IAS 17 Summary Notes

IAS 17 Leases

DEFINITIONS

LEASE AND ITS TYPES

A lease is an agreement whereby the lessor conveys to the lessee in return for a
Lease payment or series of payments the right to use an asset for an agreed period of
time.
Finance A finance lease is a lease that transfers substantially all the risks and rewards
lease incidental to ownership of an asset. Title may or may not be eventually transferred.
Operating An operating lease is a lease other than finance lease.
lease
A non-cancelable lease is a lease that is cancelable only:
(a) Upon the occurrence of some remote contingency;
Non- (b) With the permission of lessor;
cancelable (c) If the lessee enters into a new lease for the same or an equivalent asset with
lease 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.

EXAMPLE 17A
Hameed Limited has entered into following five separate lease agreements. You are required to tell
whether these lease agreement are cancelable leases or non-cancelable leases:
(a) A building lease for 5 years which Hameed Limited can cancel at any time by making the
payment for the period they had occupied the building.
(b) A car lease for 10 years which Hameed Limited can cancel if the market value of car gets
double the current price, the chance of which is less than one percent.
(c) A plant leased for 25 years from Multan Limited which Hameed Limited can cancel if Multan
Limited so permits.
(d) A car leased for 5 years which Hameed Limited can cancel if Hameed Limited enters into
another 5 year car lease of same model car with the same lessor.
(e) A factory lease for 5 years which Hameed Limited can cancel at any time by making the
payment for the whole lease term of 5 years.

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IAS 17 Summary Notes

IMPORTANT DATES
is the earlier of the date of the lease agreement and the date of commitment
by the parties to the principal provision of the lease. As at this date:
Inception of the
(a) A lease is classified as either an operating or finance lease; and
lease
(b) In the case of finance lease the amounts to be recognised at the
commencement of the lease term are determined.
is the date from which the lessee is entitled to exercise its right to use the
Commencement leased asset. It is the date of initial recognition of the lease (i.e. the recognition
of lease term of the assets, liabilities, income or expenses resulting from the lease as
appropriate).
If lease agreement contains some provision to adjust lease payments for change in cost of asset
to lessor or general price level change which takes place between inception of lease and
commencement of lease term, the same shall be deemed to have taken place at inception of
lease.

EXAMPLE 17B
J Limited enters into a contract for the lease of a car with K Leasing Limited on January 18. K Leasing
Limited agrees to transfer the car in the name of J Limited on 3 rd of February. However, J Limited
would have the right to use the car as at February 22. You are required to answer the following:
(a) What is the date of inception of the lease?
(b) What is the date of commencement of lease term?

IMPORTANT PERIODS
is the non-cancelable period for which the lessee has contracted to lease the
asset together with any further terms of which the lessee has the option to
Lease term
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.
is either:
(a) The period over which an asset is expected to be economically usable by one
Economic
or more users; or
life
(b) The number of production or similar units expected to be obtained from the
asset by one or more users.
is the estimated remaining period, from the commencement of the lease term,
Useful life without by the limitation of the lease term, over which the economic benefits
embodied in the asset are expected to be consumed by the entity.

EXAMPLE 17C
S Limited acquired a plant on lease for a period of 6 years. S Limited has right to extend the period
of lease further 4 years at the end of first 6 years. You are required to calculate the lease term
assuming that S Limited:
(a) Has intention to extend the period.
(b) Has no intention to extend the period.

