University : Torrens University Australia UniLearnO is not sponsored or endorsed by this college or university.
Subject Code : ACCT6003
Country : Australia
Assignment Task :

Question 1
Managers will not be indifferent between the alternative treatments of leases. Capitalisation treatment will result in an increased debt ratio (implying higher financial risk, an increase in the rates of interest on debt, and a reduced credit rating) and lower return on total assets (implying inferior operating performance and possibly reduced management incentives such as bonuses). Thus, managers have strong incentives to favour the expense treatment and to ensure that leases remain off balance sheet.

Question 2
Fast Freddie Finance has submitted a proposal to Redeye that is based on the requirements of the previous leasing standard to determine whether the lease is a finance lease. That is, paragraph 10 of AASB 117 identifies five examples of situations that would normally indicate the existence of a finance lease.

Two of these are:
• Lease term is for a major part of the economic life of the asset: is 74% a ‘major part’?
• At the inception of the lease the present value of the minimum lease payments amounts to at least substantially all the fair value of the leased asset, is 89% ‘at least substantially all’?

These were issues of judgement under AASB 117.
However, under the provisions of the new leasing standard, AASB 16, irrespective of these provisions, Redeye (lessee) would be required to capitalise the lease (see para. 22) unless availing of the exemption for a short-term leases or lease for which the underlying asset is of low value.

Question 3
AASB 16 does not directly define manufacturer or dealer leases. Para 72 of AASB 16 says manufacturers or dealers often offer their customers the choice of either buying or leasing an asset.
A finance lease of an asset by a manufacturer or dealer lessor gives rise to two types of income: first, profit or loss on the sale of the asset; and second, finance income over the lease term. In a direct finance lease, there is no profit on the sale of the asset and only finance income exists. Thus, the additional issue for manufacturer or dealer lessors is how to account for the profit on the sale of the asset. Paragraph 71 of AASB 16 requires that the selling profit or loss is to be recognised by the dealer in accordance with their policy for recognising profit on outright sales to which AASB 15 applies. A particular difficulty is that the dealer may offer lower than market interest rates on the finance lease to induce the customer to buy. Discounting the lease receipts at a lower interest rate will result in a higher amount being recognised for the lease receivable and potentially inflating the apparent profit. Paragraph 73 of AASB 16 requires that market rates of interest be used in discounting the lease receivables in a dealer lease.

 

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