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As per IAS 17, a lease is classified as finance lease or operating based on following criteria;
The lease transfer ownership of the asset of the lease by the end of the lease term.
The lease has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date of the option become exercisable.
At the inception of the lease it is a reasonable certain that the option will be exercised.
The lease term is for the major part of economic life of the asset even if title is not transferred.
In case above criteria is not met the lease will be classified as operating lease,
In the question the lease term is for the major part of the economic life of the asset. This situation reflects that it’s a finance lease because as per IAS 17 if this condition exists and even if title is not transferred at the end of the contract it`s a finance lease.
Statement of financial position:
As at December 30, 2000
Dr. Asset 350,000
Cr. finance lease payable 350,00
Dr. deprecation 58,333
Cr. Accumulated depreciation 58,333
Income of Statement
For the year ended on December 31,200
Dr. finance charge 40,000
Cr. Finance charge payable 40,000
Statement of Cash flow
For the ended on December 31,2000
Amount in PKR
Net profit 185,000
Add: Deprecation 58,333
Adjust profit: 243,333
Less: finance charge 40,000
Net cash consumed in operating activities 40,000
Less: Operating lease paid 52.500
Net cash consumed in financing Activities:
Net cash consumed (92,500)
& Cash equivalent 150,833
The need of standardization of lease agreements was felt by the standard setter`s reason being the need to account for the lease liability appropriately in the financial statement. By accounting lease one can be in better position to decide the expected cash flows, expenses and financial position of an entity.
D) Lessee can have the following advantage in the given scenario.
1. Lease is not legally bound to pay term basis.
2. Lease can switch to cheaper options if they are available.
3. If leased asset is no more required there would be no penalties after completing a year in turn its Bit flexible option for leasee.