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IAS 17 Summary Notes

EXAMPLE 17D
B Limited acquired a second hand plant. The total life of such plant (new) is 12 years. The plant has
already been used for 4 years by previous owners. B Limited intends to use the plant for 5 years
and then wants to sell it to someone else. You are required to calculate the:
(a) Economic Life
(b) Useful Life
(c) Remaining Economic Life

FINANCE LEASE CALCULATION

are payments over the lease term that the lessee is or can be required to make,
excluding contingent rent, cost for services and taxes to be paid by and
reimbursed to the lessor together with guaranteed residual value (GRV).
Minimum
lease
If there is bargain purchase option (BPO), the value of BPO is added rather than
payments
GRV.
(MLP)
= Down payment + Lease Rentals excl. contingent rent etc. + BPO or
GRV
is that portion of the lease payments that is not fixed in amount but a based on
Contingent the future amount of a factor that change other than with the passage of time
rent (e.g. percentage of future sales, amount of future use, future price indices,
future market rate of interest).
Initial direct are incremental costs that are directly attributable to negotiating and arranging
costs a lease, except for such costs incurred by manufacturer or dealer lessors.

HOW TO CALCULATE PRESENT VALUE (PV) DISCOUNT FACTOR

Single payment = (𝟏 + 𝒊)−𝒏
𝟏 − (𝟏 + 𝒊)−𝒏
Annuity (end of period) =
𝒊
Annuity due (beginning of 𝟏 − (𝟏 + 𝒊)−𝒏+𝟏
period) = +𝟏
𝒊

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IAS 17 Summary Notes

CLASSIFICATION

INTRODUCTION
Whether lease is a finance lease or an operating lease depends on the substance
of the transaction rather than form of the contract. The main factor is risk and
rewards. Where repair and maintenance charges, insurance charges, the loss
Substance
due to idle capacity are to be borne by lessee and the major economic benefits
are to accrue to lessee, there is an indication that risk and rewards have been
transferred to lessee.
Examples of situations that individually or in combination would normally lead to
a lease being classified as a finance lease are (not conclusive factors – risk and
rewards are):
(a) Transfer of ownership to lessee at the end of lease term;
(b) The bargain purchase option or bargain renewal option at the end of lease
term;
Examples (c) The lease term in 75% (generally) or more of asset’s economic life;
(d) PV of MLP is 90% (generally) or more of FV of asset;
(e) The leased asset is of such specialized nature that only lessee can use it
without major modification;
(f) Lessor’s losses associated with the cancellation of lease are borne by the
lessee; or
(g) Gain or losses from the fluctuation in fair value accrue to the lessee.
Timing Lease classification is made at the inception of the lease.
It is possible that lessor classifies lease as finance lease while the same lease be
Different
classified by lessee as operating lease. For example, lessor benefits from GRV
classification
provided by party unrelated to lessee.

CHANGE IN CLASSIFICATION
If at any time the lessee and the lessor agree to change the provisions of the lease,
other than by renewing the lease, in a manner that would have resulted in a different
New Lease
classification of the lease, if the changed terms had been in effect at the inception
of the lease, the revised agreement is regarded as a new agreement over its term.
However, changes in estimates (for example, changes in estimates of the
Changes in economic life or of the residual value of the leased property), or changes in
estimates circumstances (for example default by the lessee), do not give rise to a new
classification of a lease for accounting purposes.

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IAS 17 Summary Notes

LEASE OF LAND AND BUILDING

The land and building elements of a lease of land and
Consider separately building are considered separately for a purpose of lease
classification.
If title to both elements is
expected to pass to the both elements are classified as a finance leases.
lessee by the end of the lease
term
The land element is normally classified as an operating lease
unless title is expected to pass to the lessee by the end of the
When the land has indefinite
lease term.
economic life
The building element is classified as a finance or operating
lease, as the case may be.
The MLP are allocated between the land and the buildings
Allocation of MLP elements in proportion to the relative fair value of the
leasehold interest.
If the MLP cannot be allocated reliably, the entire lease is
classified as a finance lease, unless it is clear that both
If MLP cannot be allocated
elements are operating lease, in which case the entire lease is
classified as an operating lease.
The land and buildings may be treated as a single unit.
If land element is immaterial
In such a case, the economic life of the buildings is regarded
as the economic life of the entire leased asset.

