Reference:
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IFRIC4
-
Intermediate
accounting – Kieso Weygandt and Warfield (2012)
As stated in
IFRIC 4, an entity may enter into an arrangement, comprising a transaction or a
series of related transactions that does not take legal form of a lease but
conveys a right to use an asset (for example an item of property, plant or
equipment) in return for a payment or series or payments.
To summarize
the statement, sometimes an entity may enter into transactions that contain
lease. Based on my experience, this type of transactions usually happens in
automotive or other related industries. For example, there is a Company XXX
that produces lamps for motorcycle and car-makers. This Company needs to
prepare a specific dies to produce these lamps. These dies are prepared based
on the design of each lamp therefore each type of lamp needs a specific dies.
The Company charges the cost to prepare these dies to the customers by adding
the depreciation cost into the sales price.
Usually the
Company treats these transactions as ordinary sales transactions. However,
there is lease arrangement inside this transaction.
Based on IFRIC
4, to determine whether an arrangement is or contains, a lease shall be based
on the substance of the arrangement and requires an assessment of whether:
(a) Fulfillment of the arrangement is
dependent on the use of a specific asset or assets
(b) The arrangement conveys a right to
use the asset
Analyzing the
previous condition of Company XXX, we can see that the sales transaction
contains lease arrangement because:
-
The
arrangement is dependent on the use of a specific dies.
Lamp
type 010 for Customer A needs dies specifically prepared for lamp type 010.
-
The
arrangement conveys a right to use the asset
Dies
prepared for type 010 for Customer A may not be used to produce lamps for
Customer B. Because this dies was prepared based on lamp design from Customer
A. Producing lamps for Customer B using Customer A’s dies may breach the
confidentiality arrangement between Company X and Customer A.
Then what do
we do if these sales transactions contain lease arrangement?
Assessment
should be made to determine whether the sales transactions are classified as
financial or operating lease. Based on IFRS 17 (lease), a lease is classified
as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership. A lease is classified as an operating lease if it does
not transfer substantially all the risks and rewards incidental to ownership.
FASB gives
this guidance, as explained in Kieso, Weygandt and Warfield (2012):
A lease
arrangement is classified as financial lease if one or more of these criteria
is met:
The arrangement between Company XXX and Customer A must be assessed using the above 4 criteria.
What to do
after the lease category assessment?
The results
might be:
1. The arrangement is categorized as
operating lease
The
Company treats the cost of dies usage as common rent. The cost of rent is
charged through the depreciation cost which is included into the sales price.
2. The arrangement is categorized as
finance lease
Company may not recognize the dies as the
Company’s assets, but it needs to recognize this as lease receivable instead. The
Company also needs to prepare the amortization schedule for the arrangement.
The amortization schedule is similar to the amortization schedule for loan. Please
read the reference for finance lease treatment to learn further about the
calculation.
