Ireland is it a Finance Lease

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It's my first post on the forum so I would like to say Hi to everyone!


I need advice on the following issue:


My company entered into an additional contract with an existing client that involved supplying electronic equipment free of charge. As part of the contract the client will give us their old electronic equipment (the same category and brand as the new ones supplied by us) at no cost to us.

I have trouble how to record this in the books. The contract is for 3 years and if the client brakes the contract in that period they have to pay us back money for the tablets.


Initially I was told to record this in the fixed assets and to charge our Cost of sakes in P&L on a monthly basis. However, this disturbed the cash flow statement as the fixed assets decreased but there was no depreciation charged to P&L (as instead of this there was a charge to Cost of Sales).

Because of this the cash low appeared to have a gain on the sale of the asset (which was not true)



After mentioning this to our FD he proposed to move the cost to prepayments and continue charging the P&L on a monthly basis over the duration of the contract.


Additionally as part of the contract agreement we had to buy parts for the electronic equipment. The cost of them supposed to be split between us (25%) and the client (75%). Our cost was posted into the prepayments (increasing the prepayment). The 75% was supposed to be paid by the client in the following way: we invoice the client for the 75% and then pay the supplier. This “sales invoices” was posted through the Sales ledger but it was posted against the prepayments and not sales account (hence decreasing the cost of the equipment in the prepayments).


On the top of that we are expecting funds from the sale of the old equipment (that the client gave us as a part of the deal). My FD wants offset this against the cost of the equipment in the prepayments (decreasing the total cost).


I have doubts if this was dealt correctly under IFRS and IAS. In my opinion this should have been recorded either as a consignment stock (however I am not convinced) or more likely as a Finance lease where we should recognize the asset (depreciation), liability (presented at amortized cost with a monthly charge to P&L).


The arguments for the lease in my opinion are the following:

- The risk and rewards have been passed onto client but the title has not (if the contract is broken the value of the equipment is payable to us).

- Ownership will be transferred at the end of the lease.


I would be grateful for any ideas and comments.
 

Fidget

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Risks & rewards passed on to the client and ownership transferring at the end of a lease term are certainly hallmarks of a finance lease (IAS 17 - leases). The problem here though is that the equipment is being provided free of charge and the client has no obligation to pay for it unless it cancels the contract, so there's nothing to record in terms of finance lease obligations.

As far as I can see, at most, the client has a contingent liability and your company has a contingent asset based on the agreement that the client will pay for the equipment only if it cancels the contract. This would be disclosure in the notes to the accounts. And even at that, if the chances of the client cancelling the contract are remote, then there's no disclosure required at all.
 
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Hi Fidget, thank you for your reply.

Contingent assets are not present on the financial records, therefore there is no depreciation.. The question is how do I recognize the initial transaction when we paid for asset to the supplier? if this should go to Cost of sales then we have been correctly charging the P&L over the period of the contract?
 

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