Frs 117 Finance Lease - Financial Solutions

ch lease financing powerpoint

FRS 117, *Leases*, outlines the accounting treatment for leases in Singapore. Specifically, it differentiates between finance leases and operating leases, with significantly different accounting implications. A finance lease, under FRS 117, is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee. The distinction between a finance lease and an operating lease is crucial. If a lease is classified as a finance lease, the lessee essentially accounts for it as if they had purchased the asset with borrowed funds. Conversely, an operating lease is treated as a rental agreement. Several indicators, either individually or in combination, point toward a finance lease. The presence of any of these strongly suggests that a finance lease exists: * **Transfer of Ownership:** The lease transfers ownership of the asset to the lessee by the end of the lease term. This is the most definitive indicator. * **Bargain Purchase Option:** The lessee has an 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, such that, at the inception of the lease, the lessee is reasonably certain to exercise the option. * **Major Part of Economic Life:** The lease term is for the major part of the economic life of the asset, even if title is not transferred. Generally, “major part” is often interpreted as 75% or more. * **Substantially All Fair Value:** At the inception of the lease, the present value of the minimum lease payments amounts to substantially all of the fair value of the leased asset. “Substantially all” is often interpreted as 90% or more. * **Specialised Asset:** The leased assets are of such a specialised nature that only the lessee can use them without major modifications. If one or more of these conditions are met, the lease is likely a finance lease. However, the substance of the transaction always takes precedence over the form. Other indicators, such as the lessee’s ability to cancel the lease and bear the associated losses, or gains or losses from fluctuations in the fair value of the residual accruing to the lessee, should also be considered. Accounting for a finance lease involves the lessee recognizing an asset and a liability in their statement of financial position. The asset is typically depreciated over its useful life or the lease term, whichever is shorter (unless there is a reasonable certainty that the lessee will obtain ownership by the end of the lease term, in which case the useful life is used). The liability represents the obligation to make lease payments. Each lease payment is split into two components: a finance charge (interest expense) and a reduction of the lease liability. The interest expense is recognised in the statement of profit or loss over the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. For the lessor, a finance lease is treated as a sale of the asset. They derecognize the leased asset from their statement of financial position and recognize a receivable equal to the net investment in the lease. This receivable represents the future lease payments and any unguaranteed residual value. The lessor recognizes finance income over the lease term based on a constant periodic rate of return on the net investment in the lease. The application of FRS 117 requires careful judgement in assessing the substance of lease agreements. Proper classification is crucial for ensuring accurate financial reporting and providing a true and fair view of a company’s financial position and performance.

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