Financial Accounting: Analyzing Service Costs within Lease Contracts

This report addresses the accounting treatment of service costs within contracts to lease assets, as per the assignment brief. It emphasizes the need to separate the lease component from the service component, as per accounting standards. The report highlights that the lessee only controls the item's use in a lease, whereas the supplier often controls the item's use in service contracts. It explains that service contracts are generally not capitalized on the balance sheet and that the allocation of costs between lease and service components should be based on relative standalone prices. The report references the work of Deegan (2012) to support its claims and provides a clear explanation of how to account for the costs of service within a lease contract.

Contract to Lease an Asset 1
CONTRACT TO LEASE AN ASSET
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Contract to Lease an Asset 2
Question 11.8
How to account for costs of service that are encompassed in a lease contract of an asset
Essentially, the accounting standard requires that the lease element of the contract should be
separately considered from the contract of service. In most cases, the client does not obtain the
control of diverse resources as part of a services elements (Biondi, Bloomfield, Glover, Jamal,
Ohlson, Penman, Tsujiyama, and Wilks, 2011). Relatively, it necessitates that the purchased
services will be received in a future date and the supplier holds the significant control of the usage
of any item required to deliver the specific product or service. Therefore, with a lease, the purchaser
only controls the item use and with a service, the supplier often controls the usage of the item that
basically delivers the service (Deegan, 2012).
The overall principle, in this case, is that service contracts are not to be capitalized on the
statement of financial position. Since the contracts usually encompass both service component and a
lease, it is essential for a lessee to distinct the lease amounts from the amounts that will be paid in
regards to the arrangement of service (Deegan, 2012). A lessee, in this case, will then recognize on
the statement of financial position only the sum that basically relates to the component of the lease.
The amounts allocated for the non-lease (service) elements and the lease would be based on
comparative standalone costs which are on the lessor basis prices or another related supplier who
would charge on a separate ground for a related lease and for a related arrangement of service. If
apparent prices are inaccessible then the lessee will approximate the stand-alone prices (Deegan,
2012). In this case, the accounting standard consents, in apparent reaction to simplicity requests that
the lessee can make a decision that will not separate the services from the lease and then treat the
entire contract as the lease. Diverse, firms shall be required to select this apparent choice only when
the contract service component is reasonably small.

Contract to Lease an Asset 3
References
Biondi, Y., Bloomfield, R.J., Glover, J.C., Jamal, K., Ohlson, J.A., Penman, S.H., Tsujiyama, E.
and
Wilks, T.J., 2011. A perspective on the joint IASB/FASB exposure draft on accounting for
leases: American Accounting Association's Financial Accounting Standards Committee
(AAA FASC). Accounting Horizons, 25(4), pp.861-871.
Deegan, C., 2012. Australian financial accounting. McGraw-Hill Education Australia.