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Disclosures for Operating Leases
In addition to the requirements of the financial instruments standards, these disclosures are required:
• The future minimum lease payments under noncancelable operating leases for each of the following:
• Not later than one year
• Later than one year but not later than five years
• Later than five years
• Contingent rents recognized as income
• A general description of the significant leasing arrangements
PRACTICAL INSIGHT
SIC 27, Evaluating the Substance of Transactions Involving the Legal Form of a Lease, considers whether an arrangement meets the definition of a lease
under IAS 17, Leases, and, if not, how a company should account for a fee it may receive. Examples are given of indicators that demonstrate that it is
inappropriate to grant immediate recognition of the entire fee as income.
Deutsche Post discloses that it leases to companies electronic sorting systems although it remains the beneficial and legal owner of all the assets and they
remain available to Deutsche Post for its operating activities. The note in its 2002 financial statements refers to SIC 27 and discloses that the net present
value benefit from the transactions has been recognized immediately, which results in income of €136 million and expenses of €40 million being
recognized.
SALE AND LEASEBACK TRANSACTIONS AND OTHER TRANSACTIONS INVOLVING THE
LEGAL FORM OF A LEASE
Very often entities enter into complex financing arrangements involving lease-like arrangements. Careful analysis of such arrangements needs to be undertaken to
ensure that the substance of the transaction is properly reflected, not just the legal form.
A common financing transaction is a sale and leaseback whereby the owner of an asset sells it to a financier who then leases the asset back to the original owner.
Analysis is required to determine if the leaseback is a finance or an operating lease. A finance lease results in the lessee having to defer any profit on disposal over the
lease term. If the leaseback is an operating lease and the entire transaction is at fair value, gain or loss on disposal is recognized immediately.
Other more complex transactions need to be analyzed for their substance and often involve a series of transactions involving leases. On occasion, just tax benefits
arise; sometimes there is no real transaction when the series of transactions is viewed in its entirety. In such cases the substance needs to be clearly reflected in the
financial statements.
In the case of an operating lease, if the sale price is below fair value and the loss is compensated by future lease payments at below market price, then the loss should
be deferred and amortized in proportion to the lease payments over the useful life of the asset.
If the loss is not compensated by future lease payments, it should be recognized immediately.
If the sale price is above fair value and the rentals are above the normal market rates, the excess over fair value should be deferred and amortized over the useful life
of the asset.
PRACTICAL INSIGHT
KONINKLIJKE PHILIPS ELECTRONICS NV stated in its financial statements that gains arising on sale and leaseback transactions that are deferred
under US generally accepted accounting principles (GAAP) will be released to equity as IAS 17, Leases, does not permit such deferral.
Facts
CASE STUDY 5
An entity sells a piece of a plant to a 100% owned subsidiary and leases it back over a period of four years. The remaining useful life of the plant is ten
years. The selling price of the plant was 20% below its carrying and market value. The lease rentals were based on market rates. The entity has no right to
buy the plant back.
Required