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Section 20: Leases.
20.2.1 Extract from FRS 102 – Section 20.1-20.2.
20.2.2 OmniPro comment – Scope.
20.3 Determining whether an arrangement contains a lease.
20.3.1 Extract from FRS 102 – Section 20.3- 20.3A.
20.4 Classification of leases.
20.4.1 Extract from FRS 102 – Section 20.4- 20.7.
20.4.2.1 Risks and rewards of ownership.
20.4.2.2 Lease term defined and major part of an asset life – option to extend.
20.4.2.4 Indicators suggesting a finance lease exists.
20.4.2.4.1 Option to purchase at end of lease – put and call options / residual value guarantees.
20.4.2.4.2 Meaning of substantially in respect to present value of future payment
20.5 Change in lease classification.
20.5.1 Extract from FRS 102 – Section 20.8.
20.6 Initial recognition and subsequent measurement-financial statements of lessees: finance leases
20.6.1 Extract from FRS 102 – Section 20.9- 20.12.
20.6.2.2 Interest rate implicit in the lease.
20.6.2.3 Minimum lease payments including options to extend.
20.6.2.4 Depreciation of leased assets.
20.6.2.6 Lessee: Initial and subsequent measurement – finance lease.
20.7.1 Initial Recognition and subsequent measurement
20.7.1.1 Extract from FRS 102 – Section 20.15-20.15B.
20.7.1.2.2 Time when expense is recognised.
20.7.1.2.3 Costs directly incurred in negotiating/arranging lease.
20.7.1.2.4 Treatment of termination penalties.
20.7.1.2.5 Operating leases with payment linked to other variables.
20.8 Initial recognition and subsequent measurement -financial statements of lessors: finance leases
20.8.1 Extract from FRS 102 – Section 20.17-20.19.
20.9 Manufacturer or dealer lessors.
20.9.1 Extract from FRS 102 – Section 20.20-20.22.
20.10 Financial statements of lessors: operating leases.
20.10.1 Extract from FRS 102 – Section 20.24-20.25 and Section 20.27-20.29.
20.10.1.1 Recognition and measurement
20.10.1.2.2 Time when expense is recognised.
20.10.1.2.3 Costs directly incurred in negotiating/arranging lease.
20.10.1.2.4 Operating lease with payments linked to other variables.
20.10.1.2.5 Lease incentives – lesser
20.11 Sale and leaseback transactions.
20.11.1 Extract from FRS 102 – Section 20.32-20.34.
20.11.2.1 Sales and lease back defined.
20.11.2.2 Sales and lease back – finance lease.
20.11.2.3 Sales and lease back – operating lease.
20.12.1 Disclosures for operating leases – Lessors.
20.12.1.1 Extract from FRS 102 – Section 20.30.
20.12.1.2.1 Accounting policy note.
20.12.1.2.2 Extract from notes to the financial statements.
20.12.2 Disclosures – Operating leases for lessees.
20.12.2.1 Extract from FRS 102 – Section 20.
20.12.2.2.1 Accounting policy example.
20.12.2.2.2 Notes to the financial statements.
20.12.3 Sale and leaseback disclosures.
20.12.3.1 Extract from FRS 102 Section 20.35.
20.12.4 Disclosures – financial statements of lessees: finance leases.
20.12.4.1 Extract from FRS 102 – Section 20.13- 20.14.
20.12.4.2.1 Accounting policy disclosures.
20.12.4.2.2 Extract from notes to the financial statements.
20.12.5 Disclosures – financial statements of lessors: finance leases.
20.12.5.1 Extract from FRS 102 – Section 20.23.
20.12.5.2.1 Accounting policy disclosure.
20.12.5.2.2 Extract from notes to the financial statements
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20.10 Financial Statements of Lessors: Operating Leases
20.10.1 Extract from FRS 102 – Section 20.24-20.25 and Section 20.27-20.29
20.10.1.1 Recognition and measurement
20.24 A lessor shall present assets subject to operating leases in its statement of financial position according to the nature of the asset.
20.25 A lessor shall recognise lease income from operating leases (excluding amounts for services such as insurance and maintenance) in profit or loss on a straight-line basis over the lease term, unless either:
(a) another systematic basis is representative of the time pattern of the lessee’s benefit from the leased asset, even if the receipt of payments is not on that basis;
OR
(b) the payments to the lessor are structured to increase in line with expected general inflation (based on published indexes or statistics) to compensate for the lessor’s expected inflationary cost increases. If payments to the lessor vary according to factors other than inflation, then condition (b) is not met.
20.25A A lessor shall recognise the aggregate cost of lease incentives as a reduction to the income recognised in accordance with paragraph 20.25 over the lease term on a straight-line basis, unless another systematic basis is representative of the time pattern over which the lessor’s benefit from the leased asset is diminished.
20.26 A lessor shall recognise as an expense, costs, including depreciation, incurred in earning the lease income. The depreciation policy for depreciable leased assets shall be consistent with the lessor’s normal depreciation policy for similar assets.
20.27 A lessor shall add to the carrying amount of the leased asset any initial direct costs it incurs in negotiating and arranging an operating lease and shall recognise such costs as an expense over the lease term on the same basis as the lease income.