EXAMPLE 17E
You are required to advise regarding classification of these leases:
(a) E Limited acquired a special customized engine. The engine can only be used by E Limited
unless substantial modifications are made to the engine.
(b) P Limited acquired an asset on lease with fair value of $ 100,000 and present value of MLP
is $ 92,500
(c) M Limited acquired an asset on lease economic life of 20 years while M Limited wants to use
the asset only for 17 years. The company has no intention to purchase the asset at the end
of its lease term.
(d) T Limited acquired an asset on lease with an option to buy the asset at the end of lease term
for $ 12,000. The fair value of the asset at the end of lease term is expected to be at-least $
55,000.
(e) R Limited acquired an asset on lease 1 January 2007. The lease term was 10 years with no
option to purchase. The lease was classified as operating lease. On 1 January 2011 the
lessor and lessee agreed to include a bargain purchase option and now lessee can buy the
asset at the end of lease term below its fair value.
(f) S Limited acquired a building with land on lease. The building has remaining economic life of
25 years and will be transferred to S Limited at the end of lease term. However, the title of
land shall not be transferred.

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IAS 17 Summary Notes

FINANCE LEASE – LESSEE

ACCOUNTING
Journal Entry Time of recognition By the amount
Dr. Asset under FL Commencement of Lower of PV of MLP and FV
Cr. Liability under FL lease term calculated at inception of lease
Dr. Asset under FL When initial direct
Initial direct costs
Cr. Bank/Payable costs are incurred
Dr. P&L
At year end As per depreciation policy
Cr. Asset under FL / Acc. Dep.
Dr. Interest expense The interest accrued during the
At year end
Cr. Interest payable year
Dr. Interest payable  Interest (Schedule)
At the time rental is
Dr. Liability under FL  Principal amount (Schedule)
paid
Cr. Bank  Total rental
Dr. Contingent rent The period in which
As calculated under agreement
Cr. Bank / payable they are incurred

IMPORTANT POINTS - LESSEE

Discount rate used for calculating PV is interest rate implicit in the lease, and if
Discount this is not practicable to determine, the lessee’s incremental borrowing rate shall
rate be used. However, if incremental borrowing rate gives PV of MLP higher than FV
of asset, we must determine implicit interest rate.
The asset shall be fully depreciated over the shorter of the lease term and its
Depreciation useful life unless it is reasonable certain that lessee shall obtain ownership of the
asset in which case the asset shall be fully depreciated over its useful life.

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IAS 17 Summary Notes

FINANCE LEASE - LESSOR

ACCOUNTING – NORMAL LESSOR

Journal Entry Time of recognition By the amount
Dr. Net investment PV of (MLP + UGRV)
Commencement of
Cr. Asset Fair value
lease term
Cr. Bank/Payables Initial direct costs
Dr. Interest receivable
At year end The interest accrued during the year
Cr. Interest income
Dr. Bank At the time Total rental
Cr. Interest receivable payment/rental is Interest
Cr. Net Investment received Principal amount (Schedule)
Dr. Bank / accrual The period in which
As calculated under agreement
Cr. Contingent rent they are incurred

ACCOUNTING – MANUFACTURER OR DEALER LESSOR

Journal Entry Time of recognition By the amount
Dr. Net investment PV of (MLP + UGRV)
Cr. COS Commencement of PV of UGRV
Cr. Sales revenue lease term Lower of FV & PV of MLP at market
rate
Dr. Selling exp.
When incurred Initial direct costs
Cr. Cash
Dr. Interest receivable At year end The interest accrued during the year
Cr. Interest income
Dr. Bank At the time Total rental
Cr. Interest receivable payment/rental is Interest
Cr. Net Investment received Principal amount (Schedule)
Dr. Bank / accrual The period in which As calculated under agreement
Cr. Contingent rent they are incurred

IMPORTANT POINTS - LESSOR

Lessors shall recognize assets held under finance lease in their statement of
All lessors financial position and present them as a receivable at an amount equal to the NI
(GI – UFI).
The interest rate in the lease is defined in such a way that the initial direct costs
Normal
are included automatically in finance lease receivable; there is no need to add
Lessor
them separately.
Manufacturer and dealer lessors shall recognise selling profit or loss in the period,
Manufacturer
in accordance with the policy followed by the entity for outright sales, if artificially
or dealer
low rates of interest are quoted, selling profit shall be restricted to such amount
lessor
as if a market rate of interest were charged.

