(iii) Tyre has entered into two new long lease property agreements for two major retail ou
(iii) Tyre has entered into two new long lease property agreements for two major retail outlets. Annual rentals are paid
under these agreements. Tyre has had to pay a premium to enter into these agreements because of the outlets’
location. Tyre feels that the premiums paid are justifiable because of the increase in revenue that will occur
because of the outlets’ location. Tyre has analysed the leases and has decided that one is a finance lease and
one is an operating lease but the company is unsure as to how to treat this premium. (5 marks)
Required:
Advise the directors of Tyre on how to treat the above items in the financial statements for the year ended
31 May 2006.
(The mark allocation is shown against each of the above items)
(iii) Retail outlets
The two new long lease agreements have been separately classified as an operating lease and a finance lease. The lease
premium paid for a finance lease should be capitalised and recognised as an asset under the lease. IAS17 ‘Leases’ says that
costs identified as directly attributable to a finance lease are added to the amount recognised as an asset. It will be included
in the present value calculation of the minimum lease payments. The finance lease will be recognised at its fair value or if
lower the present value of the minimum lease payments. The premium will be depreciated as part of the asset’s value over
the shorter of the lease term and the asset’s useful life. Initially, a finance lease liability will be set up which is equal to the
value of the leased asset.
The operating lease premium will be spread over the lease term on a straight line basis unless some other method is more
representative. The premium will be effectively treated as a prepayment of rent and is amortised over the life of the agreement.
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