Republic of the Philippines

CENTRAL LUZON STATE UNIVERSITY

Science City of Muñoz, Nueva Ecija
Accounting 2200 – Intermediate Accounting 2
LESSON 7: LEASES
(IFRS 16)
Defined
- a contract or part that conveys the right to use the underlying asset for a period of time in exchange for
consideration (Appendix A)
- the contract must convey the right to control the use of an identified asset (Appendix B9)
- IDENTIFIED ASSET – explicitly specified in a contract or implicitly specified when made available to the
customer, i.e. a physically distinct portion of an asset such as floor of a building (Appendix B13)
Right to control the use of an asset
✓ Obtain substantially all of the economic benefits from the use of identified asset – the customer has
“exclusive use” of the asset through the period of use
✓ Direct use of identified asset
Parties: Lessee – the entity that obtains the right to use an underlying asset for a period of time in exchange for
consideration; Lessor – the entity that provides the right to use for a period of time in exchange for consideration.
Types of Lease
1. Finance Lease – lease that transfers substantially all the risk and rewards incidental to ownership of an asset.
Title may or may not eventually be transferred.
2. Operating Lease – lease other than finance lease.

Dates Relevant to a Contract of Lease

INCEPTION DATE COMMENCEMENT DATE
The earlier between the date of agreement or commitment The date when the lessee is entitled to exercise its right to
by the parties on the terms of the lease. the lease assets.
Amounts to be recognized at the commencement date are Initial recognition of assets, liabilities, income and
determined. expenses.
Classification of the lease, as to whether finance or
operating is determined.

Operating Lease Model

A lessee is permitted to make an accounting policy election to apply the operating lease accounting and not recognize
an asset and lease liability in two optional exemptions:
a. Short-term lease
b. Low value lease

If the lessee elects to apply the operating lease accounting under the two exemptions, the lessee shall
recognize the lease payments as an expense in either a straight-line basis over the lease term or another
systematic basis (if its more representative of the pattern of the lessee’s benefit); the periodic rental is simply
recognized as rent expense on the part of the lessee.

>SHORT-TERM LEASE
✓ 12 months or less from the commencement date
✓ A LEASE WITH PURCHASE OPTION IS NOT A SHORT-TERM LEASE
✓ Made by class of asset – a grouping of underlying assets of similar nature and use in an entity’s operations.

>LOW VALUE LEASE

✓ Matter of professional judgment
✓ Assessment shall be based on the value of the asset when it is new regardless of the age of the asset being
leased; made on lease by lease basis
✓ “A lease of an underlying asset does not qualify as a low value lease if the nature of the asset is such that the
asset is typically not of low value when new”

Finance Lease Model for Lease

FINANCE LEASE – LESSEE
✓ All leases shall be accounted for by the lessee as a finance lease (new lease standard)
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 Republic of the Philippines
CENTRAL LUZON STATE UNIVERSITY
Science City of Muñoz, Nueva Ecija
Accounting 2200 – Intermediate Accounting 2
✓ Commencement Date: A lessee shall recognize a right of use asset and a lease liability.
✓ RIGHT OF USE – the right to use the underlying asset over the lease term; LEASE LIABILITY – obligation
to make payments.
*Underlying Asset: the subject of the lease for which the right to use that asset has been provided.
Criteria for Classification of Lease as a Finance Lease
1. Transfer of Ownership (at the end of the lease term)
2. Bargain Purchase Option
The lease provides that the lessee has the option to purchase the leased asset at a price sufficiently lower
than the fair value of the asset at the date of option becomes exercisable, and that at the inception of the
lease, it is reasonably certain that the option will be exercised.
3. Major part of the economic life
The lease term is for the major part of the economic life of the asset even if the title is not transferred. *major
part – at least 75% of the economic life of asset (US GAAP)
The lease term is the non-cancellable period for which the lessee has contracted to lease the asset together
with any further terms for which the lessee has the option to continue to lease the asset, with or without
further payment, when at the inception of the lease it is reasonably certain that the lessee will exercise the
option.
4. Substantially all of the fair value of leased asset
The present value of the lease payments amounts to substantially all the fair value of the leased asset at
inception of the lease. *substantially all – at least 90% of the fair value of the leased asset

Other Criteria
1. Specialized nature
“only the lessee can use it without major modification”
2. Losses are borne by the lessee
3. Gain or losses from changes in fair value accrue to the lessee
4. Extension of lease term at the option of the lessee

ACCOUNTING FOR THE RIGHT OF USE ASSET

Initial Measurement of Right of Use Asset
>recognized at cost on commencement date
✓ PV of lease payments or the initial measurement of the lease liability
✓ Payments made to the lessor before commencement date, i.e. lease bonus, less any lease incentives received
✓ Initial direct costs incurred by the lessee – incremental costs of obtaining a lease that would not have been
incurred if the lease had not been obtained
✓ Estimate of costs of dismantling, removing and restoring the underlying asset for which the lessee has a
present obligation

Lease Incentives – payments made by the lessor to the lessee associated with a lease or reimbursement or assumption
by the lessor of the costs of the lessee

Leasehold improvements – not initial direct costs and not included in the cost of the right of use asset; separately
accounted for as PPE and depreciated over the shorter between the lease term and the life of the improvements.

