S4-S7: What are Leases?

Accounting for Leases

• An Introduction to Leases
• Accounting of Leases by Lessee
• Accounting of Leases by Lessor
• Other Lease Topics

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 Introduction - What is a lease?

A contract granting use or occupation of property during

a specified period in exchange for a specified rent
(layman’s definition).

FRS116:9 …A contract that conveys to the customer

(lessee) the right to use an asset for an agreed period of
time in exchange for consideration

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Introduction - Why do businesses choose
to lease (vs. buy/sell) assets?

For lessee For lessor

a.No down payment (i.e., 100% a. Increased sales — more options
financing, free up cash flow) for customers

b.Avoid risks of ownership (e.g., b. Ongoing business relationship

obsolescence, changing
economic conditions, physical
deterioration)
c. Flexibility — can more easily
replace assets in response to
business changes
with lessee
c. Residual value retained if title
does not transfer to lessee at
end of lease

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Introduction - New Lease Standard
▪ New standard FRS 116 Leases prescribes, for both lessee and
lessor, the accounting treatment for leases
▪ Effective date is 1 January 2019
▪ Replaces FRS 17, INT FRS 15, INT FRS 27 & INT FRS 104
▪ FRS 17 was criticised for condoning non-recognition of leases
in lessee’s balance sheet
▪ New FRS 116 requires lessee to recognise (with optional
exemptions)
▪ An asset for the right created by lease, and depreciation
expense for asset
▪ A liability for the obligation created by lease, and interest
expense for liability

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Introduction- FRS 116 Leases

• Definition of lease:

A contract that conveys the right to the customer (lessee) to control

the use of an identified asset for a period of time in exchange for
consideration

• Conditions:
– There must be an identified asset
– The entity has the right to control the use of the identified asset
throughout the period of use

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 Introduction - Identification of a
Lease in FRS 116
• At contract inception, an entity to determine whether a
contract is or contains a lease by assessing both conditions:
– Condition (A): There must be an identified asset
• Use of an identified asset is either explicitly or implicitly
specified
• Supplier does not have the substantive right to
substitute the asset.
• Supplier’s right to substitute an asset is substantive
only if
– Supplier has practical ability to substitute alternative
assets throughout the period of use
– Supplier would benefit economically from exercising
its right to substitute asset
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 Introduction - Identification of a
Lease in FRS 116
• At contract inception, an entity to determine whether a
contract is or contains a lease by assessing both conditions:
– Condition (B): Lessee has both the right to:
• Obtain substantially all the economic benefits from use
of the identified asset, and
• Direct the use of the identified asset
– Distinction between a lease and a service will be
critical
– A lease (service) exists when the customer
(supplier) controls the use of an identified asset

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Lessee - FRS 116 Leases

• For lessees, FRS 116 introduces a single accounting

model
– All leases will be brought onto the balance sheet as
finance leases
– Optional exemptions for leases with lease term less
than or equal to 12 months, and leases for assets
with low values (e.g. office equipment and furniture)

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Lessee - FRS 116 Leases
• What expenses does the lessee incur in these
circumstances?
➢ Single Accounting Model

▪ “Sale” of asset by lessor to the lessee

▪ Depreciation and interest expenses

➢ Low-value leases, Short-term leases

▪ Rental of asset by lessor to the lessee

▪ Rental expense

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