Formerly, based on IAS 17 Leases (2003 amendment) para. 14, leases of land and buildings are classified as operating or finance leases in the same way as leases of other assets (read also my previous post regarding the criteria which one of them a lease agreement has to meet to be classified as a finance lease in the financial statements of the lessee : The right way to classify a lease). However, a characteristic of land is that normally has an indefinite economic life and, if title is not expected to pass to the lessee by the end of the lease term, the lessee normally does not receive substantially all of the risks and rewards incidental to ownership, in which case the lease of land will be an operating lease. A payment made on entering into or acquiring a leasehold that is accounted for as an operating lease represents prepaid lease payments that are amortised over the lease term in accordance with the pattern of benefits provided.
Para. 15 stated that the land and buildings elements of a lease of land and buildings are considered separately for the purpose of lease classification. if title to both elements is expected to pass to the lessee by the end of the lease term, both elements are classified as a finance lease, whether analysed as one lease or as two leased, unless it is clear from other features that the lease does not transfer substantially all risks and rewards incidental to ownership of one or both elements. When the land has an indefinite economic life, the land element is normally classified as an operating lease unless title is expected to pass to the lessee by the end of the lease term, in accordance with paragraph 14. The buildings element is classified as a finance or operating lease in accordance with paragraphs 7-13.
However, based on IAS 17 Leases (2009 amendment), both para. 14 and para. 15 of IAS 17 (2003 amendment) were eliminated, replaced with para. 15A which states that when a lease includes both land and buildings elements, an entity assesses the classification of each element as a finance or an operating lease separately in accordance with paragraphs 7-13. In determining whether the land element is an operating or a finance lease, an important consideration is that land normally has an indefinite economic life.
Why para. 14 and para. 15 of IAS 17 (2003 amendment) was eliminated ?
As prescribed in the Basic for Conclusions on IAS 17 Leases, para. BC8A (IFRS 2010 as at 1 Januari 2010 Part B) that as part of its annual improvements project in 2007, the Board reconsidered the decisions it made in 2003, specifically the perceived inconsistency between the general lease classification guidance in para. 7-13 and the specific lease classification guidance in para. 14 and 15 related to long-term leases of land and buildings. The Board concluded that the guidance in para. 14 and 15 might lead to a conclusion on the classification of land leases that does not reflect the substance of the transaction.
For example, consider a 999-year lease of land and buildings. In this situation, significant risks and rewards associated with the land during the lease term would have been transferred to the lessee despite there being no transfer of title.
The Board noted that the lessee in leases of this type will typically be in a position economically similar to an entity that purchased the land and buildings. The present value of the residual value of the property in a lease with a term of several decades would be negligible. The Board concluded that the accounting for the land element as a finance lease in such circumstances would be consistent with the economic position of the lessee.
Further, as explained in para. BC8D, the Board noted that this amendment reversed the decision it made in amending IAS 17 in December 2003. The Board also noted that the amendment differed from the International Financial Reporting Interpretations Committee's agenda decision in March 2006 based on the IAS 17 guidance that such long-term leases of land would be classified as an operating lease unless title or significant risks and rewards of ownership passed to the lessee, irrespective of the term of the lease. However, the Board believed that this change improves the accounting for leases by removing a rule and an exception to the general principles applicable to the classification of leases.
Some respondents to the exposure draft proposing this amendment agreed with the direction of this proposal but suggested that it should be incorporated into the Board's project on leases. The Board acknowledged that the project on leases is expected to produce a standard in 2011. However, the Board decided to issue the amendment now because of the improvement in accounting for leases that would result and the significance of this issue in countries in which property rights are obtained under long-term leases. Therefore, the Board decided to remove this potential inconsistency by deleting the guidance in paragraphs 14 and 15 (Hrd).
