. The way the senior accountant lays out his thought process in a step-by-step process creates a nice “checklist” to compare to the IAS. Beginning with step one, the senior accountant classifies the lease as a finance lease on the terms that the life of the contract encompasses the majority of the equipment’s useful life. According to IAS 17.10, the senior accountant is correct.
Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following: [IAS 17.10] * the lease transfers ownership of the asset