IFRS 16 LEASES

Lease:

A contract contains lease if and only if the customer has;

· Right to obtain substantially all the economic benefits from the identifiable asset during the
lease term; and
· Right to direct the use of asset.

Right to direct the use:

A customer has right to direct the use of asset only if:

· The customer can decide how and for what purpose to use the asset through out the period
of use;
· The relevant purpose and how to use the asset are predetermined in the contract and the
customer operates the assets in those predetermined conditions (not supplier) and the
suppliers cannot change the conditions; or
· The customer has designed the asset in a way that predetermined how and for what purpose
to use the asset throughout the period of use.

In some case, seller has to add some protective rights to protects its rights or to ensure
compliance with law and regulations. So protective rights do not revoke the customer right to
direct the use of asset in any way.

Allocation of lease payments:

If a lease contract contains more than one lease and non-lease components all of which are
separately identifiable, and lessee can obtain benefits from each component separately. Than,
the consideration in the contract will be allocated to each lease component on the basis of
stand-alone price of each lease component and aggregate standalone price of non-lease
components.

Parties in a lease agreement:

Lessor the party who owns the asset to be leased out.

Lessee the party who uses the asset and pays lease payments.
Inception date vs commencement date:

Inception date is the earlier of date of contract/agreement or the date of commitment by the
parties to the principal terms and conditions.

Commencement date is the date on which a lessor makes an underlying asset available for
use by a lessee.

The accounting treatment required is applied to a lease at the date of commencement.

Residual value:

It is the value of the asset at the end of the lease term. It might be:

Guaranteed is that value that is guaranteed by a party not related to the lessor i.e. lessee and
the lessee will must pay shortfall if any.

Un-guaranteed is that value that is guaranteed by a party related to the lessor and the lessee
is not liable to pay shortfall if any.

Types of leases:

There are two type of leases:

Finance lease in which all risk and reward is transferred to lessee.

Operating lease in which risk and rewards are not transferred to lessee.

Indicators of finance lease:

A lease is finance lease if any of the following conditions met:

· Transfer of ownership after lease term;

· Contract contains purchase option i.e. less than the FV of the asset at the end of lease term;
· Lease term is more than or equals to 75% of the remaining economic life of the asset;
· Lease liability is equals to or more than 90% of FV of the asset at inception date; or
· Asset is of specialized nature that only the lessee can use.

Note: A lessee can only treat a lease as finance lease. There is no option of operating lease for
a lessee.

Exceptions:

A contract will not be lease if:

· Lease term is less than 1 year; or

· Asset is of low value.
Accounting:

Refer to Table 1.

Subsequent measurement of ROU by lessee:

Will measure it as per relevant IFRS i.e. cost model, revaluation model or fair value model,
whatever entity want to apply.

Depreciation will be charges as per IAS 16.

Use full life:

If asset will be transferred to lessee at the end of lease term or lessee intend to purchase the
asset at the end of lease term than asset will be depreciated on remaining useful life of the
asset.

If the asset will not be transferred to lessee at the end of lease term than ROU will be
depreciated on term of lease or useful life whatever is earlier.

Impairment will be charged as per IAS 36.

Sale and lease back:

There are two scenarios:

If lease back on finance lease:

It will not be considered as a sale as risk and rewards are not transferred. Any cash received
will be treated as a finance liability and accounting will be done as per IFRS 09.

Dr. Cash

Cr. Finance liability (by lessee/seller)

Dr. Finance asset (by lessor/buyer)

Cr. Cash

If lease back on operating lease:

Dr. Cash

Dr. ROU

Cr. Asset

Cr. Lease liability

Cr. Gain
Where,

Cash = Consideration received as a result of sale.

Asset = Carrying amount of asset involved.

Lease liability = PV of future lease payments

Gian = balancing figure

ROU = Portion of asset not sold or of which risk and rewards is retained by entity.

How to calculate ROU in sale and lease back transactions?

First, we will calculate percentage of sales:

% = Lease liability / FV of asset at the date of lease inception.

Than, ROU will be calculated by multiplying that percentage with the carrying amount of asset.

