Question

One of the major areas that gives rise to off balance sheet financing is leasing.

a) Explain the impact of leasing transaction on the financial statements of the lessee according to the current accounting standard for leasing (IAS 17). Support your answer with an appropriate numerical example.

b) At the beginning of 2016, IASB issued a new standard (IFRS 16) on leasing accounting. Explain the reasons behind this decision and the impact on companies’ financial statements.

Answer 1

a. According to IAS 17 the financial statements of lessee will be impacted during initial accounting and during subsequent accounting. The current accounting standard for leasing requires the lessee to capitalize the finance leased asset and at the same time set up a lease liability for the value of the asset recognized. The balance sheet will be affected here. Subsequent accounting will affect the financial statements as the lessee will be required to account for depreciation, lease rental and interest. These will have an impact on lessee’s income statement and statement of financial position.

Numerical example: Suppose that in April 1, 2017, XYZ Co. enters into a lease with regards to machinery that has an estimated life of four years. Lease period is also four years and the machinery will be returned to the leasing company after this period. Annual rental amount is $5,000 and this amount will be paid in arrears starting from March 31, 2018. Residual value will be nil and fair value is $15,000. Finance cost is 15% per annum.

Initial accounting impact:

Particulars	Debit	Credit
Property, plant and equipment	15,000.00
Finance lease obligations		15,000.00

Subsequent accounting impact:

Particulars	Debit	Credit
Depreciation	3,750.00
($15,000/4 years)
Accumulated depreciation		3,750.00

Finance cost = 15% of 15,000 = $2,250

Year	B/fwd	Interest (15%)	Rental	C/fwd
1	15,000.00	2,250.00	(5,000.00)	12,250.00
2	12,250.00	1,837.50	(5,000.00)	9,087.50
	Statement of profit or loss extract
	Depreciation	3,750.00
	Finance cost	2,250.00
	Statement of financial position extract
	Non-current assets
	Carrying value	11,250.00
	(15000-3750)
	Non current liabilities
	Lease obligation	9,087.50
	Current liabilities
	Lease obligation
	(12250-9087.50)	3,162.50

b.

IFRS 16 was introduced with an intention to ensure that all lessee leases should be reported on the balance sheet and not as off balance sheet items. The main purpose was to eliminate all guess work that is involved in computing a company’s lease obligations. IFRS 16 intends to develop and introduce more transparency with regards to lease assets and liabilities.

Lessee will be required to recognize the asset for the right to use the leased item. Liability would be recognized to the effect of present value of future lease payments. Lessor accounting will remain similar to current practice in terms of lease classification test and in terms of finance leases and operating leases. Sale and leaseback will no longer be valid as an off balance sheet financing structure.