Accounting for Leases Assignment Example | Topics and Well Written Essays - 1500 words

Accounting for Leases - Assignment Example This assignment focuses on the alternative treatments which the lessee might adopt. Two, it looks into the current accounting treatment of leases. Finally, it will look into the impact of the proposed lease standards on the users of financial statements. a) Three alternative accounting treatments which might be adopted when lessees account for lease transactions. The lessee capitalizes an asset or a liability in the balance sheet using amounts equal to the present value of the rental payments. Generally, there is four criteria’s used in capitalization of lease payments (Nikolai, Bazley and Jones 1120). They include: Transfer of ownership of lease property to the lessee The lease has a bargain and purchase option The term of lease is the major part of the assets economic life The present value of the minimum lease payments to the fair value of the leased asset. In practice, three of the four criteria are difficult to apply due to the controversies involved (Nikolai et al 1117). Criteria number one on transfer of ownership is practical and easy to apply. Our major focus on this discussion is limited to only three criteria’s. a) The bargain and purchase option This criterion gives the lessee an option to either buy the property at a price lower than the expected fair value of the property at the option date deemed exercisable (Nikolai, Bazley and Jones 1117). ... b) Economic life test criteria When an assets economic life is a major part of the lease term, all risks and rewards are transferred to the lessee from the lesser. Capitalization in this case is therefore necessary. It is difficult to determine the economic life of the asset. In practice, the International accounting and standards board (IASB) requires a 75 percent threshold on the economic life when evaluating the economic life test (Nikolai, Bazley and Jones 1117). For example, assume company X leases Lenovo PCs for a period of two years at monthly payments of $100 per computer. It can also lease these computers for $10 per month on each computer for extra two years. The lease offers a bargain renewal option. It is difficult to determine the estimated economic life especially if the item leased is specialized. c) Recovery of investments test Capitalization is essential if the present value on the minimum lease payments equals or exceeds substantially all the fair value of the asset . At this point, a company can purchase the asset since the minimum payments are close to the fair value. The US GAAP uses 90 percent threshold on fair value in assessing the recovery of investment test (Nikolai, Bazley and Jones 1117). Lessees and lesser also consider all other factors in evaluating the lease classification criteria rather than focusing on a single element. b) Current IAS 17 Leases in the financial statements of lessee In the current International accounting standard, (IAS 17), lessees are required to provide extensive financial statement disclosures on leases than even before (Epstein, Nach and Bragg 866). This is because the accounting treatment for real estate and equipment leasing transactions has changed. In the current lessee standards, all operating