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AC312 Workshop 3

Accounting for leased assets

1. (a) Using lease agreements as an example, explain what ‘off-

balance sheet financing’ is.

(b) Why is off-balance sheeting financing an issue for financial reporting?

(c) What approach to managing off-balance sheet financing has been adopted by the IASB? Explain how this has been implemented with respect to accounting for leased assets.

What exceptions to this approach are allowed in IFRS 16 Leases?

2. Clifford negotiates a lease, to begin on 1.1.20X0, with the following terms:

Term of lease: 5 years

Estimated useful life of machine: 5 years

Age of machine on inception of lease:   0 years

Annual payments: £2,000 in advance

Fair value of the leased machine: £7,710

Administration costs in involved in

negotiating the lease                                £190

Finance charge implicit in the lease: 15%

Required:

(a) Show numerically how the lease will affect each element of Clifford’s Statement of financial position.

In so doing, show how these effects ensure that the Statement of financial position at the end of the first year of the lease will balance.

(b) The approach adopted to measure the lease liability (the effective interest method) is designed to achieve a constant rate of interest on the remaining balance of the liability.

Explain what ‘constant rate of interest’ means and why this aim to lease liability measurement is important.

Question 3:

The summarised Statement of financial position for Carreras plc as at the 31 March 20X4 is as follows:

Carreras plc entered into a non-cancellable leasing agreement which commenced on the 1 April 20X3. The lease includes a primary period requiring five annual payments of £10,000 each. These payments fall due (and are paid) on the 31 March of each year.

At the end of the primary period of the lease Carreras plc has the right to extend the lease for a further three years at a rental of £2,000 per annum. As Carreras regularly replaces such equipment after five years the company does not expect to take advantage of this option, on which basis the interest rate implicit in the lease is 5% with the present value of the minimum lease payments being £43,295.

Required:

The above lease has not yet been accounted for in Carreras’s Statement of financial position above.

Show numerically how the lease will affect Carreras’s Statement of financial position, such that it continues to balance. 

Question 4 (self-study)

The summarised Statement of Financial Position for Holmes plc as at the 31 December 20X6 is as follows:

On 1 January 20X6 Holmes entered into a non-cancellable lease agreement with Watson Ltd. Under the terms of the lease Holmes is to make 4 annual payments of £35,000 payable in advance.

At the end of the primary period Holmes has the right to continue to lease the asset for a further 2 years at a rental of £5,000 per annum.

The leased asset could have been purchased for cash at the start of the lease for £108,720.

The company normally depreciates such assets on a straight-line basis and normally replaces such assets after 4 years. On which basis the present value of the minimum lease payments are calculated as £108,720 with the rate of interest implicit in the lease being 20%.

Required:

The above lease has not yet been accounted for in Holmes’s Statement of financial position.

(i) Show numerically how the lease will affect each element of Holmes’s Statement of financial position. 

(ii) Show how these effects ensure that the Statement of financial position at the end of the first year of the lease will balance

(iii) Show numerically how the lease will affect Holmes’s Statement of financial position, such that it continues to balance.