Tutorial 4

At the inception of the lease, Sugar Co recognises a right-of-use asset and a lease
liability. The right-of-use asset is measured at the amount of the lease liability, which is
the present value of the future lease payments discounted at the rate of interest implicit in
the lease, here $250,000. At 31 December, the right-of-use asset is measured at cost less
accumulated depreciation: $250,000- ($250,000/4) = $187,500. The lease liability is
measured by increasing the carrying amount to reflect interest on the lease liability and
reducing the carrying amount to reflect the lease payments made.

Lupin part (c)

Exposure draft ED 2019/5 proposes amendments to IAS12 to clarify that the recognition
exemption in IAS 12 does not apply to assets and liabilities that arise from a single
transaction.
The recognition exemption in IAS 12 is that deferred tax is not recognised on temporary
differences that arise from the initial recognition of an asset or a liability, provided that
the asset or liability was not acquired in a business combination and provided the
transaction that resulted in the recognition of the asset or liability had no effect an
accounting profit or taxable profit.
Divergence has arisen in practice over whether deferred tax should be recognised for
transactions which, on initial recognition, result in the recognition of an asset and a
related liability.
For example, when an entity first accounts for a lease transaction, it recognizes both an
asset (a right-of-use asset) and a liability (a lease liability). There is no effect on
accounting profit or taxable profit when the lease is first accounted for.
At present, it is not clear in IAS 12 whether the initial recognition exemption applies in
this situation. Some entities have therefore recognised deferred tax related to the lease
believing the recognition exemption does not apply, while other entities have not
recognised any deferred tax, believing that the recognition exemption does apply.
Effect in Lupin
Assuming that Lupin takes the advice provided in part (a) and recognizes deferred related
to the temporary difference arising on the right-of-use asset and the lease liability, there
would be no effect of the amendments on Lupin’s deferred tax calculation in relation to
leases.

Carson part (a)

Under IFRS 16 Leases, Carsoon is a lessor and must classify each lease as an operating
or finance lease. A lease is classified as a finance lease of it transfers substantially all of
the risks and rewards incidental to ownership of the underlying asset. All other leases are
classified as operating leases. Classification is made at the inception of the lease.
Whether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the form.
In this case, the leases are operating leases. The lease is unlikely to transfer ownership of
the vehicle to the lessee by the end of the lease term as the option to purchase the vehicle
is at a price which is higher than fair value at the end of the lease term. The lease term is
not for the major part of the economic life of the asset as vehicles normally have a length
of life of more than three years and the maximum unpenalised mileage is 10,000 miles
per annum. Additionally, the present value of the minimum lease payments is unlikely to
be substantially all of the fair value of the leased asset as the price which the customer
can purchase the vehicle is above market value, hence the lessor does not appear to be
received an acceptable return by the end of the lease. Carsoon also stipulates the
maximum mileage and maintains the vehicles. This would appear to indicate that the
risks and rewards remain with Carsoon.

Carsoon should account for the leased vehicles as property, plant and equipment (PPE)
under IAS 16 Property, Plant and Equipment and depreciate them taking into account the
expected residual value. The rental payments should go to profit or loss on a straight-line
basis over the lease term. Where an item of PPE ceases to be rented and becomes held for
sale, it should be transferred to inventory at its carrying amount. The proceeds from the
sale of such assets should be recognized as revenue in accordance with IFRS 15 Revenue
from Contracts with Customers.
IAS 7 Statement of Cash Flows states that payments from operating activities are
primarily derived from the principal revenue-producing activities of the entity. Therefore,
they generally result from the transactions and other events which enter into the
determination of profit or loss. Therefore, cash receipts from the disposal of assets
formerly held for rental and subsequently held for sale should be treated as cash flows
from operating activities and not investing activities.

Blackcutt part (b) Lease

The issue here is whether the arrangement with the private sector provider Waste and Co
is, or contains, a lease, even if it does not take the legal form of a lease. The substance of
the arrangement should be considered in connection with the IFRS 16 Leases. Key
factors to consider are as follows.
(i) Is there an identifiable asset?
(ii) Does the customer have the right to obtain substantially all the economic benefits
from use of the asset throughout the period of use?
(iii) Who has the right to direct how and for what purposes the asset is used?
(iv) Does the customer have the right to operate the asset throughout the period of use
without the supplier having the right to change those operating instructions?
The answer in each case is yes.
(i) The vans are an identifiable asset. Although Waste and Co can substitle another
vehicle if one of the existing vehicles needs repairing or no longer works, this substantive
because of the significant costs involved in fitting out the vehicle for use by Blackcutt.
(ii) Blackcutt can use the vehicles and uses them exclusively for waste collection for
nearly all their life. It therefore has a right to obtain substantially all the economic
benefits from the use of the asset.
(iii) Blackcutt controls the vehicles, since it stipules how they are painted, and ostensibly
owns them because they must be painted with Blackcutt’s name. It therefore has the right
to direct how and for what purpose the asset is used.
(iv) As indicated in (ii) above, Blackcutt has the right to operate the asset throughout the
period of use, although it has outsourced the driving to Waste and Co.
The arrangement ia a lease. Aright-of-use asset should be recorded, and a lease liability
set up, equal to present value of the future lease payments. The service element relating
to the waste collection must be considered as a separate component and charged to profit
or loss.

Part I Provision
Under IAS37 Provisions, Contingent Liabilities and Contingent Assets, Provisions must
be recognized in the following circumstances, and must not be recognized if they do no
apply.
(i) There is a legal or constructive obligation to transfer benefits as a result of past events.
(ii) It is probably that an outflow of economic resources will be required to settle the
obligation.
(iii) A reliable estimate of the amount required to settle the obligation can be made.
A legal or construction obligation is one created by an obligating event. Here the
obligating event is the contamination of the land, because of the virtual certainty of
legislation requiring the clean-up. As Blackcutt has no resource against Chemco or its
insurance company this past event will certainly give rise to a transfer of economic
benefits from Blackcutt.
Consequently, Blackcutt must recognize a provision for the best estimate of the clean-up
costs. It should not set up a corresponding receivable, since no reimbursement may be
obtained from Chemco or its insurance company.
Part (d) Impairment of building
The basic principle of IAS 36 Impairment of Assets is that an asset should be carries at
no more than its recoverable amount, that is, the amount to be recovered through use or
sale of the asset. If an asset’s value is higher than its recoverable amount, an impairment
loss has occurred. The impairment loss should be written off against profit or loss for the
year.
Entities must determine, at each reporting date, whether there are any indications that
impairment has occurred. In this case, impairment is indicated because the use to which
the building is to be put has changed significantly (from a school to a library), a situation
which will continue for the foreseeable future.
The recoverable amount is defined as the higher of the assest’s fair value less costs to sell
and the asset’s value in use. However, these values are unavailable because of the
specialized nature of the asset, and the only information available is depreciated
replacement cost. Using a depreciated replacement cost approach, the impairment loss
would be calculated as follows.
Cost/replacement Accumulated Carrying
amount/
Asset cost depreciation 6/25 replacement
cost
$’000 $’000
$’000
School 5,000 (1,200)
3,800
Library 2,100 (504)
(1,596)
Impairment loss
2,204
Blackcutt should therefore recognize an impairment loss of $2.204 million in profit or
loss for the year.