Accounting for Leases Week 4 Lecture ACCT2011 Financial Accounting A Jap Efendi 1 2 Accounting for Leases Learning objectives: 1. Introduction of present values in accounting 2. Understand the nature of leases (Ch 12 LO 1) 3. Distinguish between an operating lease and a finance lease (Ch 12 LO 2) 4. Understand the difference between the ‘expense’ and the ‘capitalisation’ methods of accounting for finance leases in the books of a lessee (Ch 12 LO 3) 5. Understand the implications of lease accounting for assessment of operating performance and financial risk (Ch 12 LO 5) 6. Apply the requirements of AASB 117 to the classification of leases (Ch 12 LO 6) 7. Apply the requirements of AASB 117 to accounting for operating leases in the books of the lessee (Ch 12 LO 7) 8. Apply the requirements of AASB 117 to accounting for finance leases in the books of the lessee (Ch 12 LO 8) 9. Understand the proposed new approach to lease accounting (Ch 12 LO10) 2 3 Accounting for Leases Textbook Readings: › Chapter 12 Sections 12.1 (excluding Section 12.1.5 & 12.1.6), 12.2 to 12.2.3; 12.3 (pp353 - 370; 378 - 380) › Handbook Readings : - AASB117 › Additional Reading: - IASB Investor Spotlight at: http://www.ifrs.org/Current - Projects/IASB - Projects/Leases/Documents/Investor - spotlight - leases.pdf - “ Leasing rules new liability for top 20 ” Australian Financial Review (on Blackboard) 3 4 4 Objective 1 Introduction of present values in accounting Present Value Concepts › Most long - term debts are required to be measured at present value, but before proceeding, we need to understand time value of money . › Q. Would you rather receive $1,000 now or $1,000 in a year’s time? - If now , you recognise that money received/paid in the future (FV) is worth less than the same amount in present value (PV) dollars received/paid today. Why? - The PV of $1,000 in a year’s time, is equivalent to the present amount you would need to invest at the current interest rate, to give you $1,000 in a years time. › PV of $1 formula/tables provides a discount factor to convert FV to PV. The PV of $1 000 in a years time, if interest rate is 10% PV = FV / (1 + r) n = $1,000/(1 + 0.1) 1 = $909.09 Present Value of a Single Sum (PV of $1 Table ) › Example : You have won a lottery, and must choose to receive $90,000 in 3 years time (current interest rate = 10%), or $70,000 now - To answer, you need to calculate the PV of the $90,000 in 3 yrs by discounting it at the current interest rate, so that you can compare PVs on an equivalent basis › Present Value of a single sum of $1 table helps us to calculate this by providing the relevant discount rate for each interest rate and period . - Refer to the PV of $1 table and find the discount factor at 10% interest for 3 periods - Calculate the PV by multiply the FV by the discount factor - Compare to the amounts in present value terms PV [ i =10%, n=3] of $90,000  0.75131 (see Text book appendix, Table 1) = $67,618 Amount to be received immediately 70,000 Difference - 2,382 PV=? 90,000 n=3 year, i =10% Present Value of an Annuity (PV of an annuity of $1 ) › Assume that you have also received an option to choose to receive $70,000 now or $30,000 each year for 3 yrs ( current interest rate = 10%) › To answer this, you could calculate the PV of $30 000 in each period by discounting it at the current interest rate and period, then sum the amounts Future amount PV factor of 10% PV $30,000 (1 year away) 0.90909 $ 27,276 $30,000 (2 years away) 0.82645 24,793 $30,000 (3 years away) 0.75131 22,539 2.48685 $74,605 PV=? 30,000 30,000 30,000 n=3 year, i =10% Present Value of an Annuity (PV of an annuity of $1) › Alternatively, you can look up discount factors for a PV of an annuity $1 (see textbook Appendix, Table 2) PV of an annuity of $30,000 per yr for 3yrs [ i =10%, n=3] = $30,000 x 2.4868 (see Table 2) = $74,605 rounded Amount to be received immediately 70,000 Difference + 4,605 8 9 9 Objective 2 Understand the nature of leases 10 10 Understand the nature of leases › Leases are agreements which, in exchange for lease payments, convey to one party (the lessee) the right to possess and use an asset owned by another party (the lessor ) for a stated period of time. › Parties to the lease: • Lessor - the owner of property that conveys the right to use the property for a specified period of time in return for a series of payments • Lessee - party entering into a lease agreement with a lessor 11 Key lease terms › Typical terms in lease agreements: - Period of the lease - Amount and timing of the lease payments - Whether the lease is cancellable by either party - What is to become of the asset at the end of the lease term - The asset ’ s residual value - Responsibility for payment of maintenance etc costs 11 12 12 Objective 3 Distinguish between an operating lease and a finance lease 13 Types of leases › AASB 117 focuses on the asset aspect of the lease agreement, and identifies two key types of leases based on the typical features in the lease agreement • operating lease or • finance lease 13 14 14 AASB 117 & types of leases › Operating lease : - The risks and rewards of ownership remain substantially with the lessor (AASB 117 para 8) › Finance lease : - The risks and rewards of ownership are transferred substantially to the lessee (AASB 117 para 8)