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Chapter 11
LEASES (IAS 17)
BACKGROUND AND INTRODUCTION
This Standard prescribes the accounting treatment for leases in the financial statements of lessees and lessors.
SCOPE
This Standard shall be applied in accounting for leases other than
1. Leases to explore for or use nonregenerative resources such as oil, natural gas, and so forth
2. Licensing arrangements for motion pictures, video recordings, music, and so on
This Standard shall not be applied in the measurement of
• Property held by lessees that is an investment property (see IAS 40)
• Investment property provided by lessors under operating leases (see IAS 40)
• Biological assets held by lessees under finance leases (see IAS 41)
• Biological assets provided by lessors under operating leases (see IAS 41)
(in accordance with IAS 17)
DEFINITIONS OF KEY TERMS
Lease. An agreement whereby the lessor conveys to the lessee in return for payment the right to use an asset for an agreed period of time.
Finance lease. A lease that transfers substantially all the risks and rewards of ownership of an asset. Title need not necessarily be eventually transferred.
Operating lease. A lease that is not a finance lease.
Minimum lease payments. The payments over the lease term that are required to be made. For a lessee, this includes any amounts guaranteed to be paid;
for a lessor, this includes any residual value guaranteed to the lessor.
The definition of a lease includes those contracts for hire of an asset that contain provisions for the hirer to acquire title to the asset upon fulfillment of agreed
conditions—these are sometimes called hire purchase contracts.
PRACTICAL INSIGHT
RHI AG, an Austrian entity, states in its financial statements that the move to International Financial Reporting Standards (IFRS) has increased the opening
book value of all its noncurrent assets by €69 million. It explains that, under Austrian generally accepted accounting principles (GAAP), the depreciation
of noncurrent assets is influenced partly by tax considerations, while under IFRS, it is in line with expected useful lives.
Included in the above total are increases of €5 million resulting from the capitalization of finance leases under IAS 17, Leases, and decreases of €7 million
unscheduled depreciation under IAS 36, Impairment of Assets.
CLASSIFICATION OF LEASES
The classification of a lease as either a finance lease or an operating lease is critical as significantly different accounting treatments are required for the different types
of lease. The classification is based on the extent to which risks and rewards of ownership of the leased asset are transferred to the lessee or remain with the lessor.
Risks include technological obsolescence, loss from idle capacity, and variations in return. Rewards include rights to sell the asset and gain from its capital value.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards of ownership to the lessee. If it does not, then it is an operating lease. When
classifying a lease, it is important to recognize the substance of the agreement and not just its legal form. The commercial reality is important. Conditions in the lease
may indicate that an entity has only a limited exposure to the risks and benefits of the leased asset. However, the substance of the agreement may indicate otherwise.
Situations that, individually or in combination, would usually lead to a lease being a finance lease include
• Transfer of ownership 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 lower than its fair value such that the option is likely to be exercised.
• The lease term is for a major part of the economic life of the asset, even if title to the asset is not transferred.
• The present value of the minimum lease payments is equal to substantially all of the fair value of the asset.