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Leases (Treatment of finance leases (At the commencement of the lease term…
Leases
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Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are given by the standard
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The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be excised
The lease term is for the major part of the economic life of the asset even if title is not transferred
At the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset
The leased assets are of such a specialised nature that only the lessee can use them without major modifications
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An entity may not wish to purchase an asset outright or may not be able to afford to. There are advantages in not owning assets as well as avoiding the cost of financing the purchase such as protection from technical obsolescence
Entities can choose to use an asset through a leasing arrangement whereby another party legally owns the asset but allows the reporting entity to use it for a specific period of time and at an agreed cost
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Finance leases are accounted for by lesses as if they had bought the asset and borrowed money to pay for it so the balance sheet will show an asset to be depreciated, a debt for the amount 'borrowed' and interest paid over the life of the lease. This is an example of substance over form in accounting as the reporting does not merely follow the legal form of the transaction where legal ownership of the asset remains with the lessor
Operating leases are treated as simple short term renal agreements where the levee merely shows an expense for the rental charge in each period but with disclosure of longer term commitments to pay rentals