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If you lease a land on which you build a factory / house ( qualifying asset ), can you capitalize the lease cost
Well, it cannot be a finance lease, so therefore it’s an operating lease. And if it’s an operating lease, you should write off the lease rental each year.
So I don’t believe that you should capitalise the lease rentals.
What do you think?
Dear Sir,
From where can I practice more questions of Lease (ias 17) in order to gain confidence?
(I am preparing for Dec 2014 Dipifr Exam)
Past DipIFRS exams. I believe that you’ll realise that although leasing is a hot topic (with the announcement last week that the FASB in the USA and the IASB have decided they cannot agree on leasing, so convergence takes a step back) it actually is asked exceptionally infrequently in exams (P2 more often than F7)
Check out the past DipIFRS exams and see just how infrequently leasing appears
Then ask yourself “Is it worth getting worked up over this IAS?”
Thank you Sir!
Well, I have a small question on leases. Its from December 2102 paper.
There is a part in the lease question which says:
On 1 January 2012, Omega began to construct a factory and borrowed $10 million to finance the construction. The effective rate of interest on the borrowing was 8% per annum, before tax. Omega actually spent $10·6 million on the construction materials but of this amount, $800,000 was on materials that were damaged before they were used and had to be destroyed.
The factory took six months to construct and the construction team were paid at a total amount of $750,000 per month throughout the construction period. The factory was ready for use on 1 July 2012 but production did not begin until 1 September 2012.
The year ends on 30 Sept 2012.My doubt is:
1) What do we do of this 10 mn loan that has been taken at 8 %?
2) And how do we treat the cost of borrowing (i.e. i believe 8% of 10 mn for 6 mths)? Should they both be capitalised?
3) What to do for the payment to construction team ( $750000 * 6 mths)? Do we capitalise this also? Why?Regards,
SwatiSwati, your questions are not at all clear
For example “1) What do we do of this 10 mn loan that has been taken at 8 %?” What do you want to do with it? We have to repay it – does that answer what you were asking?
“2) And how do we treat the cost of borrowing (i.e. i believe 8% of 10 mn for 6 mths)? Should they both be capitalised?” Should they BOTH…. What BOTH? Yes, we should capitalise and I believe that we should capitalise at the rate of 8% for 6 months on $10m = $400,000
“3) What to do for the payment to construction team ( $750000 * 6 mths)? Do we capitalise this also? Why?” We capitalise the $750,000 per month because that’s what the new building is costing us
Does that answer you?
What did the printed solution say?
Sir,
I am sorry, I have not been able to explain my confusion.May I ask:
1) This 10 mn loan, should we show this as a ‘non-current’ liability in Balance sheet?
2) cost of borrowing: I want to know that 8% for 6 months on $10m = $400,000, should this also be added to the loan amount of 10 mn? Or should we show this separately in B/S?
3) By ‘Both’ I meant, Loan amount (10 mn) and interest ($400000) – they both have to be shown under ‘non current’ liability in B/S?The printed solution says:
2) Cost of borrowing: The finance costs associated with the construction must be capitalised up to the date the asset is ready for use. The appropriate amount is $400,000 ($10 million x 8% x 6/12).
3) Payment to construction team: The other overheads associated with the construction of the factory of $4·5 million ($750,000 x 6) will be included as part of the construction cost of the factory.
The solution doesn’t say anything about the 10 mn we have borrowed.OK
1) This 10 mn loan, should we show this as a ‘non-current’ liability in Balance sheet?
That depends upon the agreement with the lender – it could be a current liability or, more likely a non-current liability
2) cost of borrowing: I want to know that 8% for 6 months on $10m = $400,000, should this also be added to the loan amount of 10 mn? Or should we show this separately in B/S?
That depends upon the agreement with the lender. Presumably we shall be paying interest at the annual rate of 8%. Of course, it could be that we are paying at a lower rate (say 6%) but the effective rate is per question 8%
If that is the case, we shall be paying interest at 6% on the $10m. The difference of 2% is calculated on the amount outstanding ($10m in this first year) and the $200,000 will be credited to the loan account and debited to the Statement of profit or loss as an additional finance charge
3) By ‘Both’ I meant, Loan amount (10 mn) and interest ($400000) – they both have to be shown under ‘non current’ liability in B/S?
That depends upon the agreement with the lender. It could be that payments for interest are being made monthly, quarterly, (even weekly if that was agree)
If there is no agreement about payment of interest before the due date for repayment of the loan + interest then the combined total will be a liability. Whether it is a current liability or a non-current liability depends upon ……. ????
Yes, you guessed it! It depends upon the agreement with the lender
OK?
OK sir,
I understood it.Basically, if we are not aware of the agreement with the lender, we can simply write in our answer that it is a liability or we will capitalise it (with the amounts). That would be sufficient for the examiner?
Dear Sir,
A new question on lease:
On 1 April 2011, Omega began to lease a property on a 20-year lease. Omega paid a lease premium of
$3 million on 1 April 2011. The terms of the lease required Omega to make annual payments of $500,000 in arrears, the first of which was made on 31 March 2012.
On 1 April 2011 the fair values of the leasehold interests in the leased property were as follows:
– Land $3 million.
– Buildings $4·5 million.
There is no opportunity to extend the lease term beyond 31 March 2031. On 1 April 2011 the estimated useful economic life of the buildings was 20 years. The annual rate of interest implicit in finance leases can be taken to be 9·2%. The present value of 20 payments
of $1 in arrears at a discount rate of 9·2% is $9.My doubt is on the Building depreciation. On what amount we would charge depreciation on the Building? is it $4.5 mn. If yes, then how is it been calculated? Because, when I looked at the solution, it says: The initial carrying value of the leased asset in PPE is $4·5 million ($1·8 million + $300,000 X 9).
My second doubt is: Why is it an Operating lease for Land? Whats the reason?
Thanks…
The annual payment of $500,000 is the lease payment for land and buildings. The question tells you that the land has a fair value of $3m and the buildings’ fair value is $4.5m
So of that total value of $7.5m, $3 = 40% and $4.5m = 60%
Right, 60% x $3m initial premium = $1.8m and 60% of the annual lease payment of $500,000 = $300,000
The total annual amount therefore relating to the building is $.3m and the present value of $1 per year for 20 years at 9.2% = $9 (per question)
Therefore $.3m x 9 = $2.7m and the initial premium paid as a one-off amount is $1,800,000 giving a total amount in present value terms relating to the building of $4.5m and that’s the amount that is used for the basis of the depreciation calculation
“Why is it an Operating lease for Land? Whats the reason?” – are we leasing the land for substantially the whole of its estimated useful life? Well, we may be! If Kim ??? ??? of North Korea continues with his nuclear ambitions, then yes, 20 years could be substantially the whole of the land’s useful life
But in an ordinary, non-apocalyptic scenario, the land has an infinite life
Therefore a lease of land is always an operating lease (possible exception where you are leasing the right to extract minerals / sand / organics from the land)
Now, my question to you. Have you read the course notes for F7 about leasing? Or the course notes chapter for P2 about leasing?
Swati, it’s the least you could do to avoid me having to talk you through something that is already explained in the F7 and P2 course notes ….. please
Yes Sir,
I have gone through your lectures. But i think I should again go through them so have a good understanding of Leases.May I ask you if the lease question says:
Omega intended to build a factory on this land and on 1 June 2008 borrowed $8 million at an annual interest rate of 9% to partly finance its construction.
So, while calculate the carrying amount of the factory (B/S), why do we not take $ 8 mn along with other things like Costs of construction staff, Materials..
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