Section 15 – Leases

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Section 15 – Overview

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Section 15 – Leases
Summary

Section 15 applies to all leases, including some arrangements that do not take the legal form of a lease but convey rights to use assets in return for payments. It deals with the recognition, measurement and disclosures of operating and finance leases.

The following leases do not come within the scope of Section 15: 

What is different when compared to previous GAAPs – General?

Section 15 only requires disclosures of financial commitments, guarantees and contingencies not recognised in the financial statements on a total basis. This contrasts with FRS 102 where this commitment must be split out by years detailing the amount payable in each of the bucket categories in total. Old GAAP/FRSSE requires disclosure of the future operating lease payments within various year buckets based on the total amounts payable after year end showing when the contractual term expires from the year end date. 

ROI entities are required to disclose details of fixed assets which are held as security and the amount included in liabilities in total on the balance sheet. There was far more disclosures required under the other GAAP’s.

What is new when compared to FRSSE/old GAAP?

Section 15.15 states that lease incentives should be recognised over the life of the lease which differs from old GAAP as under SSAP 21 (old GAAP/FRSSE) the lease incentive is recognised from the point of commencement to the first break clause/market rent review in the lease. This will result in the credit being released to the profit and loss account over a longer period of time.

Under Section 15, initial direct costs are included on initial measurement, whereas, under old GAAP/FRSSE there was no requirement to include such costs. As a result, there may be differences on transition if direct costs are material. However, in reality, it is not likely to have a material impact.

What is different when compared to FRSSE/old GAAP?

FRS 26 adopters under old GAAP were required to identify embedded derivatives in leases that were not closely related to the host. There is no such requirement under Section 15 nor under FRS 102.

Section 15.3 brings into scope rights to use assets in return for payments within arrangements that do not take the legal form of a lease. There is no such guidance in old GAAP (SSAP 21)/FRSSE however, FRS 5 was followed which suggested the same treatment. It is likely there will be no differences as a result.

Section 15.5 details what constitutes a finance lease which includes the fact that it should be classified as a finance lease if it transfers substantially all of the fair value of the asset. However, there is no 90% test as was detailed in SSAP 21 of old GAAP which was similar to FRSSE. Under old GAAP/FRSSE there was a presumption that transfer of risk and rewards occurred if the present value of the minimum lease payments discounted at the interest rate implicit in the lease, amounts to 90% or more of the leased asset. It is unlikely that this will result in any differences as to whether a finance lease exists and should not result in many differences on transition.

Under Section 15 the inception of the lease is the earlier of the date of the lease agreement and the date of commitment by the parties to the principal provisions of the lease.  This contrasts with old GAAP/FRSSE as the inception is the earlier of the time the asset is brought into use and the date from which the rentals first accrue. It will be very rare for differences to arise on transition unless there is specialist equipment being leased which is being constructed.

A leased asset should be accounted for at the lower of the fair value of the asset or the present value of the minimum lease payments, discounted at the interest rate implicit in the lease. This differs from old GAAP/FRSSE which stated that it should be measured at the minimum lease payments, discounted at the interest rate implicit in the lease.

What is different when compared to FRS 102?

FRS 105 does not detail how a lease should be accounted for where the lease payments increase annually by fixed instalments intended to compensate for expected annual inflation over the lease period. FRS 102 deals with this and states that the fixed minimum increment that reflects general inflation will be recognised as incurred. This is unlikely to result in differences as this would also be deemed reasonable under the concepts and principals stated in FRS 105. Old GAAP/FRSSE did not deal specifically with this.

Under FRS 102 leases that could lead to a loss to the lessor or the lessee as a result of non-typical contractual terms are excluded from scope. There is no such scope exclusion under FRS 105 which is also the case under FRSSE/old GAAP. Given the size of the entities that are able to apply FRS 105 it is unlikely to create differences as it is unlikely to arise.

Other standards affecting Section 15 where differences arise:

Section 24 – Income tax – Given that the financial statement prepared under a prior GAAP will have taxed the deduction in that year for the release of the incentive, on transition the comparative years results will need to be restated so as to show the true tax charge if FRS 105 had of applied from inception. This will result in a corporation tax asset being recognised. This asset will be recovered over a set period based on guidance issued by the tax authorities in relation to these transitional arrangements (i.e. 5 years for ROI). Note this point is only applicable for entities entities transitioning from FRSSE/old GAAP.

Section 28 – Transition to FRS 105 – A first time adopter is not required to retrospectively adjust the deferred element for lease incentives in relation to lease incentive received before the date of transition. Instead the entity can continue to release the incentives received prior to this date up to the break clause/first market rent review (i.e. continue to use GAAP rules). Note however where lease incentives have been received in the comparative years’ figures, the leasehold incentives will have to be recalculated such that it is released over the life of the lease. A first time adopter may also elect to assess whether an arrangement containing a lease exists at the date of transition as opposed to looking at the facts when the arrangement was entered into. Note these exemptions are only applicable for entities transitioning from FRSSE/old GAAP as the rules in FRS 102 are identical to FRS 105.

What are the key points?

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 (Section 15.3).

A lease asset should be accounted for at the lower of the fair value of the asset or the present value of the minimum lease payments, discounted at the interest rate implicit in the lease.

Direct costs should be capitalised with the lease.

Operating lease rentals should be charged to the profit and loss on a straight line basis.

Lease incentives are released over the life of the lease. Section 28 allows an exemption for leases entered into prior to the transition date as discussed above.

Disclosure required of the total commitments, guarantees and contingencies in relation to leases.

Contingent rent is charged to the profit and loss as incurred.

In a sale and leaseback which does not transfer substantially the risk and rewards of ownership (i.e. the creation of a finance lease) the seller-lessee does not recognise immediately, as income, any excess of sales proceeds over the carrying amount. Instead, the seller-lessee defers such excess and amortises it over the lease term.  

What do accountants need to do?

Get to grips with the changes likely as a result of the new standard.

Advise clients who regularly receive lease incentives of the need to release the credit over the life of the lease as opposed to the first break clause/market rent review. Advise clients on the impact this will have on the client’s’ profit as well as the corporation tax adjustment on transition that will need to ensure that the financial statements comply with FRS 105. Advise that this will mean that the lease incentive will be taxed over a longer period of time. Note this is only applicable for entities transitioning from FRSSE/old GAAP, it does not apply to entities transitioning from FRS 102 as the rules are the very same as FRS 105.

What do Companies need to do?

Get to grips with the differences between Section 15 and old GAAP/FRSSE and FRS 102.

Identify the adjustments required to comply with Section 15 from the date of transition, particularly adjustments for lease incentives to include the corporation tax effect for the

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