Leases

1
Leases
In accordance with the requirements of IAS 17
FASB Statement 13
Ahmad Tariq Bhatti FCMA, FPA, MA (Economics),
BSc Dubai, United Arab Emirates
2
Program Details

1. Lease assets
2. Key concepts
3. Classification
4. Definitions
5. Calculations
6. Accounting
7. Advantages disadvantages
8. Glossary
9. Appendix A Leasing Soft-wares
10. References

3
Lease Assets


4
Key Concepts

• A lease is an agreement whereby a lessor conveys
  to a lessee, in return for a payment or series of
  payments, the right to use an asset for an agreed
  period of time.
• A finance lease is an agreement that transfers
  substantially all risks and rewards incidental to
  ownership of an asset. Title may or may not
  eventually be transferred.
• A non-cancellable lease is a lease that is
  cancellable only
• Upon the occurrence of some remote contingency,
• With the permission of the lessor,
• If a lease enters into a new agreement for the
  same or an equivalent asset with the same lessor
  or
• Upon payment by a lessee of such an additional
  amount that, at inception of the lease,
  continuation of the lease is reasonably certain.
• The commencement of a lease term is a date from
  which a lessee is entitled to exercise the right
  to use leased assets.
• The lease term is a non-cancellable period for
  which a lessee has signed an agreement to lease
  an asset.

5
Key Concepts

• Minimum Lease Payments (MLPs) are payments over a
  lease term that a lessee is or can be required to
  make, excluding contingent rents, costs for
  services and taxes to be paid by and reimbursed
  to a lessor together with
• For a lessee, any amounts guaranteed by him or by
  a party related to the lessee
• For a lessor, any GRV to the lessor by
• The lessee
• A party related to the lessee or
• 3rd party guarantor unrelated to the lessor
  
• Fair Value (FV) is an amount for which an asset
  could be exchanged, or a liability settled,
  between knowledgeable willing parties, in an
  arms length transaction.
• Economic life (EL) is either
• The period over which an asset is expected to be
  economically usable by one or more users or
• The number of production or similar units
  expected to be obtained from an asset by one or
  more users.

6
Key Concepts

• Unguaranteed residual value (UGRV) is that
  portion of RV of a leased asset, realization of
  which by a lessor is not assured or is guaranteed
  solely by a party related to a lessor.
• Guaranteed residual value (GRV) is
• For a lessee, that part of RV that is guaranteed
  by a lessee and
• For a lessor, that part of RV that is guaranteed
  by a lessee or a 3rd party guarantor
• Gross investment in a lease asset is the
  aggregate of
• MLPs receivable by a lessor under a finance
  lease, and
• Any UGRV accruing to a lessor.
• Net investment in a lease asset is gross
  investment in a lease discounted at the required
  interest rate of a lessor.
• Initial Direct Costs (IDCs) are costs that are
  directly attributable to negotiating and
  arranging a lease.
• Useful life is an estimated remaining period,
  from commencement of a lease term, without
  limitation by a lease term, over which the
  economic benefits embodied in an asset are
  expected to be consumed by an entity.

7
Key Concepts

• Unearned Finance Income (U/E-FI) is the
  difference b/w
• The gross investment in the lease and
• The net investment in the lease.
• The Implicit Interest Rate (IIR) in a lease is a
  discount rate that, at the inception of a lease,
  causes aggregate PV of
• The MLPs and
• The UGRV to be equal to the sum of
• The FV of the leased asset plus
• Any IDCs of the lessor.
• Incremental Borrowing Rate (IBR) The rate a
  lessee would have paid if he had borrowed funds
  to purchase an asset
• on similar lease
• with a similar security
• Contingent rent is that portion of lease payments
  that is not fixed in amount but is based on the
  future amount of factor that changes other than
  with the passage of time.

