A company is about to enter into a three-year lease to rent a building. The lease cannot be cancelled and there is no certainty of renewal. The landlord retains responsibility for maintaining the premises in good repair. The directors are aware that in accordance with IAS 17 that technically the lease is classified as an operating lease, and that accordingly the correct accounting treatment is to simply expense the income statement with the rentals payable.
lease Given that it is reasonable to assume that the expected life of the premises will vastly exceed three years and that the landlord (lessor) is responsible for the maintenance, on the basis of the information given, the risks and rewards of ownership have not passed. As such IAS 17 prescribes that the lessee charges the rentals payable to the income statement. No asset or liability is recognised, although the notes to the financial statements will disclose the existence of the future rental payments.
However, instead of considering IAS 17 let us consider how the Framework could approach the issue. To recognise a liability per the Framework requires that there is a past event that gives rise to a present obligation. It can be argued that the signing of the lease is a sufficient past event as to create a present obligation to pay the rentals for the whole period of the lease. On the same basis, while substantially all the risks and rewards of ownership have not passed, the lessee does control the use of the building for three years and has the benefits that brings. Accordingly, when considering the Framework.
Explain how such a lease can be regarded as creating an asset and liability per the Framework.