17.1 Leases: Overview

Businesses often need to update their existing equipment or business space, or perhaps acquire entirely new equipment or accommodation as they expand their operations. The opening story describes the pros and cons of leasing assets versus buying them. The answer isn’t straightforward and requires an analysis of the business on a case-by-case basis to determine whether buying or leasing is the best option. This chapter will focus on a business’s decision to lease equipment and the accounting treatment that is required as a result.

Leasing is simply defined as the right to use an asset for a specified period in exchange for cash payments or other consideration. This definition is broad and includes common transactions, such as leasing an apartment from a landlord or leasing a car from a dealership. In the case of a private individual, these types of leases are generally treated as rental agreements and a rental expense. In the case of businesses entering into leasing agreements, such as renting office space or equipment, the accounting treatment is more complex. It depends on the economic substance of the transaction and how closely the transaction meets certain prescribed criteria set out in the ASPE and IFRS accounting standards. In some cases, it will be classified as an operating lease where cash payments are recorded to rental expense. In other cases, it will be classified as a capital lease where the business would report the leased asset in the balance sheet, along with an associated lease obligation as a liability. The main focus of this chapter will be the accounting treatments for ASPE and IFRS.

A lease is a contractual agreement between a lessor and a lessee.  The lease contract gives the lessee the right to use an asset, owned by the lessor, for a specified period of time.  The right to use the asset is provided in return for lease payments.  An important component of the lease agreement is that the lessor transfers less than the total interest in the property.  Any type of property can be leased.

The two main types of lease agreements are a sales-type lease and a direct financing type lease:

When the lease is a sales-type lease, there is a manufacturer’s profit present to the lessor.  The lessor records sales, cost of goods sold and interest revenue.

When the lease is a direct financing lease, there is no manufacturer’s profit present to the lessor. Lessors are primarily engaged in financing activities such as a lease financing company, banks or insurance companies.  The lessor only records interest revenue (not sales revenue).

The accounting for these leases will be discussed in the following section.