Week 8

Question 1

What were the problems with the ‘old’ method of accounting for leases?

Answer 1

• Before leases could be classified as finance or operating leases
• It had ‘off balance sheet finance’ arrangements: funding or refinancing of a company’s operations in such a way that, under legal requirements and traditional accounting conventions, some or all of finance may not be shown in its balance sheet

Question 2

Why was there a need for the new accounting standard on leases?

Answer 2

• Understating assets and liabilities
• Gearing low - no complete picture of debt
• EBITDA lower (earnings before interest, tac, depreciation and amortisation) - as expensed lease rentals under old method as operating expense
• Often ROCE (Return on Capital Employed) would be higher as lower asset/resource base

Question 3

What are the conceptual benefits of the ‘new’ method of accounting for leases (single lease model)?

Answer 3

• Single lease model i.e. no difference between types of leases – finance, operating, as we saw in the old accounting standard EXCEPT companies are still allowed to have short term/low value leases
• Single lease model - all ‘on balance sheet’, so increases liabilities/debt levels
• EBITDA higher - operating lease rental expenses reduce, replaced depreciation and interest (excluded from EBITDA calc)
• Gearing increases, so may cause breach borrowing covenant
• ROCE, would often be lower, as capital employed increase (CE = Total Equity + Borrowings)

Question 4

How do you identify whether a contract contains a lease?

Answer 4

• Convey the right to use (control). A key issue is the control of the leased asset - if there is control over how the asset is used to generate economic benefit then the leased asset and associated liability should be recognised
• The underlying asset (i.e identified asset). There is not an identified asset if supplier has substantive right to substitute asset
• For a period of time, in exchange for consideration (e.g money)

Question 5

How is the Right of Use model for lease accounting applied (including accounting for the lease liability and depreciation)?

Answer 5

• Right-of-use assets should be presented within non-current assets in the SoFP. They may be presented as a separate line item within NCA on the face of the SoFP, or they may be included in the total of the relevant class of assets, with the carrying amount of right-of-use assets disclosed in the notes to the financial statements
• Lease liabilities should be presented within liabilities in the SoFP. In accordance with IAS 1, Presentation of Financial Statements, lease liabilities should be analysed between non-current and current liabilities
• Depreciation should be disclosed in the noted to the SoFP under NCA

Question 6

How are exemptions applied under IFRS 16?

Answer 6

• Short-term leases applies to leases < 12 months that do not contain a purchase option
• Leases of underlying assets with a low value applies to the leases of assets with low value (laptop, computers, phones)
• The accounting for low value or short-term leases is done through expensing the rental through profit or loss on a straight line basis

Question 7

How would you account for recognising an operating lease as a financed lease asset?

Answer 7

Dr PPE
Cr Liability