€
€
1 7,419
7,649
2,330
2,100
2 5,564
5,917
2,222
2,100
3 3,709
4,070
2,108
2,100
4 1,855
2,100
1,985
2,100
5 –
–
1,855
2,100
10,500
10,500
*
The total charge combines the annual depreciation of €1,855 and the interest calculated according to the
IIR method in Example 23.10, which is in aggregate the initial carrying value of the asset of €9,274 and
the total finance charge of €1,226, i.e. the total rent paid of €10,500. Note that this example assumes
that the asset is being depreciated to a residual value of zero over the lease term, which is shorter than
its useful life, so IAS 16’s requirement to reconsider the residual value and useful life at least at each
financial year end is unlikely to have an effect. [IAS 16.51].
An entity applies IAS 36 – Impairment of Assets – to determine whether the leased
asset has become impaired in value (see Chapter 20). [IAS 17.30].
Leased assets may also be revalued using the revaluation model but the entire class of
assets (both owned and those held under finance leases) must be revalued. [IAS 16.36].
See Chapter 18 at 6.5.
Whilst it is not explicit in IAS 16, in our view, to obtain the fair value of an asset held
under a finance lease for financial reporting purposes, the assessed value must be
adjusted to take account of any recognised finance lease liability. The mechanism for
achieving this, which is mainly an issue for investment properties, is set out in detail in
Chapter 19 at 6.7.
4.2
Accounting by lessors
Under a finance lease, a lessor retains legal title to an asset but passes substantially all
the risks and rewards of ownership to the lessee in return for a stream of rentals. In
substance, therefore, the lessor provides finance and expects a return thereon.
The standard requires lessors to recognise assets held under a finance lease in their
statement of financial position as a receivable at an amount equal to the net investment
in the lease. [IAS 17.36]. The lease payments received from the lessee are treated as
repayments of principal and finance income. [IAS 17.37]. Initial direct costs may include
commissions, legal fees and internal costs that are incremental and directly attributable
Leases (IAS 17) 1645
to negotiating and arranging the lease. Incremental costs are those that would not have
been incurred if the entity had not negotiated and arranged a lease (see 3.4.8 above).
They do not include general overheads such as the costs of the sales and marketing
departments, including the employees’ fixed salaries. They are included in the
measurement of the net investment in the lease at inception and reflected in the
calculation of the implicit interest rate, except for manufacturers and dealers
(see 4.4 below). [IAS 17.38].
The recognition of finance income should be based on a pattern reflecting a constant
periodic rate of return on the lessor’s net investment outstanding in respect of the
finance lease. [IAS 17.39].
4.2.1
The lessor’s net investment in the lease
The lessor’s gross investment in the lease is the aggregate of the minimum lease
payments receivable by the lessor under a finance lease and any guaranteed and
unguaranteed residual value to which the lessor is entitled. The net investment in the
lease is the gross investment discounted at the interest rate implicit in the lease, [IAS 17.4],
i.e. at any point in time it comprises the gross investment after deducting gross earnings
allocated to future periods.
The lessor’s gross investment is, therefore, the same as the aggregate figures used to
calculate the implicit interest rate and the net investment is the present value of those
same figures – see 3.4.9 and Example 23.9 above.
Therefore, at inception, the lessor’s net investment in the lease is the cost of the asset
as increased by its initial direct costs. The difference between the net and gross
investments is the gross finance income to be allocated over the lease term.
Example 23.14 below illustrates this point.
4.2.2
Allocation of finance income
The lessor recognises finance income based on a pattern reflecting a constant periodic
rate of return on the lessor’s net investment outstanding in respect of the finance lease.
[IAS 17.39]. Lease payments, excluding costs for services, are applied against the gross
investment in the lease to reduce both the principal and the unearned finance income.
[IAS 17.40]. The standard does not refer to the use of approximations by lessors and,
accordingly, the alternative methods described in 4.1.2 above should not be used unless
the differences are clearly immaterial.
Example 23.9 at 3.4.9 above can be examined from the lessor’s perspective:
Example 23.14: The lessor’s gross and net investment in the lease
The lease has the same facts as described in Example 23.9, i.e. the asset has a fair value of €10,000, the lessee
is making five annual rentals payable in advance of €2,100 and the total unguaranteed estimated residual value
at the end of five years is estimated to be €1,000. The lessor’s direct costs have been excluded for simplicity.
