Leases and Leased Assets - Future Focused Finance



FINANCIAL PROCEDURE NOTES

LEASES AND LEASED ASSETS

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CDDFT Financial Procedure Note

|Reference Number |PROC/FIN/0008 |

|Title |Leases and Leased Assets |

|Version number |1.1 |

|Document Type |Procedure |

|Original Policy Date |31st July 2011 |

|Date approved |22/08/2011 |

|Effective date |01/09/2011 |

|Approving body |Planning & Workforce Committee |

|Originating Directorate |Finance |

|Scope |Finance Staff |

|Last review date |30/06/2014 |

|Next review date |31/07/2016 |

|Reviewing body |Senior Finance Group |

|Document Owner |Associate Director – Financial Services |

|Equality impact assessed |Yes |

|Date superseded |New Policy |

|Status |Approved |

|Confidentiality |Unrestricted |

|Keywords |Capital FPN |

Approval

|Signature : | |

|Name / job title of approving Body: |Director of Finance |

|Signed paper copy held at (location): |Financial Services Department |

Contents

|Section |Page |

|1 |Introduction |5 |

|2 |Purpose |5 |

|3 |Duties |5 |

|4 |IAS 17 – Leased Assets |5 |

|5 |Classification of Leases |5 |

|6 |Assessing if a Lease is an Operating Lease or a Finance Lease |6 |

|7 |Assessment Checklist |6 |

|8 |Lease or Purchase |6 |

|9 |Public Borrowing Limit |7 |

|10 |Annual Accounts requirements | 8 |

|11 |Maintenance of Lease Register | 8 |

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| | | |

|i |Key Performance Indicators (KPIs) | |

|ii |References | |

|iii |Associated Documentation | |

|Appendices | |

| A |Lease Proforma | |

| B |Lease Register extract | |

| C |Managers Guide to Leases | |

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Distribution List

|Policies and Procedures Intranet site |

|Director of Finance |

|Internal Audit |

|Finance Department |

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Document Control Information

Version control table

|Date of issue |Version number |Status |

|22/08/2011 |1.0 |Approved |

|31/07/2014 |1.1 |Draft |

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| | | |

Table of revisions

|Date |Section |Revision |Author |

|02/07/2014 |Numbering |Amended the procedure number |L Hartley |

| |Section 9 |Updated for revised risk framework |L Hartley |

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1. Introduction

This procedure replaces Financial Procedure Note PROC/FIN/F012 – Leased Assets.

2. Purpose

This procedure provides guidance which must be followed when deciding to lease equipment or property.

3. Duties

This procedure applies to all staff.

4. IAS 17 – Leased Assets

IAS 17 applies to all proposed lease arrangements, whether operating leases or finance leases to ascertain the accounting treatment.

This means that a lease that would have previously been an operating lease with the expenditure being allocated to expenditure on an even basis as a rental charge can be found to be a finance lease which must be capitalised and depreciated as if the item had been purchased.

IAS 17 applies to all leases other than lease agreements for minerals, oil, natural gas and similar regenerative resources and licensing agreements for films, videos, plays, manuscripts, patents and similar items.

It provides guidance on the following areas:

• Classification of Leases

• Assessing whether a contract contains a Finance Lease

• Annual Accounts Requirements

5. Classification of Leases

A lease is classified as a finance lease if it transfers substantially all the risks and rewards that arise from ownership of the item to the lessor.

All other leases are classified as operating leases.

IAS 17 gives a broader definition of finance leases. It uses a criteria-based approach that means that under IAS 17 it is likely that more leases will be classified as finance than was the case under UK GAAP.

IAS 17 requires that the land and buildings elements of a property lease should be considered separately for lease classification, unless the land element is immaterial.

A lease of land and buildings should therefore be split and treated as two leases. Unless title is expected to pass to the lessee at the end of the lease term, leases of land should normally be treated as operating leases. The buildings element would be classified as an operating or finance lease as appropriate.

Whether a lease is a finance lease or an operating lease is a matter to be decided on the substance of each case.