8
Classification

• There are two main types of leases
• Capital or Financing Lease
• Operating Lease
• Capital leases are further classified into
  following types
• Financing Lease
• Leveraged Lease
• Sales and Lease Back
• Direct Lease

9
Definitions

• FINANCE LEASE
• Capitalization Criteria
• The criteria about capitalization of leases are
  given in para 10 of IAS 17 as
• The lease transfers ownership of an asset to a
  lessee by the end of lease term
• The lessee has the option to purchase the asset
  at a price that is expected to be sufficiently
  lower than the FV at the date the option becomes
  exercisable for it to be reasonably certain, at
  the inception of the lease, that the option will
  be exercised
• The lease term is for the major part (75)¹ of
  the economic life of the asset even if title is
  not transferred
• At the inception of the lease PV of the MLPs
  amounts to the FV (90)² of the leased asset
  and
• The leased assets are of such a specialized
  nature that only the lessee can use without major
  modification.

10
Definitions
FINANCE LEASES

• Additional Capitalization Criteria
• Para 11 of IAS 17 gives some more criteria that
  distinguish capital leases from operating leases
• If the lessee can cancel the lease, the lessors
  losses associated with the cancellation are borne
  by the lessee
• Gains or losses from the fluctuation in FV of RV
  accrue to the lessee and
• the lessee has the ability to continue the lease
  for a secondary period at a rent that is
  substantially lower than market rent.
• Para 12 IAS 17 still goes on to say that the
  criteria mentioned in para 10-11 are not final.
  For instance, it says, if it is clear from other
  features that the lease does not transfer
  substantially all risks and rewards incidental to
  ownership, the lease is classified as an
  operating lease.
• __________
• ¹,² FASB Statement 13 has quantified the values.

11
Definitions

• OPERATING LEASE
• An operating lease stands in contrast to a
  financial lease in almost all aspects. This lease
  agreement gives to a lessee only a limited right
  to use an asset. The lessor is responsible for
  upkeep and maintenance of an asset. The lessee is
  not given BPO at the end of the lease period.
  This is similar to renting of assets.
• SALE LEASE BACK
• Under this arrangement, an owner of an asset
  sells the asset to a party (the buyer), who in
  turn leases back same asset to the owner in
  consideration for lease rentals. However, under
  this arrangement, assets are not physically
  exchanged but it all happens in records books
  only. Sale and lease back transaction is suitable
  for those assets, which are not subject to
  depreciation but appreciation, for instance, a
  piece of land in a exotic location. The advantage
  of this method is that the lessee can satisfy
  himself completely regarding the quality of an
  asset and after possession of an asset convert
  the sale into a lease arrangement. The lessor has
  two sources of earnings under a sales type lease
  
• A profit, at the lease inception date,
• Interest revenue over the lease term.

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Definitions
LEVERAGED LEASING Under leveraged leasing
arrangement, a third party is involved beside
lessor and  lessee. A lessor borrows a part of
purchase cost (say 70) of an asset from a third
party i.e., lender and the asset so purchased is
held as a security against such loan. The lender
is paid-off from lease rentals directly by a
lessee and surplus after meeting claims of lender
goes to the lessor. The lessor, the owner of an
asset is allowed to record depreciation expense
related with that asset. DIRECT LEASING Under
direct leasing, a company acquires a right to use
an asset from a manufacturer directly. The
ownership of an asset leased-out remains with the
manufacturer. Most direct-financing leases
involve banks, which make profits by lending
money at an interest rate specified in their
contract with the lessee. These banks do not sell
assets of the type being leased but merely
provide finance for assets acquired for a lease.
Acquisition of vehicles from the direct outlets
of car manufacturers like Honda, Mercedes,
Toyota, BMW, Ford, Jaguar, etc. is an example of
direct leasing.
13
Minimum Lease Payments
MLPs Calculation FASB St. 13
No
Check-out if the lease contract includes BPO
Clause???
Yes

• Then MLPs shall include the following
• Periodic lease payments up-to the date on which
  BPO becomes exercisable
• Amount of BPO

• Then MLPs shall include the following
• Periodic lease payments over the lease term
• The amount of GRV (if any)
• Any payment required by the lessee for failure to
  renew or extend the lease at the end of lease term

14
Residual Value Working
RV Calculation FASB St. 13 IAS 17
Check-out if the lease term equals to Economic
Life (EL) of the asset???
Equals to EL
Less than EL
It has RV of a leased asset only. Note The
lease contract may provide to guarantee all, part
or none of assets RV.

