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Accounting for transactions related to Indigenous housing arrangements (40 year lease)

Purpose

This bulletin provides local governments with guidance to assist in determining the appropriate accounting treatment for transactions relating to Indigenous housing arrangements (40 year lease).

It also provides example disclosures for the 2010-11 financial year.

Background

As part of the National Partnership Agreement on Remote Indigenous Housing, the State Government (through the Department of Communities) recently announced new tenancy arrangements in a number of Aboriginal and Torres Strait Islander communities, whereby the State Government would enter into a social housing lease with Councils to directly manage houses in the community for 40 years. The new lease arrangements will enable the State Government to build new, and upgrade existing housing in an attempt to improve housing standards in the community, by focusing on addressing issues currently associated with council housing in Aboriginal and Torres Strait Islander communities, such as overcrowding.

Further information on the new tenancy arrangements can be obtained from the Department of Communities (DOC).

Overview of the Bulletin

This Bulletin includes the following topics:

The accounting treatment for transactions generated at the end of the 40 year lease life will not be covered by this bulletin.

Initial accounting treatment

On the date that the State Government (through DOC) and Council agree to enter into the 40 year Indigenous housing lease arrangement, the affected local government will need to:

  1. de-recognise the houses / freehold land (where applicable) that form part of the arrangement as Housing Assets / Freehold land; and
  2. recognise the creation of a finance lease asset receivable.

Typically, these housing assets will have been valued at fair value less accumulated depreciation in the financial statements of the local government.

In the majority of cases, no action is required in relation to the land upon which these houses are located, as councils are typically trustees of such land under a Deed of Grant in Trust (DOGIT). DOGIT land is not valued or recognised in the statement of financial position of the council.

However, in a limited number of cases where the land upon which the housing asset is located is held by the council under a freehold title, both land and housing assets will be leased to the State Government. In this particular circumstance, the land asset will have been recognised in the financial statements of the council and valued at fair value in accordance with AASB 116 Property, Plant & Equipment. Freehold land and buildings will be treated as separate elements for lease classification purposes. Minimum lease payments will be allocated between land and buildings, in proportion to the relative fair values of the leasehold interests in the land element and buildings element of the lease, at the inception of the lease.

Under the terms and conditions of the 40 year Indigenous housing lease arrangement, the State Government (as lessee) will assume substantially all the risks and rewards incidental to ownership. In addition to receiving rental income from the leased property, the State Government will also assume responsibility for capital works and repairs and maintenance of the houses. As such, 40 year Indigenous housing leases should be classified as a finance lease (in accordance with AASB 117 Leases) in the financial statements of the lessor (i.e. the affected Aboriginal and Torres Strait Island Councils).

The table below summarises the steps that affected local governments should take in recognising the creation of the finance lease:

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Step 1 Calculate the value of the receivable associated with the 40 year finance lease
Step 2 Derecognise houses / freehold land as assets and recognise the creation of the lease
Step 3 Recognise receipt of the once-off upfront payment to Council by the State Government

Step 1: Calculate the value of the receivable associated with the 40 year finance lease

The lease receivable asset associated with the 40 year finance lease will be comprised of:

  1. the once-off upfront payment to Council by the State Government; plus
  2. the present value of the annual lease payments from the State Government.

The annual payments component of the lease receivable will need to be discounted to present value by using the following formula:

formula

Where:
i = the implicit interest rate
n = 40 years (life of lease term and number of periods to discount annual lease payments)

Alternatively Councils can opt to use an online calculator, for example: [LINK: http://www.investopedia.com/calculator/AnnuityPV.aspx]

Whilst no implicit interest rate is specified in the 40 year lease documents, Councils must still apply a discounting factor to calculate the present value of the annual lease payments to be received over the lease life, in order to satisfy the requirements of paragraph 20 of AASB 117 Leases.

DOC has advised that as lessee, it will be using an implicit interest rate / discounting factor of 6.06% for the 2010-11 financial reporting period. This rate was provided to DOC by Queensland Treasury Corporation and is based on the average 10-year fixed rate for borrowings for 2010-11. It is recommended that Councils use this discounting factor as the implicit interest rate.

