Inconsistency between IAS 17 and ICAP's IFAS 2

[Sayub]

Dear All,

I am facing difficulty in applying ICAP's IFAS 2, as the SECP has made it mandatory to apply IFAS 2 instead of IAS 17 for IJARAH transactions.

The issue is to account for a transaction as a operating lease which is in substance a Finance lease.

To further elaborate the issue following example will help

Lessor Islamic institutions

Lease type IJARAH

Lessee Manufacturing Company

Leased Asset Car

Lease amount Rs 2,000,000

Lease term 1 year

Down payment Rs 1,000,000

Lease facility Rs 1,000,000

Residual value at
the end of lease Rs 1,000

Ownership shall
be transferred at
the end of lease YES


ACCOUNTING UNDER IAS 17

The lease should be treated as finance lease as the ownership of the leased asset shall be transferred to the lessee at the end of the lease.

Accounting Entry for recognition

Vehicle (Debit) Rs 2,000,000
Finance lease obligation (Credit) Rs 1,000,000
Cash (Credit) Rs 1,000,000


You may think that why finance lease obligation is not recognised with full amount i.e Rs 2,000,000. The answer is that the fiance lease facility was availed for only Rs 1,000,000 and the remaining is down payment.

Subsequent Accounting entries will be made for payment of lease rentals(principal repayment), finance charges, depreciation expense and payment of residual value of Rs 1,000. Which are known by everyone in this forum.

ACCOUNTING UNDER IFAS 2

Under IFAS 2 the transaction shall be recognised as operating lease therefore no asset shall be recognised.

The only entry shall be made for the payment of rentals.


My question are

1. How at the end of the lease term the asset shall be recognised in the books of lessee?.

2. How Down payment shall be recognised?.

Please provide reasons and accounting entries supporting reponse.

[kamranACA]

Following are paragraph 7 and 8 of IFAS-2

QUOTE

7. Ujrah payments under an Ijarah should be recognized as an expense in the income statement on a straight-line basis over the ljarah term unless another systematic basis is representative of the time pattern of the user’s benefit.

8. For ljarah, ujrah payments are recognized as an expense in the income statement on a straight- line basis unless another systematic basis is representative of the time pattern of the user’s benefit, even if the payments are not on that basis.

UNQUOTE

1. How to account for Down Payment and Other Payments

In the backdrop of this guideline, it is clear that all payments on account of Ijarah, made by Lessee, have to be expensed out in his books of account. This even includes the Down Payment, as IFAS-2 has made no distinction.

Yes, as far as recognition of expense and its TIMING FOR RECOGNITION is concerned the standard clearly says that ujrah payments are recognized as an expense in the income statement on a STRAIGHT- LINE BASIS UNLESS ANOTHER SYSTEMATIC BASIS IS REPRESENTATIVE OF THE TIME PATTERN OF THE USER’S BENEFIT, EVEN IF THE PAYMENTS ARE NOT ON THAT BASIS.

Therefore, if considered prudent, the down payment can be recognized as pre-payment and then charged to profit and loss on straight-line basis or some other systematic basis. This will have to be seen in every case on the basis of its merits.

2. How to account for asset at the end of Ijarah

At the end of lease term, the LESSEE will record the asset in its fixed assets register (memorandum/subsidiary record) and will make no accounting entry in monetary terms in the financial ledger. However, legal transfer of vehicle/asset in Lessee’s name will be ensured. This is the essence of the standard. However, if some financial control is considered necessary the asset may be booked at Rupee 1. This is only for control purpose, otherwise there will be no monetary terms accounting entry of such Ijarah asset acquired at the end of lease term unless some additional payment is made by lessee to the lessor beyond what agreed as per Ijarah repayment schedule.

In IFAS-2 there is no concept of Residual Value for the Lessee as depreciation is charged by the lessor in his books and such residual value estimation is only necessary for the lessor.

