Lessee Ltd leased equipment from Lessor Inc. Lessee Ltd. applied IFRS. The accounting treatment for this lease requires an analysis of several factors. We have received analysis from two accountants. Each analysis is incorrect. Our objective is to determine the proper accounting treatment for the lease.
1. Was the junior accountant’s analysis correct? Why or why not?
The junior accountant has opinioned that the lease is an operating lease. He has reasoned that it is an operating lease because the equipment reverts to Lessor, Inc. at the conclusion of the lease term. This assertion would be correct if it were the only factor.
However, International Accounting Standard (IAS) 17 (2010) ...view middle of the document...
However, he has chosen the wrong interest rate. The lessee has an 11% incremental rate. The lessor has an implicit rate of 10%. He has concluded that the higher interest rate must be used. Under IAS 17 the implicit rate is always used. “The present value of the minimum lease payments should be calculated using the interest rate implicit in the lease. If this cannot be determined, the lessee’s incremental borrowing rate shall be used. “
The senior accountant calculated the present value of the minimum lease payments. He calculated the number to be $244,370. He determined the number by using the 11% incremental rate. He should have used the implicit rate of 10%. Using the implicit rate, the present value is $248,690.
The senior accountant calculated interest on a straight line basis. He assumed this was required. There is nothing in the lease to indicate this is true.
How would the answer differ under U.S. GAAP?
The answer has been calculated using a 10% (The lessor’s implicit rate) interest rate. The yearly payment due is $100,000. $2,000 is due each year for other expenses. Lessee Ltd. has guaranteed 20,000 as a residual value at the end of the lease term.
The allocation between the interest and the reduction in...