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IAS 17 Summary Notes

EXAMPLE 17F
J Limited (JL) leased a plant under finance lease on 1 January 2011. The lease term is 4 years;
however, JL uses similar owned assets for 5 years. The fair value of the asset is $ 11,420 and JL
incurred initial direct costs of $ 580. The interest rate implicit in lease is 15%. Rentals of $ 4,000 are
payable on 31 December (also financial year end) each year. Assume that contingent rent of $ 600,
$ nil, $ 800, $ 750 was paid in year 2011, 2012, 2013 and 2014 respectively. You are required to
give financial statements extracts along with workings.

OPERATING LEASE – LESSEE

Lease payments under an operating lease shall be recognized as an expense on

Accounting
a straight-line basis over the lease term unless another systematic basis is more
treatment
representative of the pattern of the user’s benefits.
Dr. Lease rental expense
Journal entry
Cr. Bank / Accrual / Prepayment

EXAMPLE 17G
Faheem Limited (FL) leased an asset under operating lease of building on 1 January 2011.
According to agreement, $ 1,600 was paid as initial deposit and further rental of $ 1,000 shall be
paid at the end next two years and then $ 3,200 shall be paid for following two years. The lease
term is also 4 years. You are required to give journal entries over the lease term.

OPERATING LEASE - LESSOR

Lease income from operating shall be recognized on a straight-line basis over the
Lease income lease term unless another systematic basis is more representative of benefit
derived from the leased asset.
Asset Asset shall be presented in statement of financial position as per its nature.
Initial direct costs shall be added to the carrying amount of the leased asset and
Initial direct
recognized as an expense over the lease term on the same basis as the lease
costs
income.
Depreciation The deprecation is to be charged as per normal depreciation policy.
Dr. Bank/accrual
Journal entry
Cr. Lease/Rent income

SALE AND FINANCE LEASE BACK

Resulting The profit shall not be immediately recognised as income by a seller lessee. Instead,
in profit it shall be deferred and amortised over the lease term.
Resulting The loss shall be recognised immediately (generally as impairment loss).
in loss

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IAS 17 Summary Notes

EXAMPLE 17H
On January 01, 2011 Kamal Limited (KL) sold its two plant to a leasing company and leased them
back under finance leases on the same date. The details are as follows:

Plant Carrying amount $ Sale price $ Lease term

I 80,000 100,000 4 years
II 50,000 40,000 5 years

Required:
Journal entries on January 01, 2011

SALE AND OPERATING LEASE BACK

Yes Recognise impairment

CA > FV?
loss immediately
No
Yes Recognise profit or
SP = FV?
loss immediately Yes Amortise loss over lease
term
No
Yes Rentals
SP < FV?
compensated? Recognise loss
No No immediately

Yes Profit up to FV is recognised immediately (FV – CA)

SP > FV ?
The excess (SP – FV) should be amortised over lease term

Example 17I
Pass the journal entries for following sale and leaseback transactions resulting in operating leases:
Situation I II III IV V VI VII VIII
Carrying amount ($) 100 100 100 100 100 100 100 100
Sale price ($) 110 80 80 125 80 70 70 80
Fair value ($) 110 110 110 110 80 80 80 70
Rental p.a. - market ($) 25 25 25 25 25 25 25 25
Rental p.a. – actual ($) 25 25 20 25 25 25 20 25

EFFECT OF INCORRECT CLASSIFICATION

If a finance lease is incorrectly treated as an operating lease it will have following impact on
financial statements and ratios:
FS Ratios
Assets understated and liability understated ROCE is overstated & Gearing in understated
Depreciation not charged, Interest not Negligible temporary effect on profit for the period.
charged but lease rental is charged as
expense.

