LEASES

GOVERNING RELATED STANDARD:

PFRS 16 – LEASES
PFRS 16, the new accounting standard for leases, is effective for
annual periods beginning on or after January 1, 2019.
LEARNING OBJECTIVES

• Identify a lease.
• Account for leases by a lessee using the general
recognition.
• Account for leases by a lessee using the recognition
exemption.
• Identify the lease classifications by a lessor.
• State the indicators of a finance lease.
• Account for a finance lease by a lessor.
• Account for an operating lease by a lessor.
 LEASE CONTRACTS

“A contract is, or contains, a lease if the

contract conveys the right to control the use
of an identified asset for a period of time in
exchange for consideration.” (PFRS 16.9)
The following are the parties to a lease contract:

a. LESSEE – “party that obtains the right to use an

underlying asset for a period of time in exchange
for consideration”

b. LESSOR – “party that provides the right to use

an underlying asset for a period of time in
exchange for consideration”
 RIGHT TO CONTROL
An entity has the right to control the use of an identified asset if
it has both of the following throughout the period of use:

a. the right to obtain substantially all of the economic

benefits from use of the identified asset; and

b. the right to direct the use of the identified asset.

 IDENTIFIED ASSET

An asset that is explicitly stated in the face of the

contract or being implicitly specified at the time
the asset is made available for use by the
customer.

A portion of an asset can be identified if it is

physically distinct.
 SUBSTANTIVE SUBSTITUTION
RIGHTS
A customer does not have the right to use an identified asset if
the supplier has the substantive right to substitute the asset
throughout the period of use.

A supplier’s right to substitute an asset is substantive if both of

the following conditions exist:

a. the supplier has the practical ability to substitute alternative

assets throughout the period of use; and
b. the supplier would benefit economically from the exercise
of its right to substitute the asset.
 RIGHT TO USE ECONOMIC
BENEFITS FROM USE
A customer controls the use of an identified asset if it has
the right to obtain substantially all of the economic
benefits from the asset throughout the period of use.

This include potential inflows from the assets output,

which can be obtained directly or indirectly from using,
holding or sub-leasing the asset.
RIGHT TO DIRECT THE USE

A customer has the right to direct the use of an identified

asset throughout the period of use if:

a. The customer has the right to direct how and for what
purpose the asset is used throughout the period of
use; or
b. The asset’s use is predetermined and the supplier is
precluded from changing the predetermined use.
 LEASE TERM
“the non-cancellable period of a lease, together
with both:

a. Periods covered by an option to extend the

lease if the lessee is reasonably certain to
exercise that option; and
b. Periods covered by an option to terminate the
lease if the lessee is reasonably certain not to
exercise that option.”
ACCOUNTING FOR LEASES BY
LESSEE
GENERAL RECOGNITION
At initial recognition the Lessee recognizes both:
1. Lease liability; and
2. Right-of-use asset
At the commencement date.

RECOGNITION EXEMPTION
(for ‘short-term” and ‘low value’ leases)Lessee recognizes
lease payments as expense over the lease term using straight
line basis, or another more appropriate basis.
INITIAL MEASUREMENT OF LEASE
LIABILITY
The lease liability is initially measured at the PRESENT VALUE of the
LEASE PAYMENTS that are not yet paid as at the commencement
date.

LEASE PAYMENTS include the following:

a. Fixed payments, including in substance fixed payments, less any
lease incentives receivable;
b. Variable lease payments that depend on an index or a rate, initially
measured using the index or rate as at the commencement date;
c. Amounts expected to be payable by the lessee under residual value
guarantees;
d. The exercise price of a purchase option if the lessee is reasonably
certain exercise that option; and
e. Payments of penalties for terminating the lease, if the lease term
reflects the lessee exercising an option to terminate the lease. (PFRS
16.27)
 DISCOUNT RATE

Discount rate is the interest rate implicit in the

lease; if not determinable, then the lessee’s
incremental borrowing rate.
INITIAL MEASUREMENT OF RIGHT-
OF-USE ASSET
The asset is initially measured at cost.

The costs include the following:

a. The amount of the initial measurement of the lease
liability;
b. Any lease payments made at or before the
commencement date, less any lease incentives received;
c. Any initial direct costs incurred by the lessee; and
d. The present value of any decommissioning and
restoration costs for which the entity has incurred an
obligation, unless those costs are incurred to produce
inventories. (PFRS 16.24)
 SUBSEQUENT MEASUREMENT OF
LEASE LIABILITY
The lease liability is subsequently measured similar to an
amortized cost financial liability subject to remeasurement
to reflect any reassessments and lease modifications.

a. The interest expense shall be computed using the

effective interest method and recognized in profit or loss.
b. Lease payments are apportioned between the interest and
a reduction to lease liability.
 SUBSEQUENT MEASUREMENT OF
RIGHT-OF-USE ASSET
Generally, the asset shall be subsequently measured under
the cost model, except when:

a. The asset relates to a class of PPE that is measured under

the revaluation model, in which case, the asset may be
measured under the revaluation model.
b. The asset meets the definition of an investment property
and the entity uses the fair value model, in which case,
the asset maybe measured under the fair value model.
 RECOGNITION EXEMPTIONS
A lessee may elect not to apply the recognition requirements described earlier for:

a. Short term leases;

b. Leases for which the underlying asset if of low value.

SHORT TERM LEASE

“a lease that at the commencement date, has a lease term of 12 months or less.”
Note: A lease that contains a purchase option is not a short term lease.

