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First, we will analyze the junior accountant’s work. The junior accountant of Lessee thought that “since the equipment reverts back to Lessor Inc., it is an operating lease.” However, this was incorrect because based on the IAS 17, paragraph 10 – Accounting for Leases:
“Situations that would normally lead to a lease being classified as a finance lease include the following:
• the lease term is for the major part of the economic life of the asset, even if title is not transferred
• at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset”
The Lessee would lease the equipment for three years and the useful life for the equipment was four years. As a result, the lease term was 75% (exhibit 1) of the economic life of the asset. Moreover, the present value of the annual payments would be $263,716 and the fair value of asset was only $265,000. The present value of the minimum lease payment would be 99.5% (exhibit 1) of the fair value of the leased asset. These situations would satisfy the requirement of IAS 17 to determine the lease as a finance lease.
Next, we will look at the senior accountant’s work. The senior accountant’s analysis was correct because he/she determined the lease as a finance lease based on the fact that the lease term was for the major part of the economic life of the asset. However, in order to calculate the lease asset and obligation the senior accounting used the incremental borrowing rate. IAS 17, paragraph 20 requires that:
“The following principles should be applied in the financial statements of lessees:
• at commencement of the lease term, finance leases should be recorded as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments (discounted at the interest rate implicit in

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