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KEY DEFINITIONS IN LEASES

July 7, 2019

INCEPTION OF LEASE

  • Inception of lease is the date on which the lessor and lessee enter into an agreement to enter into lease contract.
    (or )
    Inception of lease is the date on which the principal terms of the lease contract are agreed upon by the lessor and the lessee.

  • Date of inception of lease is also the date on which a lease is either classified as a finance lease or an operating lease.

COMMENCEMENT OF LEASE

  • The date of commencement of lease is the date on which a lessee is entitled to exercise the right to use the leased asset.

  • The date of commencement of lease is also the date on which the asset, liabilities, income and expenses of the lease are initially recognized in the financial statements.

FAIR VALUE 

 

Fair value is defined as the amount for which an asset  could be exchanged or liability settled, between knowledgeable, willing parties in an arm's length transaction. 

 

In most cases, purchase price or the transaction price will be the fair value, unless there is an evidence to prove existence another value.

 

MINIMUM LEASE PAYMENTS

 

The minimum lease payments are the payments over the lease term that the lessee is required to make.

For the lessee, it includes the following

  • Any amounts guaranteed by the lessee or by a party related to the lessee.

  • In case if there is a purchase option to purchase the asset at the end of the lease and it is reasonably certain at the inception of the lease that this option will be exercised, then the minimum lease payments will include the payment made to exercise the option.

For the Lessor, it includes the following

  • Any residual value guaranteed by the lessee or by a party related to the lessee.

  • Any residual value guaranteed by a third party who is unrelated to the lessee who is financially capable of discharging the obligations under the guarantee.

(Note the difference between MLP definition for lessor and lessee. For a lessee, it is any amount guaranteed in the case of a lessor, it is any residual value guaranteed is the MLP)

 

Let's Understand Meaning of guaranteed residual value

A guaranteed residual value is a guarantee made to the lessor that the value of the underlying asset will be at least the specified amount at the end of the lease. In case if the fair value of the underlying asset is lower than the specified amount, the lessee agrees to pay the differential amount to the lessor.

 

LEASE TERM

 

The lease term is a non-cancellable period for which the lessee has contracted to lease the asset, together with any further terms for which the  lessee has the option to continue to lease the asset, with or without further payment, if it is reasonably certain at the inception of the lease that the lessee will exercise the option.

 

Let's understand: A lease is considered non-cancellable only on the four conditions a) the lease is cancellable only on the occurrence of a remote contingency, b) the lease is cancellable only with the permission of a lessor c) the lease is cancellable because the lessee has entered into a new lease with the same lessor for the same asset or an equivalent asset d) the lessee is required to pay an additional amount to cancel the lease. (usually this termination payment is something equivalent to the present value of the remaining lease payments), this provides a reasonable certainty that the lessee will continue the lease without cancelling it.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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