LOW VALUED ASSET

The assessment value is based on the value of the asset when it is NEW, regardless
of the age of the asset being leased.

The asset is performed on an absolute basis, meaning it is not affected by

materiality or the lessee’s size, nature or circumstances.

Examples of assets with low value include tablet and personal computers, small
items of office furniture and telephones.
ACCOUNTING FOR SHORT TERM LEASE
ASSETS AND ASSETS WITH LOW VALUES

An entity may elect to recognized the lease payments as

an expense on a straight line basis over the lease term,
unless another systematic basis is more representative of
the pattern of the lessee’s benefits.
 SEPARATING COMPONENTS OF A
CONTRACT
An entity accounts for each lease component of a contract separately
from the non-lease components of the contract.

A lessee allocates the consideration in the contract to each lease

component on the basis of the relative stand-alone price of the lease
component and the aggregate stand-alone price of the non-lease
components.

Payments for activities or costs that do not transfer goods or services to

the lessee are not a separate component of the contract. The payments
for these items are included in the total consideration that is allocated to
the separately identified components of the contract.
 INITIAL DIRECT COSTS

• A lessee capitalizes initial direct costs as follows:

LEASE PAYMENTS MADE TO LESSOR AT
OR BEFORE COMMENCEMENT DATE
ACCOUNTING FOR LEASES BY
LESSOR
A lessor classifies each of its leases as either a finance lease or an
operating lease.

CLASSIFICATION OF LEASE BY THE LESSOR

1. Finance lease - a lease that transfers substantially all the

risks and rewards incidental to ownership of an asset. Title
may or may not eventually be transferred.
2. Operating lease - a lease other than a finance lease.
Whether a lease is a finance lease or an operating lease
depends on the substance of the transaction rather than the
form of the contract.

The following are the indicators of a finance lease.

1. Transfer of ownership.
2. Bargain purchase option
3. Lease term is at least 75% of the useful life of the leased
asset.
4. Present value of minimum lease payments is at lease 90%
of the fair value of the leased assets at the inception of the
lease.
5. Leased asset is of specialized nature.
Any of the following could also led to a lease being
classified as a finance lease:

a. If the lessee can cancel the lease, the lessor’s

losses associated with the cancellation are borne
by the lessee;
b. Gains or losses from the fluctuation in the fair
value of the residual accrue to the lessee; and
c. The lessee has the ability to continue the lease for
a secondary period at a rent that is substantially
lower than the market rent.
 INCEPTION AND COMMENCEMENT OF
LEASE
INCEPTION DATE – the earlier of (a) the ate of the lease agreement
and (b) the date of commitment by the parties to the principal provisions
of the lease. As at this date:
a. Lease is classified as either an operating lease or a finance lease; and
b. In the case of a finance lease, the amount to be recognized at the
commencement date are determined.

COMMENCEMENT DATE – the date on which a lessor makes and

underlying asset available for use by a lessee. It is on this date that the
lessee is entitled to exercise its right to use the leased asset.

The date of commencement is the date of initial recognition for the lease.
However, the amounts are determined at the inception date.
ACCOUNTING FOR LEASES BY
LESSOR
INITIAL RECOGNITION
Lessors recognize assets from a finance lease as receivable measured at an
amount equal to the net investment in the lease.

NET INVESTMENT – “the gross investment discounted at the interest

rate implicit in the lease

GROSS INVESTMENTS – the sum of

a. The lease payments receivable by the lessor under a finance lease; and
b. Any unguaranteed residual value accruing to the lessor.

The difference between the Gross Investment and Net Investment shall be
treated as Unearned Finance Income.
 LEASE PAYMENTS

The lease payments comprise the following:

a. Fixed lease payments, including in-substance, less lease
incentives payable
b. Variable lease payments based on index or rate
c. Guaranteed residual value
d. Exercise price of purchase option if the lessee is
reasonably certain to exercise that option; and
e. Payments of penalties for terminating the lease, if the
lease term reflects the lessee exercising an option to
terminate the lease.
 DISCOUNT RATE

The discount rate to be used in calculating the present value of

the lease payments is the interest rate implicit in the lease.
Interest rate implicit in the lease – the rate of interest that causes
the present value of (a) the lease payments and (b) the
unguaranteed residual value to equal the sum of (i) the fair value
of the underlying asset and (ii) any initial direct costs of the
lessor.
 INITIAL DIRECT COSTS

Initial direct costs are capitalized except direct costs

incurred by a manufacturer or dealer lessor under a sales
type lease, which are expensed immediately.
The interest rate implicit in the lease is defined in such a
way that the initial direct costs are included
automatically in the net investment in the lease; there is
no need to add them separately.
CLASSIFICATION OF FINANCE
LEASE AS TO THE LESSOR

As to the lessor, finance leases may be

classified as either:
a. Direct financing lease, or
b. Sales type lease
ACCOUNTING FOR OPERATING
LEASE
The accounting for operating leases is straight-forward. The
lessor recognizes the lease payments as rent income on a
straight line basis over the lease term, unless another
systematic basis is more representative of the time pattern
of user’s benefit.
 LEASE BONUS

Lease bonus is an amount, in addition to periodic rentals,

paid by a lessee to the lessor in order to induce granting of
leasehold rights to the lessee.

The lessor accounts for the lease bonus as unearned rent to

be amortized to rent income over the lease term.