Lessee Ltd.: Case Analysis

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Deciding if a lease contract is finance or operating lease, for monetary analysis functions, can be ideally confounded by a financial professional. Lessee Limited is an organization that uses IFRSs. The organization hired machine from Lessor Company so the finance section required determining whether the hire was a capital/monetary or operational lease. In this regard, both the junior and senior accountant in Lessee limited produced two varied evaluations regarding the lease. Thus, there is need to decide who is right between the junior and senior accountant and test to determine whether there is a variation when the organization applied GAAP.

First, the paper will review the work of the junior accountant. The Lessee’s junior accountant considered that “because the machine regresses back to the leasing organization, it is ideally an operational hire.” But this was not right since according to the IAS 17, section 9- Book-keeping for leases: “circumstances that would basically result to a hire being categorized to be a monetary lease comprises of:

  • The leasing period is for the larger portion of the asset’s economic existence, regardless of whether the ownership is transferred or not transferred
  • At the time of leasing, the book value of the least hire payments equals to approximately the entire fair value attached to the hired equipment”

The Lessee limited would hire this machine for thirty six months and the economic life span for the machine was forty eight months. Based on this, the lease duration was 75/100 of the useful life span of the machine. In addition, the yearly payments’ book value would amount to $263,716 while the net value of machine amounted to only $265,050. The book worth of the least hire disbursement would amount to 99.5/100 of the asset’s net value. Such circumstances would suit the requirement as stipulated in IAS 17 for the lease to be regarded as finance.

Secondly, the work presented by the senior accountant was right since he/she considered the lease to be finance on the premise that the duration of the lease was more than 50% of the asset’s useful life. However, so as to compute the lease benefit and/or requirement the accountant applied the incremental leasing rate. Based on IAS 17, section 20 and 21 require that: At the start of the lease duration, monetary lease should be considered at a price lower than the fair value and the book value of the least disbursements (discounted based on the rate of interest applicable with such leases, if significant, otherwise the asset’s increasing leasing rate is considered). The senior analyst should apply the implied rate rather than the increasing leasing rate. In addition, the senior analyst was supposed to account for the agreed scrap value since “the agreed scrap value is that portion of the scrap amount of the asset assured by the leasing company and/or third party associated with the company.” (IAS 17, section 5). Therefore, the book value based on the least lease disbursement should be $263,716 rather than $244,370.

Further, in the third step the senior analyst did not account for the asset’s financial lease: “at the start of the hire duration, Lessee Ltd needs to account for financial lease as an asset and liability in its balance sheet at value same as the fair amount of the hired equipment (IAS, section 21).” Also the depreciation practice regarding an asset acquired through financial lease should be same as that of owned equipments. Basically, it is not clear what technique that Lessee limited applied while depreciating the assets. Assuming the organization applied straight-line technique, the journal entry of 1st year should be the same as that of 2nd and 3rd year.

Lastly, there is need to check whether the journal entries vary from United States GAPP. In regard to ASC 840, the classifications for finance leases are same as IAS 17, section 9. But ASC 840 is specific. ASC 840 for instance, requires finance hiring consideration if the hiring duration is same as or more than 75/100 of the equipment’s useful life span, whereas IAS 17 needs this consideration if the hiring duration is for the larger portion of the useful life of the equipment. ASC 840 in addition requires capital hiring consideration when the book value based on least hire disbursement goes beyond 90/100 of the equipment’s book worth, whereas IAS 17 utilizes the phrase “necessary entire” asset value. Accordingly, the lease was integrated to be finance lease based on GAAP. Furthermore, United States GAAP necessitates Lessor Company to apply the implied rate, and Lessee Limited overall would apply the increasing leasing rate while computing the current value of the asset. Based on this assertion, the implied rate was low compared to the increasing leasing rate, so Lessee Ltd will have to apply the implied rate.

In summary, the analysis of the junior accountant was not right since the lease required to be analyzed as an economic (finance) lease. The duration of the lease reached 75/100 of the useful life of the asset and the current amount of minimal disbursement was 99.5/100 of the normal asset amount. The senior analyst was right to analyze the lease as an economic lease, but the senior analyst’s journal entry was not correct. The financial fee should be distributed precisely in order to yield an even intermittent interest rate on the liability’s remaining value. The senior analyst also omitted the depreciation value. No variation would arise if Lessee Ltd applied GAAP. The finance section had to apply the implied rate for GAAP since the implied level was low compared to the increasing leasing rate.

Works Cited

International Accounting Standard (IAS 17): Leases”. International Financial Reporting Standards, CGA-Canada 2011.

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