Leases

Finance lease if any one (memory aid: OWNES)

Ownership transfers · Written purchase option reasonably certain · No alternative use · Economic life major part (≈ 75%) · Substantially all fair value (≈ 90%). None → operating lease.

Initial measurement

• Liability = present value of unpaid payments at implicit rate, else incremental borrowing rate.
• Right-of-use (ROU) asset = liability + prepaid payments + initial direct costs − incentives received.
• Usage-based variable payments: excluded, expensed.

After commencement

• Finance: interest + straight-line amortization (front-loaded); principal payments = financing cash flows.
• Operating: single straight-line lease cost; all cash flows operating.

Other rules

• Short-term (≤ 12 months, no reasonably certain purchase option): may stay off balance sheet.
• Lease term includes renewal options reasonably certain to be exercised.
• Failed sale-leaseback → keep asset, record financial liability.
• Lessor: sales-type (profit at commencement), direct financing (profit deferred), operating (keep asset).

Exam traps

• Operating leases still put an ROU asset and a lease liability on the balance sheet — only the income statement pattern differs.
• Discount rate: the rate implicit in the lease if readily determinable, otherwise the incremental borrowing rate; private companies may elect a risk-free rate.
• Residual value guarantees: the lessee includes only the amount probable of being owed; the lessor includes the full guarantee.
• Non-lease components (such as maintenance) are separated unless the entity elects to combine them.