IAS 17 Leases

A leasing agreement is an agreement whereby one party, the lessee, pays lease
rentals to another party, the lessor in order to gain the use of an assets over a
period of time.
Types of leases
There are two types of lease:
1. A finance lease
A finance lease is a lease that transfers substantially all the risks and rewards
incidental to ownership of an asset to the lessee.
2. An operating lease
An operating lease is any lease other than a finance lease
Classification of leases
To decide whether a lease is finance or operating, the first step is to assess
whether the risks and rewards of ownership have transferred to the lessee.
Risks and rewards
Risks and rewards of ownership include:
Risks:
1. Lessee carries out repairs and maintenance
2. Lessee insures asset
3. Lessee runs the risk of losses from idle capacity
4. Lessee runs the risk of technological obsolescence
IAS 17 provides guidance as to the classification of leases as finance leases or
operating leases.
It gives the following list of situations in which a lease would normally be
classified as a finance lease.
The lease transfers ownership of the asset to the lessee by the end of the
lease term.
The lessee has the option to buy the asset at a price expected to be lower
than the fair value at the time the option is exercised.

The lease term is for the major part of the economic life of the asset even if
title is not transferred.
At the beginning of the lease, the present value of the minimum lease
payment (MLPs) is approximately equal to the fair value of the asset.

The leased assets are of a specialized nature so that only the lessee can use
them without major modification.
If the lease gives the lessee the right to cancel the lease, the lessors losses
associated with the cancellation are borne by the lessee.

Gains or losses from fluctuations in fair value are borne by the lessee.
The lessee has the ability to continue the lease for a secondary period at a
rent below the market rent.