Hire purchase contracts and Lease in business and how they work - Essay Example

? Table of Contents Executive summary .................................................................. 2 2) Introduction .………………………………………….. 3 3) Main findings of the study …………………………………………… 3 4) Conclusions ………………………………………....... 7 5) Recommendations …………………………………………... 8 Leasing Executive Summary: Hire purchase contracts and Lease are two different means by which business acquires the right to use or buy assets. The study of the ASB and SSAP is to build up a combined conceptual structure, derived from their current structure and is likely to influence the growth of accounting standards. The following study discusses the various methods by which leases are presently differentiated and accounted for in accordance with SSAP 21, the reason and content of ASB statement of codes, the criticism of the approach adopted by the present accounting standard and at last the amendments to the current accounting standard which have been proposed in light of this criticism. Introduction: An Accounting Standard is a principle that explains the accounting structure, utilizing it as the conceptual foundation for its work. The major role of this Statement is to offer conceptual input into the ASB's job on the growth and review of accounting standards. The study consists of various procedures regarding the “SSAP 21” (SSAP 21 Accounting for Leases and Hire Purchase Contracts 1997) and its recent amendment. The aim of financial reports is to offer information on the subject of the reporting entity’s fiscal performance and monetary position which is helpful to a large range of users for evaluating the stewardship of the entity’s organization and forming economic decisions. “Financial statements need to reflect the effects of transactions and other events on the reporting entity’s financial performance and financial position. This involves a high degree of classification and aggregation. Order is imposed on this process by specifying and defining the classes of items—the elements—that encapsulate the key aspects of the effects of those transactions and other events” (An Introduction to the Statement of Principles for Financial Reporting n.d., p. 8). Findings: The way in which leases are currently differentiated and accounted for; in accordance with SSAP 21 Accounting for hire purchase and lease agreements are dealt with in the provisions offered in SSAP 21 ‘accounting for hire purchase and leases contracts’ and IAS 17 leases. In some examples, a number of lease dealings can form division of a complex contract or which include provisions, options and assurances which could drop within the scope of FRS 5 ‘reporting the matter of dealings’. It must be noted , that where such a lease drops under the range of FRS 5 and SSAP 21, the standards containing more particular provision will be relevant. Operating and Finance Leases An operating lease is a lease that is not a “finance lease” (Finance Lease 2005). Expenses under an operating lease are taken to the statement of comprehensive income on a straight-line basis more than the lease term, unless an additional methodical basis is more suitable. “SSAP 21; paragraph 17 defines a finance lease as ‘...a lease that transfers substantially all the risks and rewards of ownership of an asset to the lease’. SSAP 21 also defines an operating lease as simply ‘...a lease other than finance lease’” (Financial Reporting 2011, para. 4). Whether or not a lease passes substantially all the rewards and risks of possession, it will usually be clear in the lease conditions. IAS 17 specifies the direction as to when substantially all the rewards and risks of possession are passed to the lessee: The “lease transfers” (Gupta 2010) possession to the lessee at the finish of the lease term. The lease tells about a good deal purchase choice at the finish of the lease term. The lease term is for the main division of the asset’s helpful economic life. The current value, at the beginning of the lease of the least amount lease expenses is at least able to substantialize a reasonable value of the leased asset, tax creditors and net of grants to the leaser at that time The leased assets are of the nature that only the lessee may use them with no alterations been made. Purpose and content of the ASB Statement of Principles: Since 1st August 1990, United Kingdom’s accounting standards have been issued by the ASB. Every accounting standard issued and enlarged by the ASB is recognized as “Financial Reporting Standards” (Financial Reporting Standards 2004 (FRSs). The standards consist of the FRSSE (Financial Reporting Standard for Smaller Entities). FRSs are generally issued as Exposure outlines for consultations that are recognized as FREDs. “The first Statement of Standard Accounting Practice (SSAP) on accounting for the results of associated companies (SSAP 1) was issued in January 1971. A total of 34 statements (or revised statements) were released between 1971 and 1990” (Knowledge Guide to UK Accounting Standards 2011, para. 8). ASB accounting standards have been used for variety of roles. The major purpose of the ASB Statement is to offer theoretical input into the ASB's job on the growth and evaluation of accounting standards. The Statement is not, an actual accounting standard nor does it include any necessities on how financial statements are to be organized. The Statement of rules still plays an extremely significant position in the standard-setting procedure. Though it is only one of the features that the ASB takes into account when setting standards other factors consist of lawful necessities, cost-advantage considerations, industry-specific subjects and the desirability of evolutionary alteration and accomplishment issues. “Different accounting treatments have important implications for reported levels of indebtedness and for standard performance measures. Profit margins, return on assets and gearing measures would all be significantly affected if operating leases were required to be recognized on the lessee’s balance sheet rather than merely disclosed in a footnote” (Beattie et al. 2006, p. 4). Criticism of the approach adopted by the current accounting standard: Current accounting