According to IAS 17, lease payments for an operating lease must be recognized as an expense on a straight-line basis over the lease term, regardless of the timing of cash payments. The total payments over the 5-year lease term are $200,000 (4 payments × $50,000). The annual straight-line expense is therefore $40,000 ($200,000 / 5 years).

For the year ended 31 December 20X8, LM recognizes a lease expense of $40,000. However, the cash paid during this first year was $0. The difference between the expense recognized ($40,000) and the cash paid ($0) results in a liability, which is an accrual of $40,000 on the statement of financial position.

B. An accrual of $50,000 was recognised.

This is incorrect. $50,000 is the annual cash payment from year two onwards, not the straight-line annual expense or the resulting accrual in year one.

C. A prepayment of $10,000 was recognised.

This is incorrect. A prepayment arises when cash paid exceeds the expense recognized. In this case, the expense recognized is greater than the cash paid.

D. An expense of $50,000 was recognised.

This is incorrect. The expense must be calculated on a straight-line basis over the entire lease term, not based on the cash payment amount for a specific year.

1. International Accounting Standards Board (IASB). (2003). International Accounting Standard 17 Leases.

Paragraph 33: "Lease payments under an operating lease shall be recognised as an expense on a straight-line basis over the lease term unless another systematic basis is more representative of the time pattern of the user’s benefit." This paragraph directly mandates the straight-line method used in the calculation.

2. Kieso

D. E.

Weygandt

J. J.

& Warfield

T. D. (2020). Intermediate Accounting

IFRS Edition (4th ed.). John Wiley & Sons.

Chapter 21

Leases

Section on Operating Lease - Lessee: This chapter explains that for operating leases with uneven payment patterns (such as a rent-free period)

the total lease payment is allocated evenly over the lease term. The difference between the recognized expense and the cash paid in a period is recorded as a lease liability (accrual) or lease asset (prepayment).

3. University of Cambridge

Judge Business School. (n.d.). MFin Accounting Course Materials - Module on Leases.

Section: Accounting for Operating Leases under IAS 17: Course notes illustrate that when lease payments are not made on a straight-line basis (e.g.

rent holidays)

the total cost is annualized. For a rent-free initial period

an expense is recognized along with a corresponding accrual

reflecting the consumption of the economic benefit of using the asset.