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IAS 17 Summary Notes

ANSWER 17A
(a) Cancelable Lease
(b) Non-cancelable Lease
(c) Non-cancelable Lease
(d) Non-cancelable Lease
(e) Non-cancelable Lease

ANSWER 17B
(a) Inception of the lease January 18
(b) Commencement of lease term February 22

ANSWER 17C
(a) 10 years
(b) 06 years

ANSWER 17D
(a) 12 years
(b) 05 years
(c) 08 years

ANSWER 17E
(a) Finance lease
(b) Finance lease
(c) Finance lease
(d) Finance lease
(e) This is case of change in classification. From January 01, 2011 the lease shall be classified
as finance lease as if it was new agreement.
(f) The lease of building is finance lease while the lease of land is operating lease.

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IAS 17 Summary Notes

ANSWER 17F

Statement of comprehensive Income 2011 2012 2013 2014

(extracts)
$ $ $ $
Depreciation expense 3,000 3,000 3,000 3,000
Interest expense 1,713 1,370 975 522
Contingent rent expense 600 - 800 750

Statement of financial position (extracts) 2011 2012 2013 2014

Non-current assets $ $ $ $
Plant under finance lease 12,000 12,000 12,000
Accumulated depreciation (3,000) (6,000) (9,000)
9,000 6,000 3,000 -

Non-current liabilities
Liability under finance lease 6,503 3,478 - -

Current liabilities
Liability under finance lease 2,630 3,025 3,478 -
Interest payable - - - -

Working 1 Finance Lease (Payments in arrears) Schedule

Liability Liability
Payment Interest Principal
at Rental after
time @ 15% Element
beginning payment
T Rupees
31.12.2011 11,420 1,713 4,000 (2,287) 9,133
31.12.2012 9,133 1,370 4,000 (2,630) 6,503
31.12.2013 6,503 975 4,000 (3,025) 3,478
31.12.2014 3,478 522 4,000 (3,478) -

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IAS 17 Summary Notes

ANSWER 17G
The journal entries are:
Date Particulars Dr. $ Cr. $
01.01.11 Prepaid lease rental 1,600
Cash 1,600
31.12.11 Lease rental expense 2,500
Cash 1,000
Prepaid lease rental 1,500
31.12.12 Lease rental expense 2.500
Cash 1,000
Prepaid lease rental 100
Accrued lease rental 1,400
31.12.13 Lease rental expense 2.500
Accrued lease rental 700
Cash 3,200
31.12.14 Lease rental expense 2.500
Accrued lease rental 700
Cash 3,200

ANSWER 17H
The journal entries are:
Date Particulars Dr. $ Cr. $
01.01.11 Cash 100,000
Plant I 80,000
Deferred income (to be amortised over lease 20,000
term)
01.01.11 Plant I under finance lease 100,000
Liability under finance lease 100,000
01.01.11 Cash 40,000
Profit or loss 10,000
Plant II 50,000
01.01.11 Plant I under finance lease 40,000
Liability under finance lease 40,000

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IAS 17 Summary Notes

ANSWER 17I
The journal entries are:
Situation Particulars Dr. $ Cr. $
I Cash 110
Profit or loss 10
Asset 100
II Cash 80
Profit or loss 20
Asset 100
III Cash 80
Deferred loss 20
Asset 100
IV Cash 125
Profit or loss 10
Deferred income 15
Asset 100
V Profit or loss (Impairment loss) 20
Asset 20
Cash 80
Asset 80
VI Profit or loss (Impairment loss) 20
Asset 20
Cash 70
Profit or loss 10
Asset 80
VII Profit or loss (Impairment loss) 20
Asset 20
Cash 70
Deferred loss 10
Asset 80
VIII Profit or loss (Impairment loss) 30
Asset 30
Cash 80
Deferred income 10
Asset 70

Dated: 19 August 2016

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