6. Assessing whether a lease is an operating lease or a finance lease.

When a proposal appears to include a lease, an assessment must be done to determine whether the lease is a finance lease or an operating lease.

The assessment to classify a lease should be done at the date of the inception of the lease.

The primary test questions in the Assessment Checklist are designed so that if the answer “yes” is given to any question in the Primary Questions List it opens the possibility of the lease’s building element being a finance lease. However other lease characteristics may of course lead to the conclusion that the lease is nevertheless an operating lease.

The secondary test questions will be applied to attempt to clarify the matter, together with an initial “high level” quantitative test.

The detailed full quantitative test calculation will normally only be required if operating lease classification is not obvious.

If in doubt about whether the lease is an operating or finance lease, consider whether the item in question really appears to be the property of the Trust despite how the item is being paid for.

• Items that are built in would usually be finance leases;

• Items where the initial term of the lease and the amount paid cover the expected life and cost of the item would usually be a finance lease, even if a nominal lease payment is due over a second term.

• Items where the responsibility for the item is the Trust’s or where the Trust must pay the remaining lease payments even if the item is returned would usually be finance leases

7. Assessment Checklist

Primary Questions

a: Does the lease transfer ownership of the asset to the lessee by the end of the lease term?

b: Does the lease give the lessee the option to purchase the asset at less than open market value?

c: Does the lease contain terms that result in the gains or losses from fluctuations in the residual value of the asset accruing to the lessee?

d: At the inception of the lease, is it reasonable to assume that the lessee and lessor either (a) expected the lease term to be for the major part of the economic life of the building, or (b) or that the residual value on expiry of the lease term would be negligible?

e: Has the payment structure of the lease been derived with reference to specific interest rates and returns on risk which would be required by a lender?*

* If the lease were part of a broader transaction, such as a PFI project, structured to reflect a lender’s risk and returns, this would be indicative of a possible finance lease.

A rent substantially in excess of normal market rents, set in a sale and leaseback transaction might indicate a finance lease.

f: Does the lease allow the lessee to cancel the lease and if so does the lessee have to bear the lessor’s losses, as predetermined in the lease terms?

g: Are the buildings of such a specialised nature that only the lessee can use them without major modification?

If the answer to all the questions is no, then no further work is likely to be required and the lease is considered an operating lease, unless there are other features of the lease that clearly show that the property risks and rewards remain substantially with the tenant.

Secondary Questions

If the answer to one or more of the primary questions above is "yes", there is a possibility that the lease should be classified as a finance lease and a further review, including the quantitative test set out in IAS 17/10d, may be required to determine whether the lease is indeed a finance lease.

Accordingly, in order for a lease subject to this further review to qualify as an operating lease, it must be clearly demonstrated that the landlord retains substantially all the property related risks and rewards.

The following secondary prompts, if answered in the affirmative, might be suggestive of operating lease attributes:

• Are there full repairing and insuring covenants in the lease and clauses to ensure the asset is reinstated, at the expense of the tenant, to its original condition at the end of the lease?

• Does the lease provide for significant contingent rent variations during the term by reference to an open market or turnover? (e.g. market rent reviews. But note that if the lease were to provide for fixed increases or increases linked to a non-property market index, this might be indicative of a finance lease).

• Were the initial passing rent and other aspects of the lease set at prevailing market rates?

• Is the lease free of contractual terms that might oblige the lessor to continue the lease at substantially less than normal market terms?

• Is lessee default the only grounds on which the lease would revert to the lessor?

• If the lessee wishes to sublet or sell (or assign) their lease rights, are there terms in the lease that allow the lessor to control the key terms of the sublet / sale?

8. Lease or Purchase?

Decisions regarding leasing vs purchase of all equipment or buildings will be made by the Capital Planning Group (CPG).

Managers seeking to enter into leasing arrangements where the total lease payments will exceed £5,000 will submit a business case to CPG that incorporates an options appraisal undertaken in accordance with IAS 17 in order to determine the option that provides best value for money to the Trust. This analysis will clearly identify the revenue implications of the options.

The appropriate Directorate Accountant will undertake this financial analysis, and will sign off the business case in addition to the sponsoring Manager.

