AASB 117 Accounting for Leases is the current accounting standard that regulates and provides guidance as to how to correctly account for and disclose leases and hire purchase agreements.
A copy of AASB 117 has been provided for you in full at the end of this section. The commentary that follows is based on the information contained in AASB 117 but has been summarised and interpreted only from the lessee's point of view.
APPLICABILITY OF AASB 117
This Standard applies to agreements that transfer the right to use assets even though substantial services by the lessor may be called for in connection with the operation or maintenance of such assets. This Standard does not apply to agreements that are contracts for services that do not transfer the right to use assets from one contracting party to the other.
DEFINITIONS
The commencement of the lease term is the date from which the lessee is entitled to exercise its right to use the leased asset. It is the date of initial recognition of the lease (i.e. the recognition of the assets, liabilities, income or expenses resulting from the lease, as appropriate).
Economic life is either:
the period over which an asset is expected to be economically usable by one or more users; or
the number of production or similar units expected to be obtained from the asset by one or more users.
A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.
A lease is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for an agreed period of time.
The lease term is the non-cancellable period for which the lessee has contracted to lease the asset together with any further terms for which the lessee has the option to continue to lease the asset, with or without further payment, when at the inception of the lease it is reasonably certain that the lessee will exercise the option.
A non-cancellable lease is a lease that is cancellable only:
(a) upon the occurrence of some remote contingency;
(b) with the permission of the lessor;
(c) if the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or
(d) upon payment by the lessee of such an additional amount that, at inception of the lease, continuation of the lease is reasonably certain.
An operating lease is a lease other than a finance lease.
Useful life is the estimated remaining period, from the commencement of the lease term, without limitation by the lease term, over which the economic benefits embodied in the asset are expected to be consumed by the entity.
The definition of a lease includes contracts for the hire of an asset that contain a provision giving the hirer an option to acquire title to the asset upon the fulfilment of agreed conditions. These contracts are sometimes known as hire purchase contracts.
CLASSIFICATION OF LEASES
The classification of leases adopted in this Standard is based on the extent to which risks and rewards incidental to ownership of a leased asset lie with the lessor or the lessee. Risks include the possibilities of losses from idle capacity or technological obsolescence and of variations in return because of changing economic conditions. Rewards may be represented by the expectation of profitable operation over the asset's economic life and of gain from appreciation in value or realisation of a residual value.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership.
Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are:
the lease transfers ownership of the asset to the lessee by the end of the lease term;
the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised;
the lease term is for the major part of the economic life of the asset even if title is not transferred;
at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset; and
the leased assets are of such a specialised nature that only the lessee can use them without major modifications.
Leases of land and of buildings are classified as operating or finance leases in the same way as leases of other assets. However, a characteristic of land is that it normally has an indefinite economic life and, if title is not expected to pass to the lessee by the end of the lease term, the lessee normally does not receive substantially all of the risks and rewards incidental to ownership in which case the lease of land will be an operating lease.
ACCOUNTING AND DISCLOSURE OF LEASES IN THE FINANCIAL STATEMENTS OF THE LESSEE
Finance Leases
Initial recognition
At the commencement of the lease term, lessees shall recognise finance leases as assets and liabilities in their balance sheets at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, each determined at the inception of the lease.
At the commencement of the lease term, the asset and the liability for the future lease payments are recognised in the balance sheet at the same amounts except for any initial direct costs of the lessee that are added to the amount recognised as an asset.
Minimum lease payments shall be apportioned between the finance charge and the reduction of the outstanding liability. The finance charge shall be allocated to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability.
In practice, in allocating the finance charge to periods during the lease term, a lessee may use some form of approximation to simplify the calculation.
A finance lease gives rise to depreciation expense for depreciable assets as well as finance expense for each reporting period. The depreciation policy for depreciable leased assets shall be consistent with that for depreciable assets that are owned, and the depreciation recognised shall be calculated in accordance with AASB 116 Property, Plant and Equipment and AASB 138 Intangible Assets. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset shall be fully depreciated over the shorter of the lease term and its useful life.
To determine whether a leased asset has become impaired, an entity applies AASB 136 Impairment of Assets.
Lessees shall, in addition to meeting the requirements of AASB 7 Financial Instruments: Disclosures, make the following disclosures for finance leases:
for each class of asset, the net carrying amount at the reporting date;
a reconciliation between the total of future minimum lease payments at the reporting date, and their present value. In addition, an entity shall disclose the total of future minimum lease payments at the reporting date, and their present value, for each of the following periods:
not later than one year;
later than one year and not later than five years;
later than five years;
contingent rents recognised as an expense in the period;
the total of future minimum sublease payments expected to be received under non-cancellable subleases at the reporting date; and
a general description of the lessee's material leasing arrangements including, but not limited to, the following:
the basis on which contingent rent payable is determined;
the existence and terms of renewal or purchase options and escalation clauses; and
restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and further leasing.
Operating Leases
Lease payments under an operating lease shall be recognised as an expense on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user's benefit.
For operating leases, lease payments (excluding costs for services such as insurance and maintenance) are recognised as an expense on a straight-line basis unless another systematic basis is representative of the time pattern of the user's benefit, even if the payments are not on that basis.
