What is leasing?
A lease is a rental agreement that provides for a purchase option at a predefined price. Leases are not listed either in fixed assets or in the company’s commitments. Financial institutions encourage this type of financing since it provides them with additional guarantees.
Regardless of leasing, companies increasingly prefer to invest the available resources in their core business and thus opt for rental agreements.
The relating global commitments have been estimated at $3,300bn for the 30,000 listed companies under IFRS or US-GAAP.
A lease is a rental agreement concerning movable or immovable property that provides for a promise to sell at a predefined price (residual value) at the end of the contract.
A lease-back is a transaction where the owner of an asset sells it to a leasing company and then leases it back.
In a leveraged leases, the lessor borrows from a leasing company the money to finance a piece of equipment that will be leased to the lessee in most cases under identical conditions.
If capital leasing requires the credit institution status, operating leasing is only regulated by the French Commercial Code. Long-term leasing is similar to operating leasing but it usually has shorter terms (2 to 3 years) and provides that the lessee returns the asset to the lessor at the end of the contract.
Real or presumed advantages and disadvantages
In the balance sheet, leases are not recorded either as fixed assets or liabilities but they must be mentioned in the notes of the company’s financial statements and restated for consolidated accounts. All rent payments are registered as operating costs.
In order to ensure transparency, the IAS 17 requires the restatement of leasing transactions as if they were company-owned assets fully financed by borrowing.
Consolidation restatement consists in cancelling the leasing transaction and restating it as a loan repayment providing for interest and principal payments. At the same time, a fixed asset is reported under balance sheet assets while a debt transaction is entered as a liability.
On January 13th 2016, the International Accounting Standards Board (IASB) published the IFRS 16 Leases. The new regulation replaces the IAS 17 and will enter into force for fiscal years starting from January 1st 2019.
The IFRS 16 aims at the convergence of American and international regulations in order to ensure greater transparency in terms of:
- Representation of companies’ assets and liabilities, and
- Comparability among companies, regardless of their financing strategies.
With respect to the IAS 17, the IFRS 16 will introduce the following changes:
- The distinction between capital and operating leasing will fall into disuse (the latter not being restated in consolidated accounts)
- It will be mandatory to record on the balance sheet all the leasing agreements lasting more than one year, with the only exception of low-value assets (indicatively $5,000).
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