1. Was the junior accountant's analysis correct? Why or why not?
The junior accountant's analysis is not correct. He cannot determine the classification of the lease based on the return of the leased asset to the lessor.
Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form. Situations that would normally lead to a lease being classified as a finance lease include the following: [IAS 17.10]
· the lease transfers ownership of the asset to the lessee by the end of the lease term
· the lessee has the option to purchase the asset at a price which is expected to be sufficiently lower than fair value at the date the option becomes exercisable that, at the inception of the lease, it is reasonably certain that the option will be exercised
· the lease term is for the major part of the economic life of the asset, even if title is not transferred
· at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset
· the lease assets are of a specialized nature such that only the lessee can use them without major modifications being made
Therefore, it is a finance lease, not a operating lease. According to IFRS, “A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred.” (IAS 17-4)
1) Transfer ownership
Since the equipment reverts back to Lessor Inc. , there is no title tranferring in this case.
2) Bargain purchase option
The lease contains no purchase and renewal options.
3) Lease term
The lease term in this case is 3 years, and the useful life of the equipment is 4 years.
3/4=75%, it is equal to 75% of the economic life of the leased equipment.
4) The present value of the lease payment
we use the lesser of