Security deposits refundable upon the lease expiration – asset on the part of the lessee

Subsequent Measurement of Right of Use Asset

>@Cost Model = COST – ACCUMULATED DEPRECIATION – IMPAIRMENT LOSS
>Carrying amount shall be adjusted to any remeasurement of the lease liability

Presentation of the Right of Use Asset

>separate line item in the SFP; also, may be included in the appropriate line item within which the corresponding
underlying asset would be presented if owned (in such case, disclosure is needed)

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 Republic of the Philippines
CENTRAL LUZON STATE UNIVERSITY
Science City of Muñoz, Nueva Ecija
Accounting 2200 – Intermediate Accounting 2
Other Measurement Model
>if a lessee applies the fair value model in measuring investment property, the lessee shall also apply the fair value
model to the right of use asse that meets the definition of an investment property.
>if the right of use assets relates to a class of PPE to which the lessee applies the revaluation model, the lessee may
elect to apply the revaluation model to all of the right of use assets that relate to the class of PPE.

Depreciation of Right of Use Asset

>the lessee shall apply normal depreciation policy
>useful life is dependent to the following conditions:
✓ Transfer of ownership at the end of the lease of term
✓ The lessee is reasonably certain to exercise a purchase option
*NOTE: If there is no transfer of ownership to the lessee or if the purchase option is not reasonably certain to be
exercised, the lessee shall depreciate the right of use asset over the shorter between the useful life of the asset and
the lease term.

MEASUREMENT OF LEASE LIABILITY

>@commencement date, the lessee shall measure the lease liability at the present value of lease payments
> discounted using the interest rate implicit in the lease, otherwise the incremental borrowing rate of the lessee
> interest rate implicit – interest rate that causes the present value to equal the fair value of the underlying asset and
initial direct costs of the lessor

> Lease Payments:

✓ Fixed lease payments
✓ Variable lease payments
✓ Exercise price of a purchase option if the lessee is reasonably certain to exercise the option
✓ Amount expected to be payable by the lessee under a residual guarantee value
✓ Termination penalties if the lease term reflects the exercise of a termination option

>>>Fixed Payments (variable in legal form but should be treated as fixed in substance)
❖ Payments that must be made only if an asset is proven to be capable of operating during the lease
❖ Payments that must be made only if an event occurs with no genuine possibility of not occurring
❖ Payments that are initially variable but for which the variability will be resolved at some point and the
payments become in-substance fixed when resolved
❖ When there is more than one set of payments, only the realistic set of payments should be considered

>>>Variable Payments – payments made by the lessee for the right to use the underlying asset during the lease term
that vary because of changes in facts or circumstances occurring after the commencement date other than the passage
of time.

***payments that are based on an index or interest rate, i.e. payments linked to a consumer price index or benchmark
interest rate are included in the lease payment; THE LEASE LIABILITY IS REMEASURED WHEN THE INDEX
OR INTEREST RATE CHANGES AND THE LEASE PAYMENTS ARE REVISED.

***payments that are based on passage of time or future usage of the underlying asset are not included in the lease
payments.

RESIDUAL VALUE GUARANTEE – guarantee made to the lessor by a party unrelated to the lessor that the value
of an underlying asset at the end of the lease term will be at least a specified amount.

UNGUARANTEED RESIDUAL VALUE – that portion of the residual value of the underlying asset, the realization
of which by the lessor is not assured or is guaranteed solely by a party related to the lessor.

EXECUTORY COSTS – ownership expenses such as maintenance, taxes and insurance for the underlying asset;
expensed immediately when incurred.

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 Republic of the Philippines
CENTRAL LUZON STATE UNIVERSITY
Science City of Muñoz, Nueva Ecija
Accounting 2200 – Intermediate Accounting 2

Disclosures (Lessee)
1. Depreciation charge for right of use assets by class underlying asset
2. Interest expense on lease liability
3. The expense relating to short-term leases excluding the expense relating to leases with a term of one month or less
4. The expense relating to low value leases excluding the expense relating to low value leases with term of one month
or less
5. The expense relating to variable lease payments not included in the measurement of lease liability
6. Income from subleasing right of use assets
7. Total cash outflow for leases
8. Addition to the right use of assets
9. The carrying amount of right use assets at the end of the reporting period by class of underlying asset
10. Short term leases or low value leases accounted for as operating lease

Additional Disclosures
A lessee shall disclose additional qualitative and quantitative information about leasing activities necessary to help
users of financial statements to assess the effect on financial position, financial performance and cash flows.
1. The nature of lessee’s leasing activities
2. Future cash outflows which the lessee is potentially exposed that are not reflected in the measurement of lease
liability
a. Variable lease payments
b. Extension option and termination option
c. Residual value guarantee
d. Leases not yet commenced to which the lessee is committed
3. Restrictions or covenants imposed

References:
Intermediate Accounting 2 (2020 ed.)
Conrado T. Valix, Jose F. Peralta, Christian Aris M. Valix

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