1. Accounting for Leases The New SORP Stephen Hall Consolidation Accountant

2. Overview The new SORP has new rules regarding the accounting treatment for leases. Some leases which would previously have been treated as operating leases which now would be treated as finance leases (and vice versa). Rules regarding the accounting for lease incentives and premiums have also changed. This process is designed to ensure : We are aware of the changes that affect Leases under the new SORP. We can correctly decide whether a lease is an operating lease or a finance lease. We can correctly account for any incentives or premiums on leases.

3. Current position The existing SORP stated that a lease should be designated as a finance lease if substantially the risks and rewards of ownership are transferred to the lessee. – This was presumed to be if the present value of the minimum lease payments were 90% or more of the cost of the asset. Lease incentives were spread over the shorter of the lease term or the period up to a rent review period. New SORP position The new SORP also states that a lease should be designated as a finance lease if substantially the risks and rewards of ownership are transferred to the lessee. BUT…… rules on how this is defined have changed. There is no ’90% rule’. A number of factors must be taken into account when deciding if a lease is a finance or operating lease. Lease premiums (on new leases) are also released over the entire lease term rather than to the rent review period.

4. Indicators of a finance lease The new SORP highlights several conditions that may be present if a lease is a finance lease. School accountants must assess these and consider overall whether the lease is a finance lease or an operating lease. These are: Do we own the asset at the end of the lease? Do we have an option to purchase at the end of the lease? Can we carry on renting for a reduced rate at the end of the lease? Does the present value of lease payments cover most of the cost of the asset? Is the asset so specialised only we can use it? If the lease is cancelled do we have to pay a penalty which effectively pays for the asset? Are we affected by fluctuations in the assets value? Do we have to repair/insure the asset? If several of these can be answered yes it is likely the lease is a finance lease. An asset and a liability will need to be brought onto the balance sheet.

5. Accounting treatment If the criteria is met, finance lease accounting applies for the asset: – An asset is brought onto the balance sheet based on the cost of the asset to the operator. – A finance lease liability is introduced based on the cost of the asset. – The additional amounts paid within each payment is deemed to be interest. – This is allocated over the life of the lease either through the sum of digits method or the actuarial method.

6. Lease premiums and incentives- treatment For new finance leases, any premiums or incentives must now be released over the whole of the lease term. Previously if there was a rent review period the incentive or premium was released over this period. This may mean releasing over a longer period than previously. A transitional provision means that any leases in place 31 July 2014 will not need adjusting for this.

7. Process under the new SORP (1) A questionnaire will be available on the intranet going forward. This shall be filled out by school accountants prior to the signing of service agreements. This aims to assist school accountants with the decision for whether an finance lease exists.

8. Process under the new SORP (2)

9. Process under new SORP (3) If the conditions are met: – Contact the capital team with a copy of the agreement and the completed lease form – The capital team will confirm if a finance lease exists and calculate the value of any lease incentive – The capital team will provide an lease schedule showing the amount of each repayment to be allocated to interest/capital, and the value of any incentive to release Account for asset, and liability based on the value of the asset received: – Dr 9041 - Leased equipment costX – Cr 9414 - Creditors – finance lease creditorsX – Cr 9416 – Amounts repayable on early termination relating to lease incentivesX Account for the depreciation on the asset going forward: – Dr 6526 – Depreciation – equipment - leased X – Cr 9043 – Lease equipment accumulated depreciation X Reallocation of the IPROC payment (which automatically goes to ‘hire of equipment’) based on the lease schedule provided by capital accounts: – Dr 9414 - Creditors – finance lease creditorsX – Dr 9416 - Amounts repayable on early termination relating to lease incentivesX – Dr 4500 – Interest payableX – Cr 6049 – Hire of equipmentX