The analysis should clearly identify the lease type (i.e. Operational or Finance) based on the quotations received, by applying the guidance in the Assessment Checklist.

A copy of the agreement for any leases entered into must be provided to the Section Head Accountancy for inclusion on the lease register.

9. Risk Framework

The Trust is monitored on its Capital Servicing Capacity and its Liquidity rating.

The interest and repayments of any leases must not jeopardise the risk rating associated with the capital servicing capacity and the liquidity.

Capital Servicing Capacity

Earnings before Interest, Taxation, Depreciation and Amortisation (EBITDA) must be 1.25 x Dividends, Interest Payable and Lease capital Repayments to ensure a rating of 2.

Liquidity Rating

Working Capital Balance x 360 divided by annual operating expenses

In order to ensure that potential leases will not breach these ratios, the future year’s planned figure for EBITDA should be compared to the planned interest and capital repayments including the proposed leases figures.

As a rough guide a leased item should be expected to generate net earnings of one and a half times the interest cost plus the lease capital repaid in a year.

10. Annual Accounts Requirements

1. Disclosure: Trust leasing to another organisation – Finance Lease

• Disclose the carrying amount of asset;

• A reconciliation between total minimum lease payments and their present value;

• Identify the amounts of minimum lease payments at balance sheet date and the present value thereof, for:

o not later than one year;

o later than one year and no later than five years

o later than five years

• Disclose any contingent rent recognised as an expense;

• Disclose the total future minimum sublease income under non-cancellable subleases; and

• Provide a general description of all significant leasing arrangements, including contingent rent

2. Disclosure: Trust leasing to another organisation – Operating Lease

1. Disclose the total of future minimum lease payments at balance sheet date under non-cancellable operating leases for each of the following periods:

o not later than one year;

o later than one year and no later than five years

o later than five years

2. Disclose the total future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet date;

3. Identify the lease and sublease payments recognised as a expense in the period, with separate amounts for minimum lease payments, contingent rents and sublease payments.

4. Provide a general description of all significant leasing arrangements, including:

o The basis on which contingent rent payable is determined;

o The existence and terms of renewal or purchase options and escalation clauses; and

o Restrictions imposed by lease arrangements, such as those concerning dividends, additional debt and further leasing.

3. Disclosure: Trust leasing from an organisation – Finance Lease

• Disclose a reconciliation between gross investment in the lease and the present value of minimum lease payments;

• Disclose the gross investment and present value of minimum lease payments receivable for:

o not later than one year;

o later than one year and no later than five years

o later than five years

• Disclose unearned finance income;

• Disclose unguaranteed residual values;

• Disclose any accumulated allowance for uncollectible lease payments receivable;

• Disclose contingent rent recognised in income; and

• Provide a general description of all significant leasing arrangements.

4. Disclosure: Trust leasing from an organisation – Operating Lease

• Disclose the amounts of minimum lease payments at balance sheet date under non-cancellable operating leases in the aggregate and for:

o not later than one year;

o later than one year and no later than five years (years 2 through 5 combined)

o later than five years

• Disclose any contingent rent recognised as in income; and

• Provide a general description of all significant leasing arrangements.

11. Maintenance of Lease Register

10.1 Calculating the capitalised value of a lease

Care Group Managers liaise with their Accountants to determine the type of leases they have i.e. whether they are Operating or Finance Leases.

Accountants must review all leases and provide the Section Head Accountancy with the details to include in the Lease Register.

Where the Lease has been identified as a Finance Lease, the Accountant must provide the Section Head Accountancy with the calculations to allow the item to be capitalised at its correct value. (Appendix A)

10.2 Annual Review of Leases

The Section Head Accountancy will carry out an audit of current leases on an annual basis, and produce a Lease Register of all the current leases operating within the Trust, in preparation for the Final Accounts.

See Appendix B for an extract from the Lease Register.

All Care Group Managers are responsible for advising the Section Head Accountancy of any changes in the assets leased by their Directorate. This information must be given to the Section Head Accountancy in writing, giving details of the expenditure incurred, the lifespan of the lease, and details of the equipment involved including serial numbers as appropriate.

