The present value is arrived at after discounting the lease payments based on the interest rate that is associated with the lease payments. Similarly, in the lessee books of accounting the periodic lease payments should be apportioned between the reduction of the current liability and the finance charges. This is done so as to reduce the amount of interest that is paid by the lessee on the regular lease payments. Another significant aspects that lessee should consider is the depreciation of the assets leased. According to IAS-17, the depreciation of property held under lease should be similar to those assets that are owned. However, if it is uncertain that the lessee will own the property, the life of the property or the lease term whichever is lower is considered during the depreciation (Carpenter et al, 1994).
One of the key aspects that characterize a lease is that the lessee purchases an asset from a lessor. However, instead of paying cash, it is deemed that the purchase is financed with a loan that is given by the lessor. In this regard, the lessees are supposed to include the loan interest on the lease payments thus decreasing the lease liability. This is computed as follows. Yearly lease payments-Interest expense (initial lease liability * interest rate) =Reduction of the lease liability (Dirsmith and Haskins, 1991). After computation of the lease liability, the lessee makes a journal entry as follows. Dr Interest Expense Account with the amount of interest expense calculated above Dr Lease Liability Account the difference Cr Cash Account amount paid Computing the value of the leased property It is imperative for lessees to determine the value of the asset that will be recorded in their books of account. This entails the amount of cash that the lessee would have paid in case he or she purchased the asset in cash. This is the current value of the minimum lease payments (MLP). To arrive at the minimum lease payments, two major interest rates are considered that include market rate and implicit rate whichever is lower. Part (a) (ii) Problems relating to the recognition and classification of leases in corporate financial statements Classification and recognition of leases in corporate financial statements is a major challenge that is faced by many organizations. This is based on the fact that different forms of leases are differently treated in the financial statements. One of the major problems is whether or not the rewards and risks associated with leases remain with the owners. Key rewards include capital gain as well as the right to sell property (Emby and Gibbins, 1988). On the other hand, risks involved are variations in the amount of returns, loss from idle assets in addition to obsolescence of the technology that is transferred from the lessor to the lessee. Transfer of rewards and risks to lessee The amount of risks and rewards that is transferred to the users is a major challenge that faces the accountants during the accounting treatments of leases. In this regard, it is fundamental for companies to highly recognize the concepts of the agreement between the lessors and the lessee even though the legal form of the agreement is vital. For example, a financial lease encompasses the transfer of all benefits and risks to the lessee (Gibbins and Mason, 1998). If there is no such transfer, then this becomes an operating lease. Similarly, the legal form of a lease may indicate that a company is exposed to few benefits and risks from the property leased but the substance condition of the agreement may indicate a very different scenario. This leaves the accountant with a major responsibility of