Posted: May 25th, 2022
By using Exhibit 1 data, prepare the lessee accounting illustrations Monet requested. How well do the Chief accountant’s assumed lease characteristics line up with the company’s past lease term experience?
In accordance to IAS 17 Leases by the International Accounting Standards Board (IASB), there are two fundamental kinds of leases: finance leases and operating leases. The classification of every lease determines the accounting requirements. Under the preceding version of IAS 17, with respect to operating leases, the lessee is not required to recognize the asset being leased in the Balance Sheet. However, in August 2010, an Exposure Draft was issued by the IASB, which encompassed revising different changes to the IAS 17 (Hawkins, 2010). In general, the net result of the exposure draft was that lessees would be required to recognize a right to use asset together with a lease liability with respect to Lease Interest for all of their short-term leases and also long-term leases reported in the balance sheet. In contrast, there would be an amortization of the right to use asset against the basis of the term of the lease or the life span of the asset being leased, whichever of the two is shorter.
Taking into account that BonneSante S.A is presently engaged in operating lease agreements with their lessor, which hands them a right of use of the company’s retail outlets and also trucks (Hawkins, 2010). Bearing in mind that the amended exposure draft postulates that the parties in the lease contract have to come to an agreement of a lease term of at least 10 years. Therefore, BonneSante ought to nullify and undo its lease agreements that have terms less than 10 years and thereafter adjust them with respect to the newfangled requirements. In turn, the lessee in the contract shall report the payments made in cash against the contract lease payment as part of financing activity in the Statement of Cash Flows. However, this should be reported in a separate manner from other financing activities (Hawkins, 2010).
As a potential BonneSante investor or creditor, how would you view the liability for future lease payments BonneSante would have to record under the ED’s lessee accounting proposals? Is it like regular bank debt? If not, what is it? Would you include 100% of the recognized amount in a debt-to-equity ratio?
Prior to the August 10 issued exposure draft, BonneSante used to report its lease records with respect to the IAS 17 Leases. The implication of this is that the company recognized and reported the lease rental payments in the Income Statements as an expense against the lease contract. In essence, at this time, there was no recognition of right of use asset as a condition. Therefore, as a potential BonneSante investor or creditor at the time, it would have been incapable to classify the liability against the lease rental payments from the balance sheet. Therefore, they were experiencing issues in ascertaining the debt-to-equity ratio of BonneSante. It is not similar to the bank debt. It is more of a balance sheet expense. I would not include at 100% of the recognized amount in a debt-to-equity ratio, but I would rather recognize the debt level incurred by the firm.
What role does management judgement play in determining the lessee right-of-use asset and lease liability amounts?
The decisions and rulings made by management do play a role in ascertaining the lessee right-of-use asset together with the lease liability amounts. To begin with, management makes the decision whether the company ought to enter into leasing contracts. Subsequent to determining this, a judgment has to be made whether an operating lease or finance lease is fitting. In line with the exposure draft, management plays the role of ensuring compliance to the measurement and recognition criteria. A judgment has to be made by management with respect to recognizing right-to-use asset and recording the asset being leased in the balance sheet. In addition, management has to make the calculation of the lease rental payments, discounted by the rate charged to the lessee by the lessor. The lease rental expenses for every financial year have to be recognized in the income statement. The asset being leased has to be amortized against the life span of the asset or the lease term, depending on which is earlier. The amortization expense has to be recognized in the income statement (Pwc, 2016).
How might the ED’s proposed lessor accounting influence, if at all, the lessor’s preferences for particular lease provisions in the BonneSante leases?
The lessor accounting proposed by the exposure draft would have an impact on the preferences for certain lease provisions in the company’s leases. To begin with, at the outset of the lease agreement, the lessor shall assess whether the lease is in line with the performance obligation centered on whether the lessor maintains risks of benefits that are linked to the leased asset. Another aspect of influence encompasses evaluating whether the lessor maintains the susceptibility to risk and return, then the performance obligation method is to be applied. In this approach, the lessor must recognize the right to obtain lease liability and lease rental. More so, the lessor removes the leased asset from the balance sheet. The lessor must recognize rental income and interest income in the income statement (Ernst Young, 2013).
Compared to your understanding of the IFRS lessee accounting rules in place in August, do you believe the ED proposals represent a significant improvement? Explain
I believe the ED proposals signify a significant improvement. An example is that the lessors may be necessitated to recognize profit for more leases at the start of the lease instead of over time. However, there are key concerns. To begin with, there is the intricacy in the accounting model, which may hamper the users’ capability to evaluate the amount, timing and ambiguity of lease-associated cash flows. There is also the downside that creation of two kinds of leases may make the accounting operationally challenging to apply and needlessly intricate. There is also the aspect that the costs may exceed the benefits of the proposal (Ernst Young, 2013).
Ernst Young. (2013). How the lease accounting proposal might affect your company. Retrieved from: http://www.ey.com/Publication/vwLUAssets/How_the_lease_accounting_proposal_might_affect_your_company/%24FILE/EY-Applying-Leases-August-2013.pdf
Hawkins, D. F. (2010). “BonneSante S.A.” Harvard Business School Case 111-063.
Pwc. (2016). IFRS 16: The leases standard is changing Are you ready? Retrieved from: https://www.pwc.co.uk/assets/pdf/ifrs-16-the-leases-standard-is-changing.pdf
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