23 March 2012

Leases - operating or finance?

In order to be awarded CPD units you must answer the following five random questions correctly. If you fail the test, please re-read the article before attempting the questions again.

  1. Joanne, the lessor, has granted a lease of land to Margaret for a term of 100 years. The rental payment was $1 million per annum with a contingent rent of 1% of Margaret's revenue. Margaret also paid Joanne a premium of $4 million at the commencement of the lease. Which of the above payments should be included in the calculation of the minimum lease payments?

  2. An entity leased an office over a period of 25 years. The finance lease contains a clean break clause providing the entity with an option of terminating the agreement after 11 years without any further payment. The lease contains an early termination clause after 5 years that would require the lessee to make a termination payment to recover the lessor’s remaining investment. What is the lease term for the purpose of calculating the minimum lease payments?

  3. An entity leased an office over a period of 25 years. The finance lease contains a clause providing the entity with an option of continuing the agreement after this period at a market rent. The optional period is for 6 years. The lease contains an early termination clause after 10 years that requires the lessee to make a termination payment to recover the lessor's remaining investment. What is the lease term for the purposes of IAS 17?

  4. An entity leased an office over a period of 25 years. The finance lease contains a clause providing the entity with an option of continuing the agreement after this period at a nominal rent. The optional period is for 6 years. The lease contains an early termination clause after 10 years that requires the lessee to make a termination payment to recover the lessor's remaining investment. What is the lease term for the purposes of IAS 17?

  5. Joan, the lessor, had granted a lease of a building to Margo for an original term of 10 years. The estimated useful life of the building was 30 years. The original lease was determined to be an operating lease. The lease is now being renegotiated and the new lease term is 25 years which is equal to the expected remaining life of the building.

  6. If an asset is specialised, then this implies that no other entity has a use for the asset. Consequently an entity will only achieve its return on investment through the lease payments and it will structure the lease accordingly. What will normally be the accounting treatment of specialised assets?

  7. An asset is leased by an entity and the rent is a nominal rent. The total value of the rents will fall short of the fair value of the asset but the rent is low because a premium has been paid up-front which is equivalent to substantially all of the fair value of the asset. What evidence do these indicators provide?

  8. Issues sometimes arise in lease contracts where an asset is held on a finance lease and then it is all or partially sub-let to another party on identical terms and conditions. What is the issue that could arise in these circumstances?

  9. An entity has entered into 2 lease agreements. Agreement A requires the lessee to make good to the lessor any shortfall between the sale proceeds and a fixed 'residual' amount and agreement B requires the sale proceeds to be passed to the lessor. In the case of agreement B the proceeds will be significant. What evidence do the above clauses give to help the accounting for agreements A and B?

  10. Which of the following situations would not normally lead to a lease being classified as a finance lease?

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