The lessor’s gross investment in the lease is the total rents receivable of €10,500 and the unguaranteed
residual value of €1,000. The gross earnings are therefore €1,500. The initial carrying value of the receivable
is its fair value of €10,000, which is also the present value of the gross investment discounted at the interest
rate implicit in the lease of 6.62%.
1646 Chapter 23
Finance
Receivable
income
Gross Gross earnings
Receivable
at start of
Rental
(6.62% per investment at
allocated to
at end of
Year
period
received
annum) end of period
future periods
period
€ €
€
€
€
€
1 10,000
2,100
523
9,400
977
8,423
2 8,423
2,100
419
7,300
558
6,742
3 6,742
2,100
307
5,200
251
4,949
4 4,949
2,100
189
3,100
62
3,038
5 3,038
2,100
62
1,000
– 1,000
10,500
1,500
The gross investment in the lease at any point in time comprises the aggregate of the rentals receivable in
future periods and the unguaranteed residual value, e.g. at the end of year 2, the gross investment of €7,300
is three years’ rental of €2,10
0 plus the unguaranteed residual of €1,000. The net investment, which is the
amount at which the debtor will be recorded in the statement of financial position, is €7,300 less the earnings
allocated to future periods of €558 = €6,742.
4.2.3 Residual
values
Residual values have to be taken into account in assessing whether a lease is a finance
or operating lease as well as affecting the calculation of the IIR and finance income.
• Unguaranteed residual values have to be estimated in order to calculate the IIR
and finance income receivable under a finance lease. Any impairment in the
residual must be taken into account; this is illustrated in 4.2.3.A below.
• Residual values can be guaranteed by the lessee or by a third party. The effects of
third party guarantees on risks and rewards are described in 3.4.6.A above.
• The terms of a lease guarantee can affect the assessment of the risks and rewards
in the arrangement as in the example in 3.2.2.A above.
• A common form of lease requires the asset to be sold at the end of the lease term.
The disposition of the proceeds has to be taken into account in assessing who
bears residual risk, as described in 3.2.2.B above.
4.2.3.A
Unguaranteed residual values
Income recognition by lessors can be extremely sensitive to the amount recognised as
the asset’s residual value. This is because the amount of the residual directly affects the
computation of the amount of finance income earned over the lease term – this is
illustrated in Example 23.15 below. The standard gives no guidance regarding the
estimation of unguaranteed residual values but it does require them to be reviewed
regularly. If there has been a reduction in the estimated value, the income allocation
over the lease term is revised and any reduction in respect of amounts accrued is
recognised immediately. [IAS 17.41].
Example 23.15: Reduction in residual value
Taking the same facts as used in Example 23.14 above, the lessor concludes at the end of year 2 that the
residual value of the asset is only €500 and revises the income allocation over the lease term accordingly. It
continues to apply the same implicit interest rate, 6.62%, as before.
Leases (IAS 17) 1647
Finance
Gross
Receivable
income investment at Gross earnings
Receivable
at start of
Rental
(6.62% per
end of
allocated to
at end of
Year
period
received
annum)
period*
future periods
period
€ €
€
€
€
€
2 8,423
2,100
419
6,800
471
6,329
3 6,329
2,100
280
4,700
191
4,509
4 4,509
2,100
160
2,600
31
2,569
5 2,569
2,100
31
500
–
500
*
The gross investment in the lease now takes account of the revised unguaranteed residual of €500, rather
than the original €1,000.
The lessor will have to write off €413, being the difference between the carrying amount of the receivable as
previously calculated in Example 23.14 and the revised balance above (€6,742 – €6,329). This is the present
value as at the end of year 2 of €500 and represents the part of the unguaranteed residual written off.
This methodology is consistent with that required when measuring expected credit
losses for lease receivables under IFRS 9 described in paragraph B5.5.46 of IFRS 9 prior
to the effective date of IFRS 16. However, as discussed in Chapter 47 at 10.2, we believe
that measurement of unguaranteed residual values is within the scope of IAS 17 rather
than the impairment requirements of IFRS 9. Impairment of finance lease receivables
is discussed further at 4.3.2.A below.