I suggest a thorough reading of IFAS-2 for further clarity. http//www.icap.org.pk/Tech_services/Ijarah.pdf

I hope it would be helpful.

Notwithstanding the above, the accounting entry suggested in your post for Finance Lease is correct in nutshell if we go to T-Ledger balances eventually, but is incorrect for practical reasons. Principally and practically, the Lease Obligation has to be credited with full amount and the down payment has to be recorded as SECURITY DEPOSIT or LEASE KEY MONEY DEPOSIT. At the end of the lease term such security deposit is adjusted against the Lease Obligation’s outstanding amount.

Regards

[Sayub]

Thanks KamranACA for such comprehensive response. However there's an issue regarding recognition of Deposit. Is this recognition in accordance with Financial asset as defined under IAS 32?

Waiting for your reply.



<blockquote id="quote"><font size="1" face="Verdana, Arial, Helvetica, san" id="quote">quote<hr height="1" noshade id="quote"><i>Originally posted by kamranACA</i>
<br />
Following are paragraph 7 and 8 of IFAS-2

QUOTE

7. Ujrah payments under an Ijarah should be recognized as an expense in the income statement on a straight-line basis over the ljarah term unless another systematic basis is representative of the time pattern of the user’s benefit.

8. For ljarah, ujrah payments are recognized as an expense in the income statement on a straight- line basis unless another systematic basis is representative of the time pattern of the user’s benefit, even if the payments are not on that basis.

UNQUOTE

1. How to account for Down Payment and Other Payments

In the backdrop of this guideline, it is clear that all payments on account of Ijarah, made by Lessee, have to be expensed out in his books of account. This even includes the Down Payment, as IFAS-2 has made no distinction.

Yes, as far as recognition of expense and its TIMING FOR RECOGNITION is concerned the standard clearly says that ujrah payments are recognized as an expense in the income statement on a STRAIGHT- LINE BASIS UNLESS ANOTHER SYSTEMATIC BASIS IS REPRESENTATIVE OF THE TIME PATTERN OF THE USER’S BENEFIT, EVEN IF THE PAYMENTS ARE NOT ON THAT BASIS.

Therefore, if considered prudent, the down payment can be recognized as pre-payment and then charged to profit and loss on straight-line basis or some other systematic basis. This will have to be seen in every case on the basis of its merits.

2. How to account for asset at the end of Ijarah

At the end of lease term, the LESSEE will record the asset in its fixed assets register (memorandum/subsidiary record) and will make no accounting entry in monetary terms in the financial ledger. However, legal transfer of vehicle/asset in Lessee’s name will be ensured. This is the essence of the standard. However, if some financial control is considered necessary the asset may be booked at Rupee 1. This is only for control purpose, otherwise there will be no monetary terms accounting entry of such Ijarah asset acquired at the end of lease term unless some additional payment is made by lessee to the lessor beyond what agreed as per Ijarah repayment schedule.

In IFAS-2 there is no concept of Residual Value for the Lessee as depreciation is charged by the lessor in his books and such residual value estimation is only necessary for the lessor.

I suggest a thorough reading of IFAS-2 for further clarity. http//www.icap.org.pk/Tech_services/Ijarah.pdf

I hope it would be helpful.

Notwithstanding the above, the accounting entry suggested in your post for Finance Lease is correct in nutshell if we go to T-Ledger balances eventually, but is incorrect for practical reasons. Principally and practically, the Lease Obligation has to be credited with full amount and the down payment has to be recorded as SECURITY DEPOSIT or LEASE KEY MONEY DEPOSIT. At the end of the lease term such security deposit is adjusted against the Lease Obligation’s outstanding amount.

Regards

<hr height="1" noshade id="quote"></font id="quote"></blockquote id="quote">

[kamranACA]

Considering the definition of financial asset given by IAS-32 (seee paragraph 11), in my view, the Lease Key Money Deposits are not the Financial Instruments.

Regards,