• It has two parts
• First, cost pertaining to remaining useful life
  of an asset
• Second, RV of an asset

15
Discount Rate Lessee
Discount Rate to be Applied by a Lessee - FASB
St. 13 IAS 17
Yes
No
Check-out if the lease contract provides interest
rate implicit in it?
Use IBR for discounting lease liability over the
lease term, if implicit rate is not determinable.
Refer to slide 17 for MLP calculations.

• IBR shall not be used when
• Implicit rate is known,
• Implicit rate is less than IBR
• That means under these two conditions implicit
  rate shall be used. Refer to slide 17 for MLP
  calculations.

16
Depreciation Calculation
Depreciation Expense Calculation FASB St. 13
IAS 17
Yes
No
Check-out if the lease contract transfers
ownership at the end of lease term or contains
BPO Clause in it???
Depreciate lease asset over the economic life.
Depreciate lease asset over the lease term.
17
Calculation
Lessees Books
Lessors Books
Lease Payable
Lease Receivable
Lease Receivable/Payable Amount FV - PV of
GRV - PV of UGRV (If any) Lease Payable amount
represents the PV of MLPs from lessees
perspective
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Calculation Formula
Total Lease Receivable/Payable amount FV -
PV of GRV - PV of UGRV(if any) Total Lease
Receivable/Payable amount

PV of GRV / UGRV ???? (????)
?? Where
R
Periodical Payment
r Rate of interest
n Lease Terms (ie
number of years)
FV Fair Value of GRV at the end of
lease term
????- ?? ???? ?? ??
19
Calculation

• Implicit Rate versus IBR
• FASB Statement 13 requires the lessee to use his
  IBR in calculating the PV of MLPs unless (1) the
  lessee can determine the implicit rate in the
  lease and (2) the implicit rate is less than the
  lessees IBR.
• IAS 17 para 20, says, the discount rate to be
  used in calculating the PV of the MLPs is the
  interest rate implicit in the lease, if this is
  practicable to determine, if not, then lessees
  IBR shall be used. Any IDCs of the lessee shall
  be added to the amount to be recognized as an
  asset.
• In practice, the number of instances in which the
  IBR should apply is small, for the following
  reasons
• Most lessors disclose the interest rate implicit
  in their lease agreements.
• The lessee knows the FV of the asset being leased
  to him.
• Leased asset may be subject to high rate of
  obsolescence, which makes expected RVs nominal.
  Thus, the impact on FV of the asset is
  negligible.
• Important note The calculations for lease
  receivable amount by a lessor at his required
  rate of return on his investment in an asset are
  done for every lease deal separately. For a
  lessee, it becomes implicit interest rate. He has
  to calculate it or it shall be known to him by a
  lessor.

20
Ordinary Annuity vs. Annuity Due

• An annuity is a series of equal cash f lows
  occurring at equal intervals over a period of
  time.
• Ordinary Annuity If the first cash flow occurs
  at the end of the first period, the annuity is
  called Ordinary Annuity or an Annuity in Arrears.
• Annuity Due If the first cash flow occurs at the
  beginning of first period. The annuity is called
  an Annuity Due or an Annuity in Advance.

PV of MLPs under Ordinary Annuity
????- ?? ???? ?? ??
PV of MLPs under Annuity Due
(1r)
????- ?? ???? ?? ??
21
Accounting
Date Description Ref. Debit Credit
Finance Lease Lessors Books AED. AED.
1/1/20xx Lease Receivable xxx
Asset xxx
(Lease Receivable recorded at Net Investment in Leased Asset by the lessor) (Lease Receivable recorded at Net Investment in Leased Asset by the lessor) (Lease Receivable recorded at Net Investment in Leased Asset by the lessor) (Lease Receivable recorded at Net Investment in Leased Asset by the lessor)
Cash xxx
Lease Receivable xxx
(On receipt of 1st lease installment)
31/12/20xx Lease Receivable xxx
Interest Income xxx
(On booking interest income earned)