4.2.4
Disposals by lessors of assets held under finance leases –
measurement
If a lessor is to dispose of an asset under a finance lease that is classified as held for sale, or
is included in a disposal group that is so classified, it is to apply the requirements of IFRS 5
– Non-current Assets Held for Sale and Discontinued Operations – to the disposal.
[IAS 17.41A]. The ‘asset under a finance lease’ is the receivable from the lessee, which is not
a financial asset under IFRS 9; see 3.5 above for an analysis of the extent to which assets
and liabilities under leases are within scope of that standard. This means that measurement
as well as classification of the asset under the finance lease is within scope of IFRS 5, unlike
financial assets within scope of IFRS 9 that are subject only to its classification rules. Once
classified as held for sale, it must be measured at the lower of carrying amount and fair
value less costs to sell. Any residual interest in the leased asset once the lease has ended
and the asset is returned to the lessor would be accounted for under IAS 16 or IAS 38, and
is clearly within scope of IFRS 5. The requirements of IFRS 5 are dealt with in Chapter 4.
4.3
Termination of finance leases
The expectations of lessors and lessees regarding the timing of termination of a lease
may affect the classification of a lease as either operating or finance. This is because it
will affect the expected lease term, level of payments under the lease and expected
residual value of the lease assets.
Termination during the primary lease term will generally not be anticipated at the lease
inception because the lessee can be assumed to be using the asset for at least that period.
In addition, early termination will be unlikely because most leases are non-cancellable.
A termination payment is usually required which will give the lessor an amount
equivalent to most or all of the rental receipts which would have been received if no
1648 Chapter 23
termination had taken place, which means that it is reasonably certain at inception that
the lease will continue to expiry.
However, there are consequences if the lease is terminated. The issues for finance
lessees and lessors are discussed in the following sections.
4.3.1
Termination of finance leases by lessees
Paragraph 2.1(b) of IFRS 9 prior to the effective date of IFRS 16 noted that finance lease
payables recognised by a lessee are subject to the derecognition provisions of IFRS 9.
IFRS 9 requires an entity to derecognise (i.e. remove from its statement of financial
position) a financial liability (or a part of a financial liability) when, and only when, it is
‘extinguished’, that is, when the obligation specified in the contract is discharged,
cancelled, or expires. [IFRS 9.3.3.1]. This will be achieved when the debtor either:
• discharges the liability (or part of it) by paying the creditor, normally with cash,
other financial assets, goods or services; or
• is legally relea
sed from primary responsibility for the liability (or part of it) either
by process of law or by the creditor. [IFRS 9.B3.3.1].
The difference between the carrying amount of a financial liability (or part of a financial
liability) extinguished or transferred to another party and the consideration paid,
including any non-cash assets transferred or liabilities assumed, is recognised in profit
or loss.
In order to identify the part of a liability derecognised, an entity allocates the previous
carrying amount of the financial liability between the part that continues to be
recognised and the part that is derecognised based on the relative fair values of those
parts on the date of the repurchase. [IFRS 9.3.3.4,]. Derecognition of part of a lease liability
will most likely come about in the context of a lease renegotiation, discussed at 6 below.
Derecognition of financial liabilities under IFRS 9 is dealt with in Chapter 48.
4.3.1.A
Early termination by lessees
Except as part of a renegotiation or business combination or similar larger arrangement,
early termination of a finance lease results in derecognition of the capitalised asset by
the lessee, with any remaining balance of the capitalised asset being written off as a loss
on disposal. Any payment made by the lessee will reduce the lease obligation that is
being carried in the statement of financial position. If either a part of this obligation is
not eliminated or the termination payment exceeds the previously existing obligation,
then the remainder or excess will be included as a gain or loss respectively on
derecognition of a financial liability.
A similar accounting treatment is required where the lease terminates at the expected
date and there is a residual at least partly guaranteed by the lessee. For the lessee, a
payment made under such a guarantee will reduce the obligation to the lessor as the
guaranteed residual would obviously be included in the lessee’s finance lease obligation.
If any part of the guaranteed residual is not called on, then the lessee would treat this
as a profit on derecognition of a financial liability.
Leases (IAS 17) 1649
The effect on the derecognition of the capitalised asset will depend on the extent to which
the lessee expected to make the residual payment as this will have affected the level to
which the capitalised asset has been depreciated. For example, if the total guaranteed
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 325