Technical Analysis of Leases Under IFRS for SMEs: Perspectives for Lessees and Lessors
Leases are a common form of financing and operational arrangement that businesses utilise to access assets. The International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs) provides simplified requirements for the recognition, measurement, and disclosure of leases, ensuring accessibility for smaller entities while maintaining comparability and transparency. This article examines lease accounting from both lessee and lessor perspectives under Section 20 of IFRS for SMEs.
Definitions and Key Concepts
Lease: A contract conveying the right to use an asset for a period in exchange for consideration.
Finance Lease: A lease that transfers substantially all the risks and rewards incidental to ownership of an asset.
Operating Lease: A lease that does not transfer substantially all the risks and rewards incidental to ownership.
2. Lessee Accounting
a) Finance Leases
Under a finance lease, the lessee effectively obtains control of the leased asset. The accounting treatment includes:
Initial Recognition:
Recognise the leased asset and a corresponding lease liability at the lower of the fair value of the leased asset and the present value of minimum lease payments.
Include initial direct costs incurred by the lessee.
Subsequent Measurement:
Asset: Depreciate over its useful life, or the lease term if shorter, unless ownership transfers at the end of the lease.
Liability: Measure using the effective interest method, splitting payments into principal and interest components.
Example:
ABC Manufacturing, a South African SME, enters into a finance lease agreement to lease production equipment a five year lease agreement with Opec LTD.. The fair value of the equipment is R 1,000,000, and the present value of minimum lease payments is R 900,000. ABC recognises the equipment and a lease liability of R 900,000 on its balance sheet. Depreciation is calculated over the 5-year lease term as ownership does not transfer.
b) Operating Leases
For operating leases, lease payments are recognised as an expense on a straight-line basis unless another systematic basis is more representative of the lease’s benefits.
Example:
XYZ Retail, an SME, leases retail space in a shopping mall. The lease term is 3 years, with annual payments of R 300,000. XYZ recognises R 25,000 per month as a rental expense in its income statement.
3. Lessor Accounting
a) Finance Leases
When a lease is classified as a finance lease, the lessor effectively transfers the risks and rewards of ownership. The accounting treatment includes:
Initial Recognition:
Derecognise the leased asset.
Recognise a receivable at an amount equal to the net investment in the lease.
Subsequent Measurement:
Measure the receivable using the effective interest method.
Recognise finance income over the lease term based on a pattern reflecting a constant periodic rate of return.
Example:
An equipment rental company leases machinery to a customer under a finance lease. The net investment in the lease is R 500,000, and finance income is recognised at an implicit rate of 10% annually.
b) Operating Leases
For operating leases, the lessor retains the asset on its balance sheet. Accounting includes:
Recognition of Lease Income:
Recognise lease payments as income on a straight-line basis unless another systematic basis better represents the lease’s pattern of benefits.
Depreciation of Asset:
Depreciate the leased asset over its useful life using consistent depreciation policies.
Example:
Sazi Ltd a property company leases office space to an SME for 2 years. The company recognises lease income of R 20,000 per month and depreciates the property over its 50-year useful life.
4. Key Judgments and Estimates
Both lessees and lessors must make judgments regarding:
Classification: Determining whether a lease is a finance or operating lease requires careful analysis of risk and reward transfer.
Discount Rates: Selecting an appropriate discount rate to calculate the present value of lease payments is critical.
Residual Values: Estimating residual values impacts the measurement of assets and liabilities.
5. Disclosure Requirements
a) Lessee Disclosures
Total future minimum lease payments under non-cancellable finance leases, split into:
Not later than one year.
Later than one year but not later than five years.
Later than five years.
A general description of the lessee’s significant leasing arrangements.
Example Disclosure Note for Lessee:
Note 10: Finance Leases The company has entered into a finance lease for production equipment:
Total future minimum lease payments:
Not later than one year: R 220,000
Later than one year but not later than five years: R 660,000
Later than five years: R 0
The lease liability is measured using a discount rate of 8%.
b) Lessor Disclosures
For finance leases:
A reconciliation between the gross investment in the lease and the present value of minimum lease payments receivable.
Unearned finance income.
Unguaranteed residual values.
For operating leases:
Total future minimum lease payments receivable under non-cancellable operating leases.
Example Disclosure Note for Lessor:
Note 12: Operating Leases The company leases office space to tenants under non-cancellable operating leases:
Total future minimum lease payments receivable:
Not later than one year: R 240,000
Later than one year but not later than five years: R 960,000
Later than five years: R 400,000
6. Practical Considerations for SMEs
a) Simplification Benefits:
IFRS for SMEs eliminates complex rules on lease reclassification and embedded derivatives, providing a more practical framework for smaller entities.
b) Transition Challenges:
Entities transitioning to IFRS for SMEs must assess existing leases and update classifications and measurements as per the standard’s guidance.
c) Technology Utilisation:
Leveraging accounting software to manage lease schedules, calculations, and disclosures simplifies compliance with IFRS for SMEs.
7. Conclusion
Lease accounting under IFRS for SMEs balances simplicity with the need for robust financial reporting. Lessees and lessors must thoroughly understand classification criteria, measurement principles, and disclosure requirements to ensure accurate and transparent financial reporting. By adhering to these standards, SMEs can achieve compliance while maintaining the flexibility to focus on their core business objectives.
To learn more on this topic do not miss out on the webinar - Accounting for Leases in Compliance with IFRS for SMEs
Date: 15 January, 2025
Time: Available from 08:00
Hours: 90 minutes
CPD Units: 2
Category: Accounting
Group: Channel 2: Growth
Format: Webinar
🎓 Boost Your Expertise in understanding leases in terms of IFRS for SMEs 📈
📢 Join us on 15 January for an insightful 90 minutes webinar designed to help accountants confidently navigate the principles and requirements of IFRS for SMEs
🔑 What you’ll learn:
✅ Understand the fundamental principles of lease accounting as per IFRS for SMEs.
✅ Learn to distinguish between operating and finance leases and apply the correct accounting treatment.
✅ Gain insights into recognizing and measuring lease liabilities and right-of-use assets.
✅ Analyse the impact of lease accounting on financial statements, including balance sheets and income statements.
✅ Explore practical examples and case studies to address common challenges in lease accounting.
✅ Stay updated on recent amendments or changes in IFRS for SMEs related to leases.
🌟 Why attend?
Stand out by mastering these essential competencies and earn 2 CPD units in accounting.
👩🏫 Your Presenter:
Faith Ngwenya, a seasoned accounting professional and leader in academia and industry standards, brings her wealth of experience to guide you through this critical topic.
💻 Format: Webinar
📅 Date: 15 January 2025
⏰ Time: Duration: 90 minutes
📚 CPD Units: 2
🔗 Don’t miss this opportunity! Register today and elevate your accounting skills.
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