Introduction
The lease agreement is the most vital document protecting all involved parties’ interests and financial and legal ownership. Each organization decides which accounting type of lease is suitable: operating or finance. The decision procedure involves the lessee’s willingness to consider their risk levels and responsibilities during the rental period. In this case, Security Devices Inc. (SDI) should choose operating lease agreements and avoid categorization under International Financial Reporting Standards (IFRS).
Preferred Lease Classification
The vital thing is that the lessor and lessee should agree on the arrangement of the asset’s ownership. While a finance lease forces the lessee to acknowledge all ownership and responsibility regarding the asset, the operating lease does not. Since SDI, as the lessee, prioritizes the exclusion of lease in the income statement, it is better to choose an operating lease. In this arrangement, SDI pays periodic rental payments without including liability on its balance sheet (Cote, 2021).
Regarding the income sheet, only rental payments are included. In contrast, a finance lease forces the lessee to include all interest rates and depreciation payments, which disrupts SDI’s smooth income. Hence, SDI needs an operating lease, which ignores liability in the income sheet and includes only periodic payments.
Meeting Reporting Objectives Under IFRS
The same decision procedure applies to International Financial Reporting Standards (IFRS) classification. When the object is reported under IFRS, it should be recognized as a liability and an asset in the balance sheet. Thus, the lessee must calculate interest rates and include its income statements, which also interferes with smooth income (Ali, 2021). It happens because IFRS declares narrower classification criteria, as most objects are forced to be recognized as finance leases. If the SDI wants to avoid income statement effects, it should be ready for more difficulties under IFRS.
Conclusion
To conclude, a company like SDI is more likely to choose an operating lease since it aims to avoid including the assets in the income statement. In such cases, the company only considers rental payments without acknowledging the lease as an asset or liability. Moreover, SDI should be ready to experience more difficulties with the lease categorization under IRFS, as it is more likely to be reported as the lease liability included in the balance and income statements.
References
Ali, A. (2021). IFRS 16 leases: Summary, example, journal entries, and disclosures. Lease Query. Web.
Cote, C. (2021). What is lease accounting and why is it important? Harvard Business School Online. Web.