22
Accounting
Date Description Ref. Debit Credit
Finance Lease Lessees Books AED. AED.
1/1/20xx Lease Asset xxx
Lease Payable xxx
Lease asset and lease liability shall be recorded at lower of (1) PV of MLPs or (2) FV of asset, at the inception of the lease Lease asset and lease liability shall be recorded at lower of (1) PV of MLPs or (2) FV of asset, at the inception of the lease Lease asset and lease liability shall be recorded at lower of (1) PV of MLPs or (2) FV of asset, at the inception of the lease Lease asset and lease liability shall be recorded at lower of (1) PV of MLPs or (2) FV of asset, at the inception of the lease
Lease Payable xxx
Cash xxx
31/12/20xx Interest Expense xxx
Lease Payable xxx
Lease Payable xxx
Cash xxx
Depreciation expense xxx
Accumulated Depreciation xxx
Depreciation of an asset is charged over The EL of an asset, if ownership transfers to lessee at the end of lease term or there is a BPO The term of lease, if title does not transfer or there is no BPO Depreciation of an asset is charged over The EL of an asset, if ownership transfers to lessee at the end of lease term or there is a BPO The term of lease, if title does not transfer or there is no BPO Depreciation of an asset is charged over The EL of an asset, if ownership transfers to lessee at the end of lease term or there is a BPO The term of lease, if title does not transfer or there is no BPO Depreciation of an asset is charged over The EL of an asset, if ownership transfers to lessee at the end of lease term or there is a BPO The term of lease, if title does not transfer or there is no BPO
23
Accounting
Finance or Capital Leases Finance or Capital Leases Finance or Capital Leases Finance or Capital Leases
Financial Statements Presentation Disclosure Financial Statements Presentation Disclosure Financial Statements Presentation Disclosure Financial Statements Presentation Disclosure
Statement of Comprehensive Income Statement of Comprehensive Income Statement of Comprehensive Income Statement of Comprehensive Income
For the financial year ended December 20xx For the financial year ended December 20xx For the financial year ended December 20xx For the financial year ended December 20xx
Lessors Perspective Lessors Perspective Lessees Perspective Lessees Perspective
AED. AED.
Interest Revenue xxx Interest Expense xxx

Depreciation Expense xxx
Important note For the information to be included in explanatory notes to the financial statements of lessee and lessor, refer to para 31 and para 47of IAS 17 respectively. Important note For the information to be included in explanatory notes to the financial statements of lessee and lessor, refer to para 31 and para 47of IAS 17 respectively. Important note For the information to be included in explanatory notes to the financial statements of lessee and lessor, refer to para 31 and para 47of IAS 17 respectively. Important note For the information to be included in explanatory notes to the financial statements of lessee and lessor, refer to para 31 and para 47of IAS 17 respectively.
24
Accounting
Finance or Capital Leases Finance or Capital Leases Finance or Capital Leases Finance or Capital Leases
Financial Statements Presentation Disclosure Financial Statements Presentation Disclosure Financial Statements Presentation Disclosure Financial Statements Presentation Disclosure
Statement of Financial Position Statement of Financial Position Statement of Financial Position Statement of Financial Position
As at December 31, 20xx As at December 31, 20xx As at December 31, 20xx As at December 31, 20xx
Lessors Perspective Lessors Perspective Lessees Perspective Lessees Perspective
ASSETS AED. ASSETS AED.
Lease Receivable xxx Leased Asset xxx
Less Accumulated Dep. (xxx)
Net Leased Asset xxx
LIABILITIES
Lease Liability xxx
25
Accounting
Date Description Ref. Debit Credit
Operating Lease Lessors Books AED. AED.
1/1/20xx. Cash xxx
Lease Rental Revenue xxx
(Being the revenue earned through leased assets rental)
31/12/20xx Depreciation Expense xxx
Accumulated Depreciation xxx
(Being the depreciation of leased asset recorded)
Operating Lease Lessees Books
Lease Rent Expense xxx
Cash xxx
(Being the lease rent expense paid)

