IFRS: lease classification
Airway leasing entered into an agreement to lease aircraft to Ouachita airlines. Consider each of the following a-e to be independent scenarios.
A: The agreement calls for ownership of the aircraft to be transferred to Ouachita Airlines at the end of the lease term.
B: the fair value of the aircraft is expected to be 500,000 at the end of the lease term. Ouachita has the option to purchase the aircraft at the end of the lease term for 90,000
C: the aircraft has a useful life of 20 years, and the term of the lease is 14 years
D: the present value of the lease payments is 8,900,000 and the fair value of the leased aircraft is 10,000,000
E: the aircraft was manufactured to meet specifications provided by Ouachita to optimize the exclusively regional nature of its flights.
1.In each scenario, indicate whether Ouachita would classify the lease as an operating lease or capital lease under US GAAP. Assume the lease agreement has not met any of the other criteria of a capital lease. Provide brief explanations
2: In each scenario, indicate whether Ouachita would classify the lease as an operating lease or finance lease under IAS 17 assume the lease agreement has not met any of the other indicators of a finance lease. Provide brief explanations.
1. Section 7 of Statements of Financial Accounting Standards No. 13, "Accounting for Leases," states that "If at its inception ... a lease meets one or more of the following four criteria, the lease shall be classified as a capital lease by the lessee. Otherwise, it shall be classified as an operating lease. ...
a. The lease transfers ownership of the property to the lessee by the end of the lease term.
b. The lease contains a bargain purchase option. (Section 5d defines a "bargain purchase option" as "A provision allowing the lessee, at his option, to purchase the leased property for a price which is sufficiently lower than the expected fair value of the property at the date the option becomes exercisable that exercise of the option appears, at the inception of the lease, to be reasonably assured.")
c. The lease term ... is equal to 75 percent or more of the estimated economic life of the leased property ... . However, if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property, including earlier years of use, this criterion shall not be used for purposes of classifying the lease.
d. The present value at the beginning of the lease term of the minimum lease payments ... excluding that portion of the payments representing executory costs such as insurance, maintenance, and taxes to be paid by the lessor, including any profit thereon, equals or exceeds 90 percent of the excess of the fair value of the ...
This solution cites the specific FASB and IFRS statements which discuss lease classification, details their findings, and applies those findings to a fact set.