During the financial year, the Section Head Accountancy sends the Lease Register to all Care Group Managers for confirmation that the details shown are correct and there are no omissions, all responses will be chased up prior to the provision of information for final accounts as detailed below.

Key Performance Indicators (KPIs)

None

References

Associated Documentation

This procedure refers to the following CDDFT Trust policies and procedures:

• None

This procedure is referenced from the following CDDFT Trust policies and procedures:

• None

This procedure refers to the following guidance, including national and international standards:

• IAS 17 – Accounting for Leases

Appendix A – Calculating the Capital Leased Value

Use the Finance Lease Calculation Spreadsheet to calculate the value of a Lease repaid in quarterly instalments.

PV of Min Lease Payment Sheet

• Insert the Minimum Annual Lease Payments into Cell D8 to D10

• Add the Total Minimum Lease Payments into the relevant years (Cells B15 to B24) to calculate the total Present Value of the Minimum Lease Payments using a 3.5% discount factor. This gives the Capitalisation Value.

On SOFP Sheet

• Calculate the Depreciation Value by inserting the Useful Economic Life of the equipment being leased (Cell G9).

• Insert the number of years in the contract (Cell G14)

• Add the number of cash payments in each financial year (Cell E28 to E37).

• Calculate the Interest rate by using the Goal Seek Formula to make the final Cumulative Interest Charge cell the total of the Total Finance Interest Charges, by amending the interest rate cell (Cell G26)

• Add the number of Months Depreciation in each financial year (Cells K28 to K37)

Appendix B – Lease Register

|Trust Reference |Lease Description |Equipment |Supplier |

|Number | |or | |

| | |Property | |

| | | | |

| | | | |

Appendix C

Manager’s guide to leases

Leases are not the straight forward things they used to be.

All Leases must have a business case approved before agreeing to the lease.

All Lease Documents where the total value of the lease payments (number of periods x the periodic payment) is greater than £5000 must be signed on behalf of the Trust by Director of Finance or Associate Director of Financial Services.

When we lease an item from a company, the Finance department has to look at the nature of the transaction to see if the lease is really just a way of paying for a piece of equipment in instalments.

The Company will still say it’s an operating lease.

The Trust will still pay for it in a fixed number of monthly, quarterly or annual payments.

To everyone else it is still an operating lease or rental and we could recover the VAT in the same way as we would have done before.

BUT

The Trust must account for it differently if the item ‘smells’ i.e. gives the appearance of being owned by the Trust.

How the cost hits your budget

Operating Leases

Normal operating leases would be charged to your budget each year as we make the payments. The rentals would usually be charged to a lease expense number as an annual expense. The Trust has no other obligation to the company.

Operating Leases which are really Finance Leases

If the leased item is found to ‘smell’ it would no longer be treated in the Trust’s books as an operating lease, but instead would be treated as a finance lease i.e. as if we had bought the asset using external financing.

The value of this financed asset would be held to be approximately the value of the lease payments that will be paid over the length of the lease.

As an asset the cost to the trust wouldn’t be the usual revenue charge to the Trust, but the item would instead be treated like a capital asset and would be depreciated. The value of the asset would be depreciated across the length of the contract.

Because the asset is now being treated like a capital asset, the lease needs to have a business case submitted for approval by capital planning group just as if the budget holder had suggested buying the item.

This needs to happen before the lease is signed which is why any mention of the word lease in a contract and you need to immediately speak to your divisional accountant.

The Trust has to then put aside an amount of money equivalent to the total value of the payments and use this to make the annual payments. The total amount put aside in this manner is limited by Monitor to ensure that we do not get into too much debt as a Trust.

All new leases must ensure that this limit is not breached.

Does my lease ‘smell’ ?

The term ‘smell’ has been used by numerous people to describe what to look for.

Is the lease a straightforward rental for a period, after which the leasing company takes back the item and then refurbishes it and leases it again?

Or does it feel like the asset is really ours despite how we are paying for it ?

