15 Able

 

(a) The development of conceptual frameworks for financial reporting by accounting standard setters could fundamentally change the way in which financial contracts such as leases are accounted for. These frameworks identify the basic elements of financial statements as assets, liabilities, equity, income and expenses and set down their recognition rules. In analysing the definitions of assets and liabilities one could conclude that most leases, including non-cancellable operating leases, qualify for recognition as assets and liabilities because the lessee is likely to enjoy the future economic benefits embodied in the leased asset and will have an unavoidable obligation that will result in an outflow of resources embodying economic benefits to the lessor. Because of the problems of accounting for leases, there have been calls for the capitalisation of all non-cancellable operating leases so that the only problem would be the definition of the term 'non-cancellable.'

 

Required

 

(i) Explain how leases are accounted for in the books of the lessee under IAS 17 Leases.

(ii) Discuss the current problems relating to the recognition and classification of leases in corporate financial statements. (Candidates should give examples where necessary. )

 

(b) (i) During the financial year to 31 May 20X8, Able a public limited liability company disposed of electrical distribution systems from its electrical power plants to Cain a public limited liability company for a consideration of $198m. At the same time Able entered into a long- term distribution agreement with Cain whereby the assets were leased back under a 10-year operating lease. The fair value of the assets sold was $98m and the carrying value based on depreciated historic cost of the assets was $33m. The lease rentals were $24m per annum which represented twice the normal payment for leasing this type of asset.

 

(ii) Additionally on 1 June 20X7, Able sold plant with a book value of $100m to Esau a public limited liability company when there was a balance on the revaluation reserve of $30m which related to the plant. The fair value and selling price of the plant at that date was

$152m. The plant was immediately leased back over a lease term of four years which is the asset's remaining useful life. The residual value at the end of the lease period is estimated to be a negligible amount. Able can purchase the plant at the end of the lease for a nominal sum of $1. The lease is non-cancellable and requires equal rental payments of $43.5m at the commencement of each financial year. Able has to pay all of the costs of maintaining and insuring the plant.

The implicit interest rate in the lease is 10% per annum. The plant is depreciated on a straight-line basis. (The present value of an ordinary annuity of $1 per period for three years at 10% interest is $2.49.)

 

Required

 

Show and explain how the above transactions should be dealt with in the financial statements of Able for the year ending 31 May 20X8 in accordance with IAS 17 Leasesand the Conceptual Framework.