Step 2: Derecognise houses / freehold land as housing assets and recognise the creation of the lease

The following journal entry will be used to derecognise houses / freehold land as housing assets and recognise the creation of a finance lease asset receivable:

Dr Lease Receivable AA
Dr Accumulated Depreciation (Housing) BB
Cr Housing Assets / Freehold Land CC
Dr/Cr Loss / Gain on de-recognition of Housing Assets / Freehold Land subject to a finance lease DD

Where:
AA = agreed upfront payment + present value of agreed annual payments
BB = depreciation accumulated to date on the existing houses that form part of the housing arrangements
CC = fair value of houses / freehold land that form part of the housing arrangements as recorded in Council’s accounting system (there is no need to revalue prior to the lease transaction)
DD = (AA + BB – CC)

Step 3: Recognise receipt of the once-off upfront payment to Council by the State Government

The following journal entry will be used to recognise the receipt of the once-off upfront payment by the State Government, in relation to the finance lease:

Dr Cash at Bank AA
Cr Lease Receivable AA

Where:
AA = agreed upfront payment

Subsequent accounting treatment of lease over the 40 year lease life

Each year local governments will need to recognise the receipt of the annual lease payment from the State Government and reduce the value of its lease receivable, by processing the following journal entry:

Dr Cash at Bank AA
Cr Lease Receivable BB
Cr Interest Revenue on Lease Receivable CC

Where:
AA = agreed annual lease payment
BB = portion of agreed annual lease payment that relates to the principal reduction
CC = portion of agreed annual lease payment that relates to the finance charge component

Disclosures

Affected local governments will need to provide information about the Indigenous housing lease arrangement, as well as the transfer of the public housing assets to the State Government, in the notes to the financial statements.

AASB 117 paragraph 47 outlines the disclosures that would be necessary given the Indigenous housing lease arrangements:

(a) a reconciliation between the gross investment in the lease at the end of the reporting period, and the present value of minimum lease payments receivable at the end of the reporting period. In addition, an entity shall disclose the gross investment in the lease and the present value of minimum lease payments receivable at the end of the reporting period, for each of the following periods:
       (i) not later than one year;
        (ii) later than one year and not later than five years;
        (iii) later than five years;
(b) unearned finance income;
(c) the unguaranteed residual values accruing to the benefit of the lessor;
(d) the accumulated allowance for uncollectible minimum lease payments receivable;
(e) contingent rents recognised as income in the period; and
(f) a general description of the lessor’s material leasing arrangements.

The table below summarises the recommended additions / amendments to Council’s existing notes to the financial statements:

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Financial Assets and Liabilities Accounting Policy Note
  • Insert finance lease asset receivable measurement base in financial asset sub-heading
Other Financial Assets Accounting Policy Note
  • Insert details of the Indigenous housing lease arrangement (as illustrated in Attachment 2).
Leases Accounting Policy Note
  • Insert details of “finance leases asset”.
  • Amend finance leases title to “finance leases liability”.
Finance Leases and Hire Purchase Commitments Receivable note
  • New note to be added.

Example disclosures for the above Significant Accounting Policies note and Finance Leases and Hire Purchase Commitments Receivable note are included in Attachment 2. The disclosures follow the Tropical’s sample financial statement examples.

Initiative to enable eligible people to become homeowners on Indigenous land via a 99 year lease for private residential purposes

Legislative reforms introduced in 2008 enable eligible persons to become homeowners on Indigenous land by acquiring a 99 year lease for private residential purposes.

Given its complexity, this subject will not be addressed as part of this bulletin. A separate bulletin discussing this issue in greater detail will be released by the Department at a later date,. It will also discuss the accounting implications associated with the surrender of a 40 year lease to allow a 99 year home ownership lease to take place.

Relevant Accounting Standards

The following Accounting Standards are relevant to this bulletin:

  • AASB 7 Financial Instruments: Disclosures
  • AASB 117 Leases

The latest versions of these Accounting Standards can be accessed online.

Further information

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