Leases:
Leases is defined as the contractual agreement between two parties’ lessor and lessee. Under this agreement,the owner of the assets (lessor) awards the rights to the lessee to use its assets for acontracted period and under agreed conditions in return for agreed rental or lease payment.
Background of Lease
Under the old lease standard requirements, thelessee has to record the lease either as the finance lease or the operating lease. A finance lease is defined as the lease under which all risk and reward are transfer to the lessee at the maturity of the contract therefore under this contract lessee has to recognize assets and liabilities in its balance sheet while the lessor has to recognize receivables in its balance sheet. However, the risk and rewards of the assets,under anoperatinglease,remains with the lessor therefore, lessor recognizes it as assets while the lessee recognizes an expense in its income statement.(IasPlus, n.d.)
A situation which indicates that the risk and rewards of the assets have been shifted towards the lessee are as follows:
• Under the lease agreement, the assets will be shifted to the lessee at the end of the agreement.
• At the time of the agreement,the lessee has the option that at the end of the contract it may buy the asset at the price lower than the market value of the assets and it is expected that the lessee will use this option.
• The agreed period under the contract covers the substantial portion of the assets economic life.
• The present value of minimum lease payment represents the generous portion of the fair value of the assets.
• The leased assets are such of thetype that without any major modification only lessee can use it.
If any of the above conditionshave been met then the lease should be treated as the finance lease.
Leases Harvard Case Solution & Analysis
Accounting Issues of Lease
Under the old standard, the lessee has to account the lease either as the finance lease or as the operating lease. And in theoperatinglease, the lessee did not recognize an asset or liability on its balance sheet instead of this it just recognizes lease payment as the expense in its income statement. However, there are some operating leases which give both assets and liabilities to the lessee such as non-cancellable leases. But due to the requirements of the standard, the lessee only recognize expenses in its income statement for such operating leases hence its hides the liabilities from the readers.Moreover, under the old standard, the lessee account service contracts and operating lease contract using the same principle such as expense in profit and loss statement and therefore lessee did not separate services from a lease.(M., 2016)
So we can conclude that the main accounting issues in old lease standard are that it eliminates some off-balance sheet item. In short,we can conclude that the old standard does not give a true picture of the transaction (operating lease).................
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