34 3 Reduction of External Funding Needs
For example, IFRS (IAS 17 Leases) make a fundamental distinction between
finance leases and operating leases.
A finance lease is defined as one that transfers to the lessee substantially all the
risks and rewards of ownership. It is treated as an “in substance” purchase by the
lessee and sale by the lessor. An asset is shown on the lessee’s balance sheet at the
present value of the minimum lease payments and a corresponding liability is rec-
ognised.
An operating lease is any other lease. The underlying asset appears in the bal-
ance sheet of the lessor and the lessee simply recognises the rental payments as an
expense, with additional footnote disclosure regarding total minimum future lease
rental commitments. This commitment must be classified into time horizon cate-
gories (less than one year, two to five years and more than five years).
IFRS and the US GAAP share the same basic principles. There are nevertheless some dif-
ferences in their treatment of leases. Particularly notable is that the “bright line” tests of
FAS 13^50 used by the Financial Accounting Standards Board (FASB) in the US are not
used under IFRS in Europe. On 19 July 2006, the FASB announced that it would be adding
to its agenda a comprehensive reconsideration of the standards on accounting for leases.
Hire-purchase Agreements
A hire-purchase agreement^51 keeps the title to the relevant asset with the
hirer/seller until all payments under the agreement have been made in full at the
end of the stipulated hire period. Hire-purchase resembles financial leasing in
most aspects, with the one exception that the parties know from the beginning that
the hiree/buyer will become the owner of the asset after making all payments un-
der the agreement. Title to the goods may then pass automatically (usually after all
repayments have been made),^52 or the hirer may have been given the option to
purchase the hired goods at a certain point.
Reasons to use hire-purchase. Hire-purchase tends to be an expensive form of
finance. The benefit of hire purchase is that equipment supplied by the hire pur-
chase company can be used immediately by the hiree who will only have to make
an initial payment rather than pay the full purchase price. The hiree will make a
(^50) The US standard FAS 13 introduces “bright lines” into lease classification. It defines
lease as one under which any one of the following conditions is met: (i) the present
value at the beginning of the lease term of the payments not representing executory costs
paid by the lessor equals or exceeds 90% of the fair value of the leased asset; (ii) the
lease transfers ownership of the asset to the lessee by the end of the lease term; (iii) the
lease contains a bargain purchase price; (iv) the lease is equal to 75% or more of the es-
timated economic life of the asset. On 19 July 2006, the FASB announced that it is add-
ing to its agenda a comprehensive reconsideration of the standards on accounting for
leases.
(^51) In German: Mietkauf.
(^52) The Law Commission, Registration of Security Interests: Company Charges and Prop-
erty other than Land (A Consultation Paper) [2002] EWLC 164(6) (14 June 2002) para-
graph 6.14.