Leases, Foreign Exchange and Deferred Tax

Question 1

What is the basic definition of a lease?

Answer 1

A lease is an arrangement where the lessor gives the lessee the right to use an asset for a certain period in exchange for payments.

Question 2

In the context of leases, what does the “arrangement for asset use” refer to?

Answer 2

It refers to transferring the right to use an asset from the lessor to the lessee without transferring legal ownership.

Question 3

What asset does the lessee recognise in their financial statements?

Answer 3

A right-of-use asset.

Question 4

What liability does the lessee recognise at lease commencement?

Answer 4

A lease liability, representing the present value of future lease payments.

Question 5

What two expenses does a lessee report over the lease period?

Answer 5

Depreciation of the right-of-use asset and interest expense on the lease liability.

Question 6

What are two main reasons businesses choose leasing over buying?

Answer 6

Insufficient cash to buy assets and flexibility to return the asset after use.

Question 7

Name two other reasons businesses lease assets.

Answer 7

Avoiding debt and possible tax benefits.

Question 8

What are the two types of leases for lessor accounting?

Answer 8

Finance leases and operating leases.

Question 9

In a finance lease, what does the lessor recognise instead of the leased asset?

Answer 9

A receivable asset equal to the present value of lease payments.

Question 10

In an operating lease, does the lessor remove the leased asset from their balance sheet?

Answer 10

No, the lessor continues to recognise and depreciate the leased asset.

Question 11

How does a lessor earn income in a finance lease?

Answer 11

By recognising a profit at lease start and recording interest income over time.

Question 12

How does a lessor earn income in an operating lease?

Answer 12

By receiving lease payments and depreciating the asset.

Question 13

What is the purpose of requiring lessees to recognise both assets and liabilities for leases?

Answer 13

To prevent off-balance sheet financing and enhance transparency and comparability.

Question 14

What exceptions exist for standard lessee accounting treatment?

Answer 14

Low-value assets and short-term leases (under 12 months).

Question 15

How does accounting for exchange rate changes depend on the type of foreign activity?

Answer 15

It depends on whether the business is engaged in a foreign currency transaction or operating a foreign business unit.

Question 16

How are foreign currency transactions accounted for when exchange rates change?

Answer 16

Gains or losses arise on monetary items like receivables and payables and are reported in profit or loss.

Question 17

How are non-monetary items like inventory or PPE measured in foreign currency transactions?

Answer 17

They are measured at the amount initially recorded using the spot rate on the transaction date and are not restated.

Question 18

Give an example of a foreign currency gain and loss on a payable.

Answer 18

If a French company buys inventory for Rs. 120,000 at €1 = Rs. 160 (recorded at €750) and year-end rate is €1 = Rs. 200 (restated to €600), there’s a €150 gain. If later settled at €1 = Rs. 192 (pays €625), there’s a €25 loss.

Question 19

What is functional currency in the context of foreign exchange accounting?

Answer 19

It is the currency of the primary economic environment in which a business operates and is used to measure financial statement items.

Question 20

Is a business’s functional currency always the same as its country’s currency?

Answer 20

No, it’s based on the main economic environment, not necessarily the business’s physical location.

Question 21

How are foreign operations’ financials translated into the parent company’s currency?

Answer 21

Assets and liabilities use the year-end rate, and income and expenses use the transaction date rate or average rate.

Question 22

Why do foreign currency translation differences arise in foreign operations?

Answer 22

Because different rates are used for the balance sheet (year-end) and income statement (transaction date), leading to imbalances in equity.

Question 23

Where are foreign currency translation differences recognized?

Answer 23

In the foreign currency translation reserve within equity and reported in Other Comprehensive Income (OCI).

Question 24

What are the two broad ways exchange rates impact international reporting?

Answer 24

1) Foreign currency transactions
2) Operating foreign business units (foreign operations).

Question 25

How are exchange rate changes for monetary items reported?

Answer 25

As gains or losses in profit or loss.

Question 26

How are exchange rate changes for non-monetary items reported?

Answer 26

They are generally not restated after initial measurement.

Question 27

Why does deferred tax arise?

Answer 27

Because of differences between the principles used to determine accounting profit and the laws that determine taxable income.

Question 28

What is the purpose of deferred tax?

Answer 28

To ensure tax consequences of income and expenses are reported in the same period as the items themselves.

Question 29

Where does deferred tax typically appear in financial statements?

Answer 29

On the statement of financial position as a liability or an asset.

Question 30

When does deferred tax arise?

Answer 30

When the accounting treatment of an item is different from its tax treatment, and the difference is temporary.

Question 31

Do permanent differences give rise to deferred tax?

Answer 31

No, only temporary differences do because they will reverse over time.

Question 32

Example: What happens when an equity investment increases in value but is not sold?

Answer 32

A deferred tax liability is recognised for the notional tax on the unrealised gain.

Question 33

Example: What creates a deferred tax asset in the deferred income example?

Answer 33

Receiving advance payments that are taxed now but only recognised as revenue later.

Question 33

In the fair value example, what happens when shares are later sold?

Answer 33

The deferred tax liability is reversed, resulting in deferred tax income.

Question 34

Example: How are tax losses treated for deferred tax?

Answer 34

If future profits are probable, tax losses are recognised as deferred tax assets.

Question 35

When is a deferred tax asset derecognised in the tax loss example?

Answer 35

When the tax loss is used to offset future taxable income.