Important note For the information to be included in explanatory notes to the financial statements of lessor and lessee, refer to para 56 and para 35 respectively. Important note For the information to be included in explanatory notes to the financial statements of lessor and lessee, refer to para 56 and para 35 respectively. Important note For the information to be included in explanatory notes to the financial statements of lessor and lessee, refer to para 56 and para 35 respectively. Important note For the information to be included in explanatory notes to the financial statements of lessor and lessee, refer to para 56 and para 35 respectively. Important note For the information to be included in explanatory notes to the financial statements of lessor and lessee, refer to para 56 and para 35 respectively.
26
Accounting
Operating Leases Operating Leases Operating Leases Operating Leases
Financial Statements Presentation Disclosure Financial Statements Presentation Disclosure Financial Statements Presentation Disclosure Financial Statements Presentation Disclosure
Statement of Comprehensive Income Statement of Comprehensive Income Statement of Comprehensive Income Statement of Comprehensive Income
For the financial year ended December 20xx For the financial year ended December 20xx For the financial year ended December 20xx For the financial year ended December 20xx
Lessors Perspective Lessors Perspective Lessees Perspective Lessees Perspective
AED. AED.
Lease Rental Revenue xxx Lease Rental Expense xxx
Depreciation Expense xxx

Important note For explanatory notes to be included in the financial statements of lessor and lessee, refer to para 56 and para 35 respectively. Important note For explanatory notes to be included in the financial statements of lessor and lessee, refer to para 56 and para 35 respectively. Important note For explanatory notes to be included in the financial statements of lessor and lessee, refer to para 56 and para 35 respectively. Important note For explanatory notes to be included in the financial statements of lessor and lessee, refer to para 56 and para 35 respectively.
27
Land Building Lease
When a lease includes both land and buildings, a
company MUST consider land and building parts
separately for their classification as operating
or finance lease. MLPs are allocated between the
land and buildings parts in proportion to the
relative FVs of the leasehold interests in the
land and buildings parts.
28
An Illustrative Model
On January 01, 2008, AAA company leased-out a
generator to BBB company . The terms and
conditions of the lease are as given
below
Description of Terms Conditions of the lease
1 Cost to AAA and FV of the generator is AED. 20,000
2 Term of lease, 4 years (covers 67 of EL of the generator)
3 Economic life of the asset, 6 years
4 The lessee has guaranteed 100 RV, at the end of lease term, VIZ estimated at AED. 3,000
5 Implicit rate of interest used in the lease payments and lessees IBR is 12
6 Annual lease payments to be made at the beginning of each year is (annuity due) are determined by the lessor as given on next slide.
7 The lease uses straight-line depreciation on the leased asset.
29
Calculations by the Lessor
Description Amount
AED.
Cost FV of the generator 20,000
PV of GRV (1,906)
PV of MLPs (90 i.e. 90.47) 18,094
Annual Lease Payment (Recoverable amount / PV factor)
Annual Lease Payment (AED. 18,094 / 3.4018) 5,319
PV of GRV