practices of the SSAP 21 describe the two different types of leases. Leasing is a significant foundation of money for the company. So that both operating and financial lease play significant role for the foundation of this money for the business. But at the same time, amendments made by the ASB for the SSAP 21 describes the tax-free grant. Existing standards provide various opportunities to create amendments which will help in better utilization of the new standards. “The current accounting requirements for leases have been criticized primarily because the current requirements allow manipulation of leases to achieve ‘off balance sheet finance” (Financial Reporting 2011, para. 3). IAS 17 ‘Leases’ (that is the international leasing standard) is one of the fundamental standards worldwide. It makes a basic distinction between operating leases and finance leases. Describing a finance lease as one that transfers to the lessee in the particular business the rewards and risks of ownership. “The UK standard (SSAP 21) also includes a bright line classification test. Under SSAP 21, a lease is presumed to be a finance lease if the present value of the minimum lease payment at the inception of the lease amount to substantially all (normally 90% or more) of the fair value of the leased asset (ASC, 1984)” (Beattie et al. 2006, p. 4). The ASB thinks it is necessary for accounting practice around the earth to converge towards a set of internationally accepted standards. It also thinks that, unless an ordinary set of principles is adopted by every standard-setter, such convergence will be difficult to accomplish. Amendments to the SSAP 21Standard: The Accounting Standards Board has published a revelation draft 'Amendment to SSAP 21 Accounting for hire purchase and leases agreement: “tax-free grants' which proposes to prohibit the practice of accounting for tax-free grants by grossing up the grant including the grossed up amount in arriving at profit before tax” (Tax-Free Grants: Proposed Amendment to SSAP 21 1996). The International Accounting Standards Board (IASB) newly issued a revelation draft suggesting development to the present systems on lease accounting. In the United State, the IASB and US “Financial Accounting Standards Board (FASB)” (Dr. Rao n.d., p. 1) have been working together to overhaul lease accounting standards and the UK will undoubtedly pursue the suit. “Leases have always been problematic in the profession because of the scope to manipulate the concept of ‘off balance sheet finance’. The proposal to treat leases as liabilities together with the corresponding ‘right of use’ asset is considered a significant change in the profession and one which standard setters in jurisdictions do not currently adopt, IFRS may consider” (Collings 2010). Under the present IFRS rule, Topic 840 on leases and IAS 17 ‘Leases’ in US GAAP needs the lessee to recognize an asset connected liability in economics leases. Also, the standard needs the lessee to charge lease expenses against profit where the lease is categorized as an operating lease. Categorization as an operating or finance lease all depends on whether the rewards and risks of the asset’s possession has passed to the lessee or remains with the lesser. “SSAP 21, IAS 17, and the accompanying notes are well worth studying in order to get a better understanding of the nature of finance leasing and the accounting mechanics” (BLM11205- Lease Accounting: Lease Classification: Defining Finance Leases Under IFRS n.d.). Conclusion: Before accounting standards were introduced for leasing preparations, it was not rare for entities to influence the economic statements regarding leases. By ignoring the idea of ‘substance over form’ and so, understating liabilities for the reason that entities were closing that (as they were not the legal proprietor of the assets) then neither the asset topic to the lease was identified in the balance sheet and neither was the connected liability. In several cases, it is rather clear whether a lease is an operating or finance lease; other than in circumstances where it may not be necessarily clear and it is therefore very important that the contractual conditions of the lease are inspected cautiously to ensure the right accounting treatment. Recommendation: To provide importance to assets and liabilities that should be identified in the financial reports of lessees. State must be capable to pursue the new amendments made in the existing laws. To follow new accounting policies. Create an essential distinction between operating and finance leases. Reference List An Introduction to the Statement of Principles for Financial Reporting. n.d. ASB Publication. [Online] Available at [Accessed 12 Nov. 2011]. Beattie et al. 2006. International Lease Accounting Reform and Economic Consequences: The Views of UK Users and Preparers. University of Glasgow. [Online] Available at [Accessed 12 Nov. 2011]. BLM11205- Lease Accounting: Lease Classification: Defining Finance Leases Under IFRS. n.d. HM Revenue & Customs. [Online] Available at [Accessed 12 Nov. 2011]. Collings, S. 2010. Lease Accounting Regulation Changes: A Practical Guide. Accounting Web.Co.UK. [Online] Available at [Accessed 12 Nov. 2011]. Dr. Rao, VA. n.d. Financial Accounting Standards Board (FASB) Convergence with the International Accounting Standards Board (IASB). Financial Accounting Standards Board (FASB) Convergence. [Online] Available at [Accessed 12 Nov. 2011]. Financial Reporting Standards. 2004. Accounting Standards Council. [Online] Available at [Accessed 12 Nov. 2011]. Finance Lease. 2005. Money Terms. Co. Uk. [Online] Available at [Accessed 12 Nov. 2011]. Financial Reporting. 2011. Accountancy Students. [Online] Available at [Accessed 12 Nov. 2011]. Gupta, A. 2010. Lease Transfers Right to Use Property. The Economic Times. [Online] Available at [Accessed 12 Nov. 2011]. Knowledge Guide to UK Accounting Standards. 2011. ICAEW. [Online] Available at [Accessed 12 Nov. 2011]. SSAP 21 Accounting for Leases and Hire Purchase Contracts. 1997. ICAEW. [Online] Available at [Accessed 12 Nov. 2011]. Tax-Free Grants: Proposed Amendment to SSAP 21. 1996. Practical Law Publishing Limited. [Online] Available at [Accessed 12 Nov. 2011]. Read More