Understanding ASPE Section 3065, Leases

1 Understanding ASPES ection 3065, Leases2 | Understanding ASPE Section 3065, LeasesA better working world begins with better questions. Asking better questions leads to better answers. To help preparers of financial statements with Canadian accounting standards for private enterprises (ASPE) Section 3065, Leases , we ve summarized the key aspects of the Section and offer relevant practical considerations for private mid-market companies through answering four commonly asked questions for private business owners: Leases Question1 Question2 What is a lease arrangement?

2 Section (n) defines a lease as the conveyance, by the lessor to a lessee, of the right to use a tangible asset, usually for a specified period of time in return for rent. Licensing agreements for intangible assets such as patents and copyrights are specifically excluded from the scope of Section 3065. However, the accounting for these agreements is often, but not always, analogous to Leases . Section 3065 classifies Leases into the four classifications as defined below: Capital lease : a lease that, from the point of view of the lessee, transfers substantially all the benefits and risks incident to ownership of property to the lessee Operating lease : a lease in which the lessor does not transfer substantially all the benefits and risks incident to ownership of property Sales-type lease .

3 A lease that, from the point of view of the lessor, transfers substantially all the benefits and risks incident to ownership of property to the lessee and, at the inception of the lease , the fair value of the leased property is greater or less than its carrying amount, thus giving rise to a profit or loss to the lessor (usually a manufacturer or dealer) Direct financing lease : a lease that, from the point of view of the lessor, transfers substantially all the benefits and risks incident to ownership of property to the lessee and, at the inception of the lease , the fair value of leased property is the same as its carrying amount to the lessor (usually not a manufacturer or dealer) What does transfer substantially all the benefits and risks incident to ownership mean?

4 Per Section , the following are conditions that may indicate a transfer of all of the benefits and risks of ownership to the lessee: There is reasonable assurance that the lessee will obtain ownership of the leased property by the end of the lease term, generally evidenced by a bargain purchase option The lease term exceeds 75% of the economic life of the leased property The present value of the minimum lease payments exceeds 90% of the fair value of the leased property. The amounts that comprise the minimum lease payments differ from the perspective of the lessor and the lessee and are described in paragraphs (r)(i) and (r)(ii)If any of these conditions are met, the lease is not classified as an operating Section , from the point of view of a lessor, in addition to any one of the items above, a lease normally transfers substantially all of the benefits and risks of ownership to the lessee when, at the inception of the lease , both of the following conditions are present.

5 The credit risk associated with the lease is normal when compared to the risk of collection of similar receivables The amounts of any unreimbursable costs that are likely to be incurred by the lessor under the lease can be reasonably estimated Understanding ASPE Section 3065, Leases | 3 Question4 Question3 What are the steps in accounting for a capital lease from the perspective of the lessee or a sales-type or direct financing lease from the perspective of the lessor?Lessee: capital lease The asset value and the amount of the obligation, recorded at the beginning of the lease term, are equal to the present value of the minimum lease payments discounted using the lower of the lessee s incremental borrowing rate and the interest rate implicit in the lease .

6 The asset value and the amount of the obligation are limited to the fair value of the leased asset ( Section ). The leased asset is amortized over the period of expected use. If the lease contains terms that allow ownership to pass to the lessee or a bargain purchase option, the period of amortization shall be the economic life of the asset. Otherwise, the property shall be amortized over the lease term ( Section 3065). An obligation under a capital lease is similar to a loan. lease payments shall be allocated to a reduction of the obligation, interest expense and any related executory costs ( Section ).

7 Lessor: direct financing lease The leased asset is removed from the lessor s balance sheet, and the lessor s net investment in the lease calculated as the minimum lease payments receivable less any executory costs and related profit included therein plus any unguaranteed residual value of the leased property accruing to the lessor less unearned finance income remaining to be allocated to income over the lease term is recognized as an asset. A direct financing lease gives rise to income in the form of finance income, which is composed of the difference between the following: T he total minimum lease payments, net of any executory costs and related profit therein, plus any guaranteed residual value of the lease property accruing to the lessor The cost or carrying amount, if different, of the leased propertyLessor.

8 Sales type lease The leased asset is also removed from the lessor s balance sheet, and the lessor s net investment in the lease , calculated as described above, is recognized as an asset. A sales-type lease gives rise to two types of income: the initial profit on the sale of the product at the inception of the lease and finance income over the lease term. The sales revenue recorded at the inception of a sales-type lease is the present value of the minimum lease payments net of any executory costs and related profit included therein, computed at the interest rate implicit in the lease .

9 The cost of sale recognized at the inception of the lease is the cost or carrying value, if different, of the leased property reduced by the present value of the unguaranteed residual accruing to the lessor, computed at the interest rate implicit in the lease . Finance income arising from a sales-type lease is composed of the difference between the following: T otal minimum lease payments, net of any executory costs and related profit included therein, plus any guaranteed residual value of the leased property accruing to the lessor The aggregate of their fair present valuesHow are operating Leases accounted for?

10 Operating lease payments are recognized as an expense on a straight-line basis over the term of the lease or another basis representative of the time pattern in which the user derives benefit from the leased asset. Depending on the terms of the lease arrangement ( , when the lease contains rent escalation), this may result in rent expense that differs from the amount of cash paid. lease arrangements may include incentives for a lessee to sign the lease , such as an initial up-front cash payment to the lessee, an initial rent-free period, the reimbursement of costs of the lessee such as moving costs or leasehold improvements, or the assumption by the lessor of the lessee s pre-existing lease .