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ACCA Applied Knowledge · Financial Accounting · The regulatory framework

A standard includes a rule that a lease is treated as a finance lease only if the lease term is at least 75% of the asset's life. Entity X signs a lease for 74% of the asset's life, with terms that otherwise transfer substantially all risks and rewards to X, and treats it as an operating lease. Which statement is correct?

This illustrates a weakness of a rules-based approach. The 75% bright-line test lets the lease be structured just below the threshold, so operating lease treatment results even though substantially all risks and rewards transfer. A principles-based approach would focus on the substance of the arrangement instead.

  1. AThis illustrates a rules-based weakness, as the bright-line threshold allows a result inconsistent with substanceCorrect
  2. BThis illustrates a principles-based approach, because judgement of substance was applied
  3. CThis is required under IFRS because thresholds must always be followed exactly
  4. DThis shows that convergence has failed because X is outside the US

Explanation

The 75% threshold is a bright-line rule. Structuring a term at 74% avoids finance lease treatment even though substance indicates risks and rewards are transferred. This is the classic rules-based weakness, whereas a principles-based approach would focus on substance.

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