860 SECTION 3 Financial Instruments and Liabilities (concluded) Ordinarily, it will not be a single indicator, but the combined implication of two or more indicators that will sway the classification decision under IFRS. Often the appropriate classification is obvious. At other times, careful consideration of all aspects of the agreement with reference to the classification indicators is needed. Substance over form is the goal. Professional judgment is key. Operating Leases If a lease does not meet any of the criteria for a capital lease it is considered to be more in the nature of a rental agreement and is referred to as an operating lease . 11 We assume that the fundamental rights and responsibilities of ownership are retained by the lessor and that the lessee merely is using the asset temporarily. In keeping with that presumption, a sale is not recorded by the lessor; a purchase is not recorded by the lessee. Instead, the periodic rental payments are accounted for merely as rent by both parties to the transaction— rent revenue by the lessor; rent expense by the lessee. Let’s look at an example that illustrates the relatively straightforward accounting for operating leases. The earlier example comparing a capital lease to an installment purchase assumed rental payments at the end of each period. A more typical leasing arrangement requires rental payments at the beginning of each period. This more realistic payment schedule is assumed in Illustration 15–5 . FINANCIAL Reporting Case Q1, p. 853 11 The term operating lease got its name long ago when a lessee routinely received from the lessor an operator along with leased equipment. ● LO15–4 On January 1, 2016, Sans Serif Publishers, Inc., a computer services and printing firm, leased printing equipment from First LeaseCorp. The lease agreement specifies four annual payments of $100,000 beginning January 1, 2016, the inception of the lease, and at each January 1 thereafter through 2019. The useful life of the equipment is estimated to be six years. Before deciding to lease, Sans Serif considered purchasing the equipment for its cash price of $479,079. If funds were borrowed to buy the equipment, the interest rate would have been 10%. How should this lease be classified? We apply the four classification criteria: 1. Does the agreement specify that ownership of the asset transfers to the lessee? No 2. Does this agreement contain a bargain purchase option? No 3. Is the lease term equal to 75% or more of the expected economic life of the asset? No (4yrs < 75% of 6 yrs) 4. Is the present value of the minimum lease payments equal to or greater than 90% of the fair value of the asset? No ($348,685 < 90% of $479,079) $100,000 5 3.48685* 5 $348,685 L ea se payments Present value Since none of the four classification criteria is met, this is an operating lease. *Present value of an annuity due of $1: n 5 4, i 5 10%. Recall from Chapter 6 that we refer to periodic payments at the beginning of each period as an annuity due. Illustration 15–5 Application of Classification Criteria Using Excel, enter: 5 PV(.104,100000,1) Output: 348685.2 Using a calculator: enter: BEG mode N 4 I 10 PMT – 100000 FV Output: PV 348685
Spiceland_Inter_Accounting8e_Ch15
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