PV of GRV
3,000/(1.12)4 3,000 x 0.6355 1,906

???? (????) ??
The aggregate PV of MLPs to be recovered is 90,
therefore, it is a capital lease.
30
Lease Schedule
Year Annual Lease Payments (Annuity Due Method) Net Receivable/Payable outstanding during the year Interest Revenue/Expense for the year Reduction in Receivable/Payable Balance Net Receivable/Payable on 31 December
1 2 3 4 5 6
6-2 3x12 2-4 34
AED. AED. AED. AED. AED.
01/01/08 - - - - 20,000
01/01/08 5,319 14,681 1,762 3,557 16,443
01/01/09 5,319 11,124 1,335 3,984 12,459
01/01/10 5,319 7,140 857 4,462 7,997
01/01/11 5,319 2,678 322 4,997 3,000 (RV)
Total 21,276 4,276 17,000
31
Journal Entries for 2008
Lessors Books AAA Co. Books Lessors Books AAA Co. Books Lessors Books AAA Co. Books Lessors Books AAA Co. Books Lessees Books BBB Co. Books Lessees Books BBB Co. Books Lessees Books BBB Co. Books Lessees Books BBB Co. Books
Description Dr. Cr. Description Dr. Cr.
1 Lease Receivable 20,000 1 Lease Asset- Generator 20,000
Lease Asset - Generator 20,000 Lease Liability 20,000
(To record capital lease on 01/01/08) (To record capital lease on 01/01/08) (To record capital lease on 01/01/08) (To record capital lease on 1/1/08) (To record capital lease on 1/1/08) (To record capital lease on 1/1/08)
2 Cash 5,319 2 Lease Liability 5,319
Lease Receivable 5,319 Cash 5,319
(To record the 1st lease payment on 01/01/2008) (To record the 1st lease payment on 01/01/2008) (To record the 1st lease payment on 01/01/2008) (To record lease payment on 1/1/08) (To record lease payment on 1/1/08) (To record lease payment on 1/1/08)
3 Lease Receivable 1,762 3 Interest Expense 1,762
Interest Revenue 1,762 Lease Liability 1,762
(To record interest earned on 31/12/08.) (To record interest earned on 31/12/08.) (To record interest earned on 31/12/08.) (To record interest expense on 31/12/2008) (To record interest expense on 31/12/2008) (To record interest expense on 31/12/2008)
4 Depreciation Expense 4,250
Accumulated Depreciation 4,250
To record Depreciation (20,000-3000)/4 4,250 p.a. To record Depreciation (20,000-3000)/4 4,250 p.a. To record Depreciation (20,000-3000)/4 4,250 p.a.
32
Journal Entries for 2011 (F/Y)
Lessors Books AAA Co. Books Lessors Books AAA Co. Books Lessors Books AAA Co. Books Lessors Books AAA Co. Books Lessees Books BBB Co. Books Lessees Books BBB Co. Books Lessees Books BBB Co. Books Lessees Books BBB Co. Books
Description Dr. Cr. Description Dr. Cr.
1 Cash 5,319 1 Lease Liability 5,319
Lease Receivable 5,319 Cash 5,319
(To record the last lease payment) (To record the last lease payment) (To record the last lease payment) (To record lease payment on 01/01/2011) (To record lease payment on 01/01/2011) (To record lease payment on 01/01/2011)
2 Lease Receivable 322 2 Interest Expense 322
Interest Revenue 322 Lease Liability 322
(To record interest earned on 31/12/11) (To record interest earned on 31/12/11) (To record interest earned on 31/12/11) (To record interest expense on 31/12/2011) (To record interest expense on 31/12/2011) (To record interest expense on 31/12/2011)
3 Lease Asset Generator 3,000 3 Depreciation Expense 4,250
Lease Receivable 3,000 Accumulated Depreciation 4,250
(Final Settlement entry 31/12/11) (Final Settlement entry 31/12/11) (Final Settlement entry 31/12/11) To record Depreciation (20,000-3000)/4 4,250 p.a. To record Depreciation (20,000-3000)/4 4,250 p.a. To record Depreciation (20,000-3000)/4 4,250 p.a.
4 Accumulated Depreciation 17,000
Lease Liability 3,000
Lease Asset 20,000
(Final settlement entry on 31/12/11) (Final settlement entry on 31/12/11) (Final settlement entry on 31/12/11)
33
Advantages

1. There is no requirement to pay entire amount
   upfront for an asset acquired through a lease
   arrangement. Further, it provides flexible
   payment plan suiting best to the businesses
   according to their income streams and cash flow
   patterns.
2. The arrangement under leases provide great deal
   of flexibility in terms of adopting to rapid
   changes in technology and capacity needs from
   lessees point of view. It helps companies to
   stay competitive in business.
3. Leasing arrangement has resolved critical cash
   problem for a lessee by providing 100 financing
   for a leased asset.
4. Leases preserves credit-lines for other business
   pursuits like purchase of inventory of raw
   materials, project finance or other emergency
   uses.
5. Leasing may help a manufacturer accelerate sales
   of his products.