20.28 To determine whether a leased asset has become impaired, a lessor shall apply Section 27.
20.29 A manufacturer or dealer lessor does not recognise any selling profit on entering into an operating lease because it is not the equivalent of a sale.
20.10.1.2 OmniPro comment
20.10.1.2.1 Overview
Section 20.24 to 20.29 of FRS 102 provides the rules for lessors to account for operating leases. Accounting for operating leases by lessors is a mirror of the treatment for lessees. Lessors do not recognise a profit on entering into an operating lease because it is not the equivalent of a sale.
Section 20.25 of FRS 102 requires the lease payments under an operating lease to be recognised over the life of the lease on a straight-line basis unless another basis is more reflective of the time period in which the entity will benefit, or the payments are structured to compensate the lesser for inflationary costs increases and it is linked to expected inflationary increases stated in published indexes. See the example in section 20.25 of FRS 102 for application of the general inflation point. Also refer to example 8 of 20.10.1.2.4
20.10.1.2.2 Time when expense is recognised
The entity recognises an expense from the date when the lease commences rather than the inception date. Where for example, an entity has taken out a lease, but the retailer is not ready to open, the standard requires that this cost be expensed during the period, it cannot be deferred on the balance sheet.
20.10.1.2.3 Costs directly incurred in negotiating/arranging lease
In line with section 20.25A of FRS 102 Where costs which are directly attributable to negotiating and arranging a lease, these should be capitalised and recognised against income over the life of the lease on a straight-line basis. If it is not related to that lease, then it is recognized immediately.
20.10.1.2.4 Operating lease with payments linked to other variables
As can be seen from the example included in Section 20.15 (b) of FRS 102 above, only lease increases specifically linked to a general inflationary index which is published can be expensed as incurred. If they do not or are linked to other variables, then they are recognized as income on a straight-line basis over the life of the lease. See example 8 for illustration of same.
Example 8: Operating lease with inflationary increases – lessor
Company A enters into a lease on a building for 5 years for an annual fee of CU20,000. Under the lease agreement rents will increase in line with the general increase/decrease in published inflation. However, it also stipulates that the minimum inflation rate that will be charged is 2% even where the published rate is lower. As the lease agreement is no longer linked to a general inflation rate and is capped, it does not meet the conditions in Section 20.25(b) of FRS 102 so therefore the amount that should be recognized in income immediately each year is as follows:
CU20,000+(CU20,000*1.02) + (CU20,000*1.04)+ (CU20,000*1.06)+ (CU20,000*1.08)= Total income over the 5 years = CU104,080 /5year = CU20,816
Anything above the CU20,816 in any year is expensed as incurred.
20.10.1.2.5 Lease incentives – lessor
It is not unusual for landlords to provide tenants with incentives to enter into a lease agreement, especially for land and buildings. In order to encourage a key tenant to take on a lease, landlords may offer a cash sum, a specific length of time rent free or provide a contribution towards the cost of fitting out the premises. Section 20.25A of FRS 102 requires such incentives to be deferred and debited into the profit and loss account on a straight-line basis over the life of the lease.
Example 9: Rent free period – lessor
Company A entered into a lease with a landlord for 10 years with a rent review after year 5. The rent payable on the lease per annum is CU200,000. As part of the agreement, the landlord agreed to provide the first 3 months rent free (CU200,000/12mths*3mths=CU50,000). Under Section 20, the lease incentive needs to be written off over the life of the lease. Assume the lease agreement commenced on 1 October and Company A’s year end is 31 December. The journals required to be posted in Company A’s TB at the 31 December are
| CU | CU | |
| Dr Accrual income on BS
(CU16,250* X 3 months) |
48,750 | |
| Cr Turnover in P&L | 48,750 |
Being journal to recognise the income for the first 3 months in year one
From year 2 on, the CU48,750 is debited to the profit and loss and set against turnover i.e. at the end of year 2 the accrued income would be reduced to CU43,750 (CU48,750-CU5,000) to show the net income of CU195,000 per annum.
If in the above example the landlord provided a contribution of CU50,000 towards the cost of fixed assets or towards the cost of relocating, the treatment would be the same.
* Calculate the actual total rental receipts over the 10 years i.e. actual rent payments are only received for 9 years and 9 months = CU200,000 *9.75 years= CU1,950,000. Therefore the total amount of rent to be charged over the life of the lease is = CU1,950,000/10 years = CU195,000 per annum or CU16,250 per month. Therefore for the first 3 months accrued income is required as no receipts are made. However, this accrued income is then reduced over the life of the lease such that the income shown in turnover each year is CU195,000. NOTE: the date of the rent review is ignored.
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Example 1: Residual value guarantee.
Example 2: Changes in lease classification.
Example 3: Accounting for finance leases – initial recognition and subsequent measurement– Lessee
Example 4: Operating lease with inflationary increases.
Example 4A: Leases linked to general inflation indexes.
Example 6: Finance lease accounting for the lessor
Example 7: Finance lease accounting for the lessor – change in residual value.
Example 8: Operating lease with inflationary increases.
Example 10: Sale and Leaseback
Example 10A: Extract from an accounting policy note and the related disclosures – Operating Lease.
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