Leases and licences

Anne Harrison

Five sets of cases

• Fixed assets other than land

• Prepayments

• Land, both natural and converted

• Other natural resources

• Other types of contract

Fixed assets

• Contracts concerning fixed assets whose real prices decline over their service lives are operating or financial leases. They are not assets in their own right

Operating lease

• Where the lessor undertakes an economic activity associated with the maintenance and repair of the asset being leased and is responsible for these; the asset appears in the balance sheet of the lessor

Financial lease

• The asset plays no technical part in the production of the lessor; the lessee is responsible for maintenance and repair. The asset appears in the balance sheet of the lessee.

Timing

• Operation leases tend to be shorter than financial; financial tend to cover most or all of the asset’s life; these facts are indicative and not determining

Canberra recommendations

• Agreed operating and financial leases determined by economic ownership using criteria of risk and reward

Financial lease

• Do we estimate the breakdown between repayment and interest in a manner similar to determining depreciation and net operating surplus/return to capital in the case of a fixed asset?

Financial lease (2)

• Is there a financial service associated with a financial lease

• Is it a specific fee only

• If indirectly measured, how is this established

Canberra recommendations

• Financial service may be provided by lessor

• If lessor is a financial institution, this is reflected in FISIM

Partitioning assets

• Group agrees it is possible in theory; reluctant to do so often

• SAS (para 14.27 and 14.34- from BPM)

• IASB still considering

• PPP

• Residual value on financial lease

Market price exceeds lease payment

• Lessee has an asset if he can legally and practically transfer/trade the lease

• New asset is “contract premium ” or “premium on leased assets”

• No non-financial liability; show as +ve for lessee; -ve for lessor (impairment)

• Applies only to operating leases

Canberra recommendation

• If lease is transferable, value of asset is unencumbered value (180) plus lessee has asset of 40 and lessor of -40

• If lease is not transferable, value of asset is encumbered value (140)

Prepayments

• No single rule - depends on contract terms

• Single up front payment - originals and copies; financial asset

• Single up front payment on operating lease - trade credit

Prepayments (2)

• Large initial payment followed by smaller ones - may be acquisition (copy or equipment) followed by service agreement

• May be trade credit for operating lease (deposit)-eg caution on property lease

Prepayments (3)

• One unit may contribute asset to collective project in lieu of finance

• Suggest SNA treatment would be impute financial transaction and purchase of equipment (parallel with wages in kind)

Canberra recommendations

• Agree but make clear that upfront payments can be prepayment for a service of payment for acquisition of an asset depending on nature of the lease

Land

• Propose natural and converted

• Does land converted long ago revert to natural because depreciation complete

• Or does it remain converted because depreciation is negligible

Converted land

• Treat as other fixed assets

• Can have operational lease

• Is a long term lease where lessee has all rights of land protection a financial lease?

• Is property income shown as interest or rent (on converted land)?

Residual values in general

• What happens to residual value of land under a financial lease? Capital transfer or financial claim (PPP)

• Does solution for land work for other financial leases with residual values for lessor?

Canberra recommendations

• Treat land improvements/improved land as any other asset

• If financial lease is for less than whole life, treat as PPPs

Natural land

• As converted land but…

• Lessee may change to converted land

• Does increase in value show in lessee’s books or lessor’s

• Does eventual transfer to lessor still work in this case

Canberra recommendations

• Not resolved. E –consultation to be organised by AH and Peter Harper

Other natural resources

• Radio spectra, waterways for fish farming do not change resource

• Mineral exploration (maybe forestry) destroys asset

What sort of lease?

• Owner retains wealth in his book but this diminishes

• Extractor determines rate of run down

• Profit sharing arrangements ( not just owner extractor but maybe several extractors)

Possibility 1

• Deposit in books of owner - incomplete link between operating surplus of extractor and capital on his books

Possibility 2

• Deposit in books of extractor - no wealth shown for owner

Possibility 3

• Financial lease

• Length and terms not known at outset

• Size of principle changes each year

• Splitting repayments and interest problematical in this situation

• Financial accounts changed by large amounts in non-financial units

Solution

• Not which is correct, which is least bad

• No resolution- e-consultation

Permits

• Those issued by govt are taxes

• What about those not issued by govt?

• Does Group confirm record on an accrual basis?

• What about reselling prepaid taxes?

Canberra recommendation

• Non-government permits service or rent depending on underlying asset

• Government permit with a fee- change in value gives rise to non-produced, non-financial asset for owner of permit

• For free permit – non-produced non-financial asset created at inception; thereafter value changes with market conditions

Provision of goods in future

• Examples

• Aircraft options

• Full order books

Only assets when

• the market price of the good at the promised time of delivery differs from the contract price,

• a deposit is made by the purchaser against future delivery,

• a producer can claim with an acceptable level of probability that a given level of sales in the future is assured.

Canberra recommendations

• Options are financial derivatives treat as others

• Prepayments – treat as others

• Otherwise contracts to but goods are not assets

Provision of services in future

• Examples

• Time share

• Footballers

Even with repeated deliveries, only assets when

• the market price of the service at the promised time of delivery differs from the contract price,

• a deposit is made by the purchaser against future delivery,

• a producer can claim with an acceptable level of probability that the potential future earnings of an employee under contract is in excess of the contract payments.

Canberra recommendations

• Can have non-produced non-financial assets in some case eg tradeable contracts on footballers

Guidelines 1

• Leases licences and contracts may relate to

– The use of fixed assets

– The use of natural assets

– Permissions to engage in specified actions or activities

– The provision of goods and services in future under agreed conditions

Guidelines 2

• Leases licences and contracts between the owner of a fixed or natural asset (licensor or lessor) and a potential user (licensee or lessee) may be in the form of an operational lease or a financial lease.

• The interpretation of the nature of the lease may be affected by timing questions (prepayments).

Guidelines 3

• The recording of ownership of assets under financial leases and possibly other contract conditions (PPPs and extraction of natural resources) must allow for the eventual resumption of the residual value of the asset by the legal owner.

• Still need to determine how

Guidelines 4

• Financial leases and contracts for the future provision of goods and services may be subject to a further contract between the lessee and a third party. These contracts may have a market value when they are legally and practically tradeable and represent assets distinct from the subject of the primary contract.

Guidelines 5

• When issued by government, permissions to engage in specific activities are to be recorded as a tax.

• When not issued by government, they are fees for service or rent

• Permission to use natural resources or another asset is itself an asset

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