IFA WEEK 4:Leases

What is a lease

A lease is a contract that gives the (lessee) right to control the use of an identified asset for a period of time in exchange for consideration

Why would someone lease from a cash flow perspective

If purchasing via equity: it requires large upfront payment

if purchasing via borrowing it requires principal repayments alongside interes

HOWEVER LEASING

you only pay for the portion of the asset you are using during the lease term + interest

Why would someone lease from a operational flexibility perspective

Purchases are a long term commitment since you own the asset and if you want to upgrade you have to dispose of the old one and buy a new one

• leases are highly adaptable bc. you can easily upgrade to new equipment once lease expires

• it also reduces the risk of asset value decreases

Decision tree for having alease

Is there an identified asset

1. is there a specified asset ie.

   1. the asset is explicitly specified in contract

   2. or implicitly specified for use by the customer (Only one asset capable of being used to meet contract terms even if multiple assets are available)

2. Is there an absence of SSR (substantive substitution rights)

   1. SSR EXISTS IF BOTH ARE MET

      1. suppler has practical ability to substitute asset for alternative assets at the time they like during period of use

         1. ie. customer can’t prevent them from substituting

         2. have backup ready

      2. supplier would economically benefit from substitution ie. benefits of substitution>costs of substitution

Right to control the use of asset

1. right to obtain substantially all economic benefits (eg. exclusive use of asset and its benefits)

2. right to direct the use of asset (ie. can direct how and what purpose the asset is used for)

   1. if this is not satisfied check these

      1. the relevant decisions about how and for what purpose the asset is used for is pre-determined and

         1. customer has right to operate asset without supplier having right to change operating instructions OR

         2. customer designed asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use.

How do you initially recognise a lease in general and exemptions to this recognition

• as a right of use asset: an asset that represents lessee’s right to use an underlying asset for the lease term

• as a lease liability: PV of future lease payments

YOU JUST RECOGNISE IT AS AN EXPENSE IF

• The lease is short term ie. under 12 months

• if the lease has an underlying asset of low value ie. under 5k.

Initial measurement of lease liability and what does this include

at the starting date, the lease liability payable by the lessee is the PV of the lease payments not paid yet that will be discounted using the interest rate implicit in the lease

• fixed payments less any lease incentives: e.g. monthly payment $50,000, $1,000 reduction for every $50,000.

• variable lease payments dependent on index or rate

  • ie. based on cpi, interest rates etc

• residual value guarentees

• exercise price of pruchase option IF THE LESSEE IS REASONABLY CERTAIN TO EXERCISE THE OPTION

• payment of penalities to terminate the lease if the lessee exercises option to terminate.

subsequent measure of lease liability

• increase carrying amount to reflect interest on lease liability

• reduce carrying amount to reflect the lease payments made

residual value guarentee (GRV)

if GRV>fair/expected value and expected to return asset: have to pay the short fall

if GRV<expected/fair value and expected to return asset: don’t include any amount

if they intend to purchase asset: use purchase option instead

Initial measurement of ROU asset

• initial measurement of lease liability

• any lease payments made before starting date minus an lease incentives received

• any initial directly attributable costs eg. legal fee for signing contract

• an estimate of costs of dismantling, removal and restoration costs

• 
  

subsequent measure of lease liability

only reduce by depreciation based on if they want to purchase or return

How to present lease in statements

current asset in lease payment - interest next year

non current asset is closing bal of lease liability in current year minus current asset