34
Advantages

1. A lessee may avoid many of restrictive covenants
   that are usually part of long term contracts for
   credit-lines. Requirements with respect to,
   minimum net working capital, subsequent
   borrowings, changes in management, mortgages or
   pledges on assets, nominees in Board of
   Directors, and so on are not normally found in
   lease contracts.
2. Leasing arrangements help a lessor to prevent
   dilution of ownership which otherwise is inherent
   when equity shares or convertible bonds are
   issued for raising the necessary finance for
   acquisition of assets.
3. The use of sale and lease back arrangements may
   permit a company to increase liquidity by
   converting an existing asset into cash that can
   be used as a working capital.
4. Leasing balances usage and cost of an asset.
   Leasing makes sense when an asset used creates a
   return that exceeds its cost. It is said for this
   point that leases means good business sense.

35
Advantages

1. Leasing provides fixed rate financing. Leasing is
   not subject to market fluctuations and interest
   rate increases. One can negotiate periodic lease
   payments and secure a fixed rate for the term of
   lease. This makes it much easier to manage
   project cash flows and budgets for planning
   purposes.
2. Leasing provides hedge against inflation. Since
   lease payments apply to use of an asset and are
   not paid for ownership of an asset that
   depreciates consistently. Furthermore, cash
   savings can yield a return that fights
   inflationary pressures.
3. Leasing conserves working capital. Leasing
   enables a lessor to save working capital for his
   company, since it covers all costs associated
   with capital asset purchases like maintenance,
   insurance, up-keep etc., etc.
4. Leasing may help a lessee to avoid the risk and
   cost of idle asset after required utility of an
   asset is over.

36
Advantages

1. Lease mode of financing is also compared to
   security-tied credit. It saves capital for other
   needs of a company.
2. In case of operating leases arrangement, the
   lessees Debt to Equity Ratio and Return on
   Capital Employed (ROCE) is not increased. This is
   due to off-balance sheet financing of the asset.
3. Operating lease provides tax benefits to a
   lessor. Some leasing companies transfer tax
   benefits received from ownership of assets to
   lessees through competitive rates and lower
   execution fees.
4. With a bank loan or direct purchase, a company
   normally claim depreciation according to IAS 16
   recommendation of useful life of an asset.
   Depreciation for an asset can be spread over 5 to
   7 years. However, the same asset under a lease
   can be expensed-out 100 over the lease term
   selected by a company. This could, for instance,
   write-off an asset over 3 years instead of 5 or 7
   years. This will, eventually, provide bigger tax
   benefits to the lessee.

37
Disadvantages

1. A company is unable to sell or sub-lease an asset
   in the event it is no longer required and cannot
   upgrade it to a newer or better asset without
   either paying-off the remaining contract dues, or
   paying fines to cancel the contract.
2. A lessee loses certain tax benefits which are
   available to a lessor (owner) who uses the assets
   himself.
3. A lessee has often to bear technological
   obsolescence since some lease contracts have
   non-cancelable clause in them.
4. Early termination of a contract by a lessee may
   impose severe penalties from a lessor.
5. Although leasing avoids paying an upfront amount,
   over a long period of time, it often works out
   considerably more expensive than outright
   purchase. A company pays cost of asset as well as
   the leasing companies charges and other dues
   incidental to the lease contract.
6. Lessees are responsible for the maintenance and
   repair of leased asset. Some leasing companies
   allow lessee to cover the maintenance and repair
   costs for an extra sum in their lease
   installment.

