Lease Accounting

search Assignment for 6227: Lease Accounting

AASB 117 (IAS 17) incorporates a controversial approach to accounting for leases. In this essay, you should appraise the role of accounting regulation and draw on relevant academic research (journal articles) and other forms of support to understand and evaluate this quote:

“Let’s turn to leasing. One of my great ambitions before I die is to fly in an aircraft that is on an airline’s balance sheet” (Sir David Tweedie, former Chair of the International Accounting Standards Board, 25 April 2008, available fromhttp://www.ifrs.org/news/announcements-and-speeches/Pages/sir-david-tweedie-addresses-the-empire-club-of-canada.aspx

In part, this relates to the issues of off-balance sheet financing. It also relates to issues concerning the interaction of the conceptual framework for financial reporting and accounting standards.

This essay has two key associated learning outcomes:                                     

3. Analyse specific accounting standards and interpretations to identify where they facilitate off-balance sheet financing and earnings management; and

4. Drawing on theories, evaluate the forces that shape accounting rules especially in relation to off-balance sheet financing and earnings management.

In order to satisfy the learning outcomes, in support of your evaluation of the quote, you should refer to relevant accounting standards in your answer, draw on examples from companies (as these constitute applications of the techniques), as well as relevant academic research journal articles, and understand the forces and pressures that impact upon standard setters when developing these rules.

The essay should be approximately 2,000 words in length.

Assignment marking criteria:

The Research Assignment will be assessed on the following basis:

•    Research analysis – demonstrated by drawing upon and employing relevant research in accounting – 30 %

•    Problem solving – 20%

•    Logical progression of argument – 10%.

•    Appropriate application of issues in company accounting – 20%.

•    Effective communication – 20%.

Lease accounting is one area that has attracted quite some controversy because of the potential for exploitation by companies. The classification of leases often proves difficult because lease indicators may not give similar implications. Finance leases give the lessee all the associated risks and rewards at inception. Any other lease is classified under operating leases. Specialised assets that are exclusively used by one entity are classified as finance leases and the lessor gets his return on investment from the lease payments (Edmonds et al, 2011). Non-specialised assets that can be sold or leased to other parties, with the financial risk going to the lessor, are generally treated as operating leases.

There are situations in which non-specialised assets can be converted to specialised category and vice versa (Jones, 2011). For example, an entity may lease some heavy equipment which has to be installed in its premises for many years. At the end of the lengthy lease period, the lessor may find it too expensive to facilitate the removal of such equipment. The conversion of a specialised asset into an operating lease requires that the equipment should still be functional at the end of the lease period but this might not be the case, with only the lessee finding value for it. In such situations, the lessee normally acquires such assets at the end of the lease period, either for free or pays some amount. When this happens the lease will now be considered a financial lease.

For assets that have been subject to multiple leases while still economically viable, the last lease before they are written off is treated as a finance lease (Edman, 2011). This is because the total amounts paid under the last lease may approximate the prevailing market valuation of the asset. Such a lease is unlikely to be extended, neither can the asset be bought a reasonable price because it is about to be written off. The last lease will only cover the remaining functional duration of the asset, and is thus treated as non-specialised.

According to IAS 17, the economic viability of an asset is the major determinant for classification as a finance lease. The multiple leases during the life of the asset are classified as operating leases because they form the basis for the lessor to recoup his investment in the asset (Edmonds et al, 2011). It follows that the last lease agreement before the asset is written off should not be treated any different since it is based on similar terms as the previous leases.

IAS 17 also provides that when assets are leased with payment of nominal rents, the agreement still qualifies as a lease. This is a form of operating lease because all the rent paid during the lease agreement are not enough to match the market value of the asset (Edman, 2011). For such agreements where rents are low, there is usually a premium paid upfront which amounts to a substantial portion of the assets fair value. For agreements with low rent and no upfront premium charged, it would appear the lessor is not keen on how the risks and rewards impact on his commercial interests.  Before such leases are classified, it is imperative to analyse the lessor’s intentions that drove him to enter into such terms (Lambert & Lambert, 2011)…

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