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L 2 - Lease Classification

The document outlines the classification of leases into finance and operating leases, detailing key indicators for each type. A finance lease transfers substantially all risks and rewards of ownership to the lessee, while an operating lease does not. The document also discusses the classification of a specific lease for Bantex Ltd, concluding that it should be classified as a finance lease based on ownership transfer, lease term relative to asset life, and risk and reward considerations.

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Joeden Kamati
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6 views3 pages

L 2 - Lease Classification

The document outlines the classification of leases into finance and operating leases, detailing key indicators for each type. A finance lease transfers substantially all risks and rewards of ownership to the lessee, while an operating lease does not. The document also discusses the classification of a specific lease for Bantex Ltd, concluding that it should be classified as a finance lease based on ownership transfer, lease term relative to asset life, and risk and reward considerations.

Uploaded by

Joeden Kamati
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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L2 Lease Classification

A lessor is required to classify each of its leases as either


an operating lease or finance lease.
• Finance leases and
• Operating leases.

A Finance lease is a lease that transfer substantially all


the risks and rewards of ownership of an underlying asset
to the lessee.
Key Indicators of a Finance Lease:
 The lease transfers ownership of the asset to the lessee at the end of the
lease term.
 The lessee has a purchase option to buy the asset at a price that is
expected to be significantly lower than its fair value.
 The lease term is for the major part of the economic life of the asset
(e.g., typically ≥ 75% of the asset’s useful life).

(Useful life = 5 years )

(lease term = 4 or 5 )

 The present value (PV) of lease payments is substantially all of the fair
value of the asset (e.g., ≥ 90% of the asset’s fair value).

 The asset is of a specialized nature such that only the lessee can use it
without major modifications.
An operating lease - is one that does not transfer
substantially all the risks and rewards of ownership of an
underlying asset.
Key indicators of an Operating Lease:

 The lease does not transfer ownership of the asset to the lessee.
 The lessee does not have a bargain purchase option.
 The lease term is not a major part of the asset’s useful life.

Useful life is 10 years

Lease term = 5 years

 The PV of lease payments does not constitute substantially all of the


asset’s fair value.
 The asset is not specialized and can be used by others after the lease ends.
QUESTION 1
Part A
(b) Discuss in terms of IFRS 16: whether the contract should be classified
as a finance lease or operating lease.
A lessor is required to classify each of its leases as either an operating lease
or finance lease.
 An operating lease is one that does not transfer substantially all the risks
and rewards of ownership of an underlying asset.

 A finance lease is one that does transfer substantially all the risks and
rewards of ownership of an underlying asset.
Key Considerations for Classification
1.Transfer of Ownership at the End of the Lease
The contract explicitly states that Bantex Ltd will obtain ownership of the
plant at the end of the contract. Which indicates that these is a finance lease
as the ownership is transferred at the end of lease
2. Useful Life of the Asset and Lease Term
The lease term is 60 months (5 years), and the estimated useful life of the
plant is 6 years
Which indicates / cover substantial a portion of 83%. Which indicates the
lease term covers a major part of the economic life and that is classified as
finance lease
3. Substantially All Risks and Rewards
Bantex Ltd is effectively utilizing the plant for almost its entire useful life
and will own it at the end of the lease term and that’s classified as a finance
lease
4. Present Value and Fair Value
-
In conclusion based on the above key indicators Bantex will therefore
classify the lease as a Finance lease

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