Lessees shall, in addition to meeting the requirements of AASB 7, make the following disclosures for operating leases:
the total of future minimum lease payments under non-cancellable operating leases for each of the following periods:
not later than one year;
later than one year and not later than five years;
later than five years;
the total of future minimum sublease payments expected to be received under non-cancellable subleases at the reporting date;
lease and sublease payments recognised as an expense in the period, with separate amounts for minimum lease payments, contingent rents, and sublease payments;
a general description of the lessee's significant leasing arrangements including, but not limited to, the following:
the basis on which contingent rent payable is determined;
the existence and terms of renewal or purchase options and escalation clauses; and
restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and further leasing.
EXAMPLE OF FINANCIAL STATEMENT DISCLOSURES
LEASING COMMITMENTS
Finance Lease Commitments
Future minimum lease payments payable at 30 June 20XX:
Not later than 1 year $25,000
Less than 1 year but not greater than 5 years $80,000
The leased assets are all motor vehicles financed under both finance leases and hire purchase agreements with a term of five years. Lease & HP payments are payable monthly in advance. The lease & HP agreements have a common expiry date of 15 March 2010 have options to purchase by payment of a residual amount at expiry.
Operating Lease Commitments
Non-cancellable operating leases contracted for but not capitalised in the financial statements:
Future minimum lease payments payable at 30 June 20XX:
Not later than 1 year $40,000
Less than 1 year but not greater than 5 years $60,000
The leased assets, medical equipment, are non-cancellable leases with a five year term, with rent payable monthly in advance. The lease expires on 30 April 2010. There are no restrictions placed upon the lessee by entering into these leases.
EXAMPLE OF ACCOUNTING TREATMENT
Finance Lease or Hire Purchase
Motor Vehicle Purchased for $32,000 on 1 July 2006.
Leased over 36 months (3 years)
Total cost of lease $36,000
Zero residual
Monthly payments in advance on the 1st day of each month of $1,000 per month.
Total lease interest charges $4,000
Using the Rule of 78 the apportionment of the finance charges is calculated as:-
Year ended 30 June 2007 55% x $4,000 = $2,200 / 12 = $183.33
Year ended 30 June 2008 33% x $4,000 = $1,320 / 12 = $110.00
Year ended 30 June 2009 12% x $4,000 = $480 / 12 = $40.00
Journal Entries Required
01/07/06 Dr. Motor Vehicle Asset (B/S) $32,000
Cr. Lease Liability (B/S) $36,000
Dr. Unexpired Lease Charges (B/S) $4,000
To bring to account motor vehicle asset and lease liability at the inception of the lease.
01/07/06 Dr. Lease Liability (B/S) $1,000.00
Cr. Cash at Bank (B/S) $1,000.00
To record first lease payment at 1 July 2006.
01/07/06 Dr. Lease Charges/Interest (P&L) $183.33
Cr. Unexpired Lease Charges (B/S) $183.33
To record lease interest charges that have expired as at 1 July 2006.
30/06/07 Dr. Depreciation Expense (P&L) $6,400.00
Cr. Accumulated Depreciation (B/S) $6,400.00
To record depreciation charges as at 30 June 2007.
CASE STUDY 1
Prepare the disclosure note required as at 30 June 2007.
Operating Lease
Entity enters into an operating lease with ABC Medical Equipment for the rent of an ECG monitoring machine. ABC Medical Equipment will ensure that the medical equipment is repaired and maintained as per the terms of the lease in return for a monthly payment of $750 over 24 months. The entity has no option to cancel the lease or to purchase the equipment at the expiry of the lease term.
01/07/06 Dr. Lease Charges/Interest (P&L) $750.00
Cr. Cash at Bank (B/S) $750.00 To record lease interest charges that have expired as at 1 July 2006.
Note: No Asset or Liability is created under this type of lease arrangement and therefore no depreciation charges are eligible.
CASE STUDY 2
Prepare the disclosure note required as at 30 June 2007.
GST AND LEASES AND HIRE PURCHASE AGREEMENTS
Depending on whether you report and record your GST through Cash Basis or Accruals Basis.
How do you claim GST credits on hire purchases?
If you account for GST on a non-cash (accruals) basis, you claim the full amount of your GST credit entitlement in the earlier of the tax periods in which either you make your first payment or an invoice is issued to you.
If you account for GST on a cash basis, you may claim one eleventh of the principal component of each instalment in the period in which you actually pay the instalment. If the supplier provides regular accounts or statements that show the principal and interest components for each instalment, you need to always use that information as the basis for calculating GST credits in the relevant tax period. If you do not know the principal component for each instalment, you need to take reasonable steps to find out this information from the supplier.
How do you claim GST credits on lease agreements?
If you account for GST on a non-cash (accruals) basis, you are entitled to a GST credit of one-eleventh of the lease instalments for each tax period. You claim the GST credit for a tax period when payment of any part of the lease payments due in that period is made, or an invoice for that period is issued, whichever is the earlier.
If you account for GST on a cash basis, you claim a GST credit of one-eleventh of the lease instalment amounts paid in each tax period.
What happens if ownership of goods changes at the end of the lease?
Residual payments under lease agreements may be subject to GST. These are payments made for ownership of the goods changing hands at the end of the lease, which is a separate transaction to the lease agreement.
If you purchase the goods at the end of the lease agreement, you may be eligible to claim a GST credit for any GST you paid in the price of the purchase.
