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IAS 17 Leases
Indicators of finance lease
1. The lease term is for the major part of the asset’s useful life
2. The present value of minimum lease payments is greater than or substantially equal to the asset’s fair valuePLEASE CAN YOU EXPLAIN ME THE TWO INDICATORS IN SIMPLER WORDS, I AM NOT UNDERSTANDING THEM???????? Please reply
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1. For example if the asset has a useful life of 10 years, and the lease term is for 8 years, it is a finance lease because 8 years is a major part of the assets useful life.
2. For example, you need a machine for 5 years. You have 2 options to acquire the machine:
a. buy the machine for $10000 – this is the fair value
b. lease the machine for 5 years by paying lease payments of $2500 each year @12.6% interest rate.If you lease the asset, you have to see that the payments continue for quite a bit into the future. If that is the case, you have to discount the payments to take into account the time value of money and ultimately arrive at present value. If you calculate the present value from the values stated above, it is $9998. This is substantially equal to $10000, which is the fair value of the asset. Thus, it is a finance lease. (source of example and explanation: Student Guide to IFRS, Clare Finch)
Hope this helps,
Sadaf
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