38
Glossary

• Lessor may be owner of an asset being leased.
• Lessee is a party to whom right to use an asset
  is being transferred.
• Bargain Purchase Option (BPO) refers to a
  provision giving the lessee the right to acquire
  leased asset at a price so favorable that
  exercise of the option appears reasonably assured
  at the inception of the lease.
• Bargain Renewal Option (BRO) refers to a
  provision that gives the lessee a right to renew
  a lease at a rental so favorable that exercise of
  the option appears reasonably assured at the
  inception of the lease.
• Contingent rentals means increase or decrease in
  lease payments after the inception of a lease
  that result from changes in factors on which
  lease payments are based.
• Economic Life (E/L) of a leased asset means the
  remaining usable life of an asset for the purpose
  to serve.
• Fair Value (FV) of a leased asset refers to
  normal selling price.
• Inception of Lease Contract refers to date of
  lease contract.
• Sublease (S/L) refers to further transfer of the
  right to use an asset from a lessee to a third
  party. It is subject to the contract between
  first and second party.
• Lease Term refers to the fixed non-cancellable
  term of a lease.

39
Glossary

1. Minimum Lease Payments (MLP) Consists of all
   amounts that a lessee is obligated to pay under
   the terms of a lease agreement. It excludes
   contingent rents, costs for services and taxes
   paid by a lessor. These shall be additional
   payments.
2. Estimated Residual Value (ERV) refers to FV of
   an asset at the end of the lease term. It has two
   parts namely Guaranteed Part and Unguaranteed
   Part. FV is calculated for two parts separately
   and then added to show ERV.
3. Guaranteed Residual Value (GRV) A lessees
   assurance to a lessor that lessor will recover at
   least guaranteed amount at the end of the lease
   term. A lessor usually writes this clause in his
   contract in order to cover risk of deterioration
   of an asset value beyond what is mentioned in a
   contract.
4. Unguaranteed Residual Value (UGRV) The portion of
   a leased assets RV at the end of a lease term
   that is not guaranteed by a lessee.
5. Initial Direct Costs (IDCs) are costs of legal
   consultancy, processing of documents, negotiating
   the contracts etc., etc.
6. Incremental Borrowing Rate (IBR) refers to a rate
   that a lessee otherwise had paid to the borrowed
   amount to acquire an asset under similar lease
   arrangement.
7. Implicit Interest Rate (IRR) refers to the
   discount rate (applied to MLPs GRV) that causes
   the aggregate PV to be equal to FV of leased
   asset to a lessee.

40
Abbreviations used
Abbreviation Description
1 BPO Bargain Purchase Option
2 BRO Bargain Renewal Option
3 b/w Between
4 GRV Guaranteed Residual Value
5 EL Economic Life
6 ERV Estimated Residual Value
7 FV Fair Value
8 IBR Incremental Borrowing Rate
9 IIR Implicit Interest Rate
10 IDCs Initial Direct Costs
11 F/Y Final Year
12 MLPs Minimum Lease Payments
13 PV Present Value
14 RV Residual Value
15 S/L Sublease
16 UGRV Unguaranteed Residual Value
17 U/E-FI Unearned Finance Income
41
Appendix A Leasing Soft-wares
Name Web address
1 SiriusPro Rental Software http//www.orion-soft.com
2 Dominion Leasing Software http//www.dominionls.com
3 LeaseWave http//www.odessatechnologies.com
4 ProLease http//www.proleasesoftware.com
5 AMTdirect http//www.amtdirect.com
6 Propertyware http//www.propertyware.com
7 LeaseEagle http//www.leaseeagle.com
8 Visual Lease http//www.visuallease.com
9 Skire Unifier http//www.skire.com
10 Ryznware Software http//www.ryzn.com
42
References
Source Entitled/Author

1 IAS 17 Leases
2 SIC-15 Operating leases incentives
3 SIC-27 Evaluating the substance of transactions involving the legal form of a lease
4 SIC-29 Service concession arrangements Disclosures
5 SIC-32 Intangible assets Website costs
6 IFRIC 4 Determining whether an arrangement contains a lease
7 IFRIC12 Service concession arrangements
8 FASB St. 13 Leases
9 Intermediate Accounting 5/e Lanny G. Chasteen, Richard E. Flaherty, Melving C. OConnor
43
Thank you!
A presentation by Ahmad Tariq Bhatti FCMA, FPA,
MA (Economics), BSc. Contact At.bhatty_at_gmail.com
Dubai, United Arab Emirates
The end.