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Lessee Ltd.

In: Business and Management

Submitted By laksh81
Words 1137
Pages 5
Facts
Lessee Ltd, a British company has leased equipment from Lessor Ltd, as of January 1, 2007 for three years. On expiration the equipment reverts to Lessor Ltd. Annual expenses include a lease payment of $100,000 and other expenses of $2,000 with no expenses incurred by Lessor Ltd. The remaining useful life of the equipment is 4 years. At the time, the equipment had a Fair Market Value (FMV) of $265,000. Lessee Ltd guaranteed a residual value of $20,000 by the end of the lease term. The salvage value of the equipment was estimated as $2000 at the end of the economic life. The lessor’s implicit rate was calculated at 10% with the Present Value (PV) of the residual at $15,026 and lease payments at $248,690. The lessee’s incremental borrowing rate is 11% with the PV of the residual at $14,624 and lease payments at $244,370.
Issue
Is the lease an operating lease as analyzed and interpreted by the junior accountant or is it a finance lease along with other calculations as determined by the senior accountant?
Would the answer differ if Lessee Ltd were to adapt U.S GAAP accounting policies as opposed to IFRS?
Rule
The IFRS standards are known by the name International Accounting Standards (IAS). The IAS 17 helps distinguishes between lease transactions. It states, “A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership” (www.iasb.org). The definition could lead us to believe that the lease signed by Lessee Ltd, is a finance lease.
The IAS 17, paragraph 10 also provides a list of indicators to determine a finance lease. The one’s applicable are:
 The term of the lease is for the major part of the economic life of the lease.
 A persuasive factor in classifying a…...

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