A lessor leases specialized manufacturing equipment to a lessee under a contract whose term covers most of the equipment's remaining economic life, and the present value of the lease payments amounts to substantially all of the equipment's fair value at inception, although legal title never transfers and there is no purchase option. Under IFRS 16 paragraphs 61-62, how should the lessor classify this lease?
- As an operating lease, because a finance lease under IFRS 16 requires that legal title to the underlying asset transfer to the lessee, or that the lessee hold a purchase option, and neither condition is present here
- As a finance lease, because the combination of a lease term covering a major part of the asset's economic life and lease payments whose present value amounts to substantially all of the asset's fair value indicates that substantially all the risks and rewards incidental to ownership have transferred to the lessee, even though legal title and a purchase option are absent
- As an operating lease, because IFRS 16 requires lessors to classify every lease of equipment, as opposed to real estate, as an operating lease regardless of the lease term or payment structure
- As a finance lease only if the lessee also applies the recognition and measurement exemptions available to lessees, because IFRS 16 requires a lessor's classification to mirror whichever accounting treatment the lessee elects
Why B? And why not the others?
Correct answer: B. As a finance lease, because the combination of a lease term covering a major part of the asset's economic life and lease payments whose present value amounts to substantially all of the asset's fair value indicates that substantially all the risks and rewards incidental to ownership have transferred to the lessee, even though legal title and a purchase option are absent
IFRS 16 paragraphs 61-62 classify a lease as a finance lease when it transfers substantially all the risks and rewards incidental to ownership to the lessee, and list indicators, including a lease term covering a major part of the underlying asset's economic life and a present value of lease payments amounting to substantially all of its fair value, that support this conclusion even without a transfer of legal title or a purchase option; both indicators are present here, so the lease is a finance lease. The option requiring title transfer or a purchase option for finance-lease classification is wrong because paragraphs 61-62 present title transfer and purchase options as indicators among several, not as mandatory conditions; a lease can qualify as a finance lease through other indicators alone. The option mandating operating-lease classification for all equipment leases is wrong because IFRS 16's lessor classification test turns on the transfer of risks and rewards, not on the category of underlying asset being leased. The option tying lessor classification to whichever exemption the lessee elects is wrong because IFRS 16 requires lessors to classify leases based on their own risks-and-rewards assessment, independent of any recognition exemption the lessee may apply under the lessee accounting model.
Source: IFRS 16 Leases, paragraphs 61-62 (lessor classification of leases)