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IAS 17 (Leases) -Inv split between lease & service

Wholly Expense or Partly Capitalise

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Hi,

Currently my organisation is treating leases under IAS 17 (due to move to IFRS 16 in the near future) and I have an issue with a treatement of a leased invoice for a car.  The FV (list price) of the car at inception was £29k.

The inv (£29k) is split between lease rental (total rental cost £19k over the 5 years) and service rental (total rental cost £10k over the 5 years), the lease being capatlised and the service being expensed.

Looking at the IAS 17 rules to capitalise, ownership transferred at the end of the lease; option to purchase at the end; lease for majority of economic life of asset and PV of min. lease payments amounts to substantially all of the FV of the asset (plus other rules not applicable to this situation), none of these are apply to this vehicle and specifically the PV of lease payments compared to FV of asset.  When looking at the last point as they only wanted to capitalise the leased part then the total leased payments is only 65% of the FV of the vehicle at inception.

Am I correct in thinking the whole of the invoice should be expensed?

Thanks

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By paul.benny
22nd Nov 2019 11:50

IFRS16 is mandatory for periods beginning on or after 1 January 2019. It's very likely that whatever you do will have to be restated for your stats anyway.

Under IFRS16, the amount capitalised in the NPV of future lease payments. The fair value of the underlying asset (in this case, the list price of the car) is irrelevant. The monthly rentals are split between interest and principal, just as you would with a straightforward finance lease. The standard lets you ignore costs such as maintenance on vehicle lease.

The numbers you quote don't quite make sense. You're apparently getting a day1 invoice for the entire lease cost (is this perhaps a payment schedule?). If the total payments are the same as the list price, where are the financing costs and where is the option price at the end of the lease?

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Replying to paul.benny:
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By yellowenvelope
25th Nov 2019 07:41

Thanks for your reply Paul.

We have a special exemption until the end of March 20.

The numbers I provided were for the full cost for the 5 years to help with the calculations for IAS 17. Rentals are paid annually (fifth of what I showed as the total of rental cost).

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Replying to yellowenvelope:
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By paul.benny
25th Nov 2019 08:44

IAS17 has the more familiar split into finance and operating leases, where a finance lease is one that transfers substantially all of the risks and rewards of ownership to the lessee.

In your case do you have substantially all of the risks and rewards of ownership: Five years is quite long for a vehicle lease. Is there an excess mileage charge? Can you cancel early without penalty? Is the residual value fixed (ie do you have an option to purchase for a known price?)

Three- and four-year car leases are generally accepted as being operating leases but at five years, I’m leaning towards this being a finance lease. The actual conclusion would depend on the facts.

If it’s an operating lease, you simply straight line the rentals; if it’s a finance lease, you capitalise the vehicle at fair value – the 65% you mention is largely irrelevant. You could assume a residual of 35% of the list price when determining the periodic depreciation charge.

Feel free to send a PM if you would like a more detailed discussion.

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Replying to paul.benny:
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By yellowenvelope
26th Nov 2019 09:26

Just managed to get a copy of the agreement.

Excess mileage - Yes
Cancel w/o Penalty - No
Option to Purchase - No

A little more detail (if needed?), it's a contract hire agreement and there is no interest on the payments.

Thanks again for your help Paul.

Peter

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Replying to paul.benny:
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By yellowenvelope
26th Nov 2019 09:39

Also, the service is an optional extra (i.e. routine servicing, tyres and replacement parts/repairs).

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Replying to yellowenvelope:
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By paul.benny
26th Nov 2019 11:10

The test of whether a lease is a finance lease is whether substantially all of the risks and rewards of ownership transfer to the lessee.

You have
- full use of the vehicle for five years (reward)
- all of the maintenance costs - some of which are predictable, others not (risk)
- five year commitment, regardless of whether your needs change
- contractual mileage commitment - excess charge if you exceed but no rebate for under-use

The finance company has
- risk of residual value - but some of that is passed back to you via excess mileage charges

So do you have substantially all of the risks and rewards of ownership? I think this is borderline. On balance I would probably treat it as an operating lease on the basis that the residual value is likely to be 30-40% of the cost and therefore does not satisfy the 'substantially all' test.

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Replying to paul.benny:
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By yellowenvelope
26th Nov 2019 12:12

Like you said it is borderline, so was difficult to determine.

Thanks Paul really appreciate the time and effort you've put into helping me.

Peter

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