Lessee Ltd

Date: April 8, 2014

To: President, Lessee, Ltd

From: Mrs. Morales, Finance Controller

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Re: Lease Accounting, IFRS

Mrs. President, I have evaluated the analysis from both our junior accountant and our senior accountant and found the following:

1. Our junior accountant classified the lease in question as an operating lease. In this he is mistaken.

a. As per IAS 17-10 a lease would be considered a financial lease if its term is for most of its useful life regardless of it not being transferred to the lessee at the end of the term. The lessee will be in the control of the asset for 3 of its 4 useful years: 75% of its useful life.

b. Another of IAS 17-10 criteria for financial lease states that the present value of the lease’s minimum payments must amount to substantially all of its fair value. Even though the junior accountant calculated the present value of the annual payments correctly ($248,690 + $15,026 = $263,716.00), he failed to recognize that its value represents 99.5% of the asset’s fair value ($265,000.00).

c. Both conditions satisfy IAS 17-10 criteria and classifies the lease as financial.

2. Our senior accountant classified the lease as a finance lease, but he made other mistakes.

d. IAS 17-20 states that the implicit rate (10%) shall be used when calculating the present value of the minimum lease payments if it’s practicable to determine, which in this case it is. Using the incremental rate (11%) is incorrect.

e. In addition, the senior analyst failed to include the present value of the residual in his computation. The correct amount should be $263,716.00 ($248,690 + $15,026), as mentioned above.

f. Also, the senior accountant used the straight-line method for an operating lease to calculate the interest expense, when IAS 17-25 states that “[t]he finance charge shall be allocated to each period during the lease term so as to produce a...