The following scenarios would suggest an item that ‘smells’ :

• if the Trust manages this piece of equipment as if it were its own and is responsible for insuring it, and maintaining it.

• if the total amount of the lease payments are pretty much the total value of the item and the item is worth negligible amounts at the end of the lease so it is unlikely to be sold on by the leasing company.

• If at the end of the lease we will be offered a further lease period for very small amounts of money – sometimes called peppercorn rentals.

• If we have the option to buy the item at the end of the lease for a very small amount of money and we have every intention of doing so.

• If the item is built into one of our buildings –e.g switchboard equipment

• If the item could only be used by this Trust, has been modified to suit us and so couldn’t be used by anyone else easily.

In each of those circumstances the asset is to all intents and purposes ours, the lease is really an HP agreement, even if it does say operating lease on it.

Equality Analysis / Impact Assessment

EAIA Assessment Form v3/2013

|Division/Department: | |Finance / Financial Services |

| | | |

|Title of policy, procedure, decision, | |PROC-FIN-0008 – Leases and Leased Assets. |

|project, function or service: | | |

| | | |

|Lead person responsible: | |Associate Director – Financial Services |

| | | |

|People involved with completing | | |

|this: | | |

Type of policy, procedure, decision, project, function or service:

Existing X

New/proposed

Changed

|Date Completed: |12th June 2014 |

Step 1 – Scoping your analysis

|What is the aim of your policy, procedure, project, decision, function or service and how does it relate to equality? |

|To advise staff of the requirements for accounting for leases under International Accounting Standards. |

| |

|Who is the policy, procedure, project, decision, function or service going to benefit and how? |

|Ensure the trust accounts for items correctly |

| |

|What barriers are there to achieving these outcomes? |

|none |

| |

|How will you put your policy, procedure, project, decision, function or service into practice? |

|Procedure available on the intranet and publicized to care groups |

| |

|Does this policy link, align or conflict with any other policy, procedure, project, decision, function or service? |

|No |

Step 2 – Collecting your information

|What existing information / data do you have? |

|International Financial Reporting Standards and Monitor’s Accounting Reporting Manual |

| |

|Who have you consulted with? |

|None |

| |

|What are the gaps and how do you plan to collect what is missing? |

|None |

Step 3 – What is the impact?

Using the information from Step 2 explain if there is an impact or potential for impact on staff or people in the community with characteristics protected under the Equality Act 2010?

|Ethnicity or Race |

|No |

| |

|Sex/Gender |

|No |

| |

|Age |

|No |

| |

|Disability |

|No. |

| |

|Religion or Belief |

|No |

| |

|Sexual Orientation |

|No |

| |

|Marriage and Civil Partnership (applies to workforce issues only) |

|No |

| |

|Pregnancy and Maternity |

|No |

| |

|Gender Reassignment |

|No |

| |

|Other socially excluded groups or communities e.g. rural community, socially excluded, carers, areas of deprivation, low literacy skills |

|etc. |

|No |

Step 4 – What are the differences?

|Are any groups affected in a different way to others as a result of the policy, procedure, project, decision, function or service? |

|No |

Does your policy, procedure, project, decision, function or service discriminate against anyone with characteristics protected under the Equality Act 2010?

Yes No x

|If yes, explain the justification for this. If it cannot be justified, how are you going to change it to remove or mitigate the affect? |

| |

Step 5 – Make a decision based on steps 2 - 4

|If you are in a position to introduce the policy, procedure, project, decision, function or service? Clearly show how this has been |

|decided. |

|Procedure to be introduced as this is a national requirement |

| |

|If you are in a position to introduce the policy, procedure, project, decision, function or service, but still have information to |

|collect, changes to make or actions to complete to ensure all people affected have been covered please list: |

| |

| |

|How are you going to monitor this policy, procedure, project or service, how often and who will be responsible? |

|Impact of this procedure to be reviewed on a rolling basis |

Step 6 – Completion and central collation

Once completed this Equality Analysis form must be forwarded to Jillian Wilkins, Equality and Diversity Lead. jillian.wilkins@cddft.nhs.uk and must be attached to any documentation to which it relates.

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