There are further three scenarios:

Selling price = FV of the asset

In this case, LL = PV of Future Lease payments

Selling price > FV of the asset

Additional cash received will be treated as finance liability or will be deducted from lease liability
while calculating percentage of sale as above.
Selling price < FV of the asset

Less cash received will be treated as prepayment of lease liability or will be added to lease
liability while calculating percentage of sale as above.

Sub-lease:

If sub-lease is on finance lease:

Lessee will transfer risk and rewards of ROU asset recorded from original lease. Thus, it will
show it as a disposal of asset and will record lease receivable instead.

At inceptions:

Dr. Lease receivable

Cr. ROU
At year end:

Dr. Cash (lease rental received)

Cr. Lease receivable

Cr. Interest income

Dr. Lease liability

Dr. Interest expense

Cr. Cash (lease rental paid)

If sub-lease is on operating lease:

Lessee will not transfer risk and rewards of ROU asset recorded from original lease. Thus, it will
record rental income only.

At inception:

No entry

At year end:

Dr. Cash (rental received)

Cr. Rental income

Dr. Lease liability

Dr. Interest expense

Cr. Cash (lease rental paid)

Modifications:
If new lease contract is on the basis of standalone price than it will treated as a separate lease
and if it is not on standalone price than both the lease will treated as one contract and the
previous contract will deemed to be cancelled. (Same as IFRS 15)

Increase / decrease in scope:

Increase or decrease in ROU:

Lease liability and ROU will be adjusted proportional to the increase or decrease in ROU.
Difference will be taken to P/L.
Increase / decrease in payments:

Lease liability will be recorded using the PV of the increased or decreased amount of the lease
payments due to increase or decrease in scope. ROU will also be adjusted by the same amount
of Lease liability.

Increase / decrease in lease term:

Lease liability will be recalculated using the new lease term and will be adjusted accordingly.
ROU will be adjusted by the amount of depreciation of the period increase or decreased i.e. If
the lease term decreased than depreciation of that period will be deducted from ROU and vice
versa.

The balancing gain/loss will be taken to P/L.

Change in discount rate or variable lease payments:

If discount rate implicit or lease payments depends on variable factors e.g. KIBOR, than change
in them is not a modification but a reassessment. PV of lease liability will be calculated using
the new rate or payments and ROU will also be adjusted by the same amount.

Reassessment:

Reassessment means change of estimate or any other component as per original contract. Any
reassessment will be adjusted to both LL and ROU.

Note:

If question has all these modifications than the effect of each will be calculated in this order:

1. Change in ROU due to change in scope;

2. Change in lease term;
3. Change in discount rate; than
4. Change in payments due to change in scope.

Refer to Table 2.
 Table 1
Lessor
Particulars Lessee
Non-manufacture Manufacture dealer

At inceptions:
Dr. Lease receivable
At inceptions: Cr. Revenue At inceptions:
Dr. Lease receivable Dr. Cost of revenue Dr. Right of use asset (ROU)
Cr. Asset/Cash Cr. Inventory Cr. Lease liability
Dr. Lease receivable
Finance lease
At year end: Cr. Inventory (GRV if any) At year end:
Dr. Cash (lease rental) Dr. Lease liability
Cr. Lease receivable At year end: Dr. Interest expense
Cr. Interest income Dr. Cash (lease rental) Cr. Cash (lease rental)
Accounting treatment
Cr. Lease receivable
Cr. Interest income

At inception: At inception:
No entry No entry

At year end: At year end:

Operating lease
Dr. Depreciation expense
Cr. Accumulated depreciation
Dr. Cash
Cr. Rental Income
PV of:
Fixed payment + Variable payment + GRV +
Lease receivable / liability
URGV + purchase options + Penalties + initial
direct costs.
Discount rate Interest rate implicit (i.e. IRR of lessor)
ROU N/A
Will be included in Lease receivable and
Initial direct costs effective interest rate will be adjusted
accordingly.
Any other incentive or liability (e.g.
Will be adjusted against lease receivable.
decommissioning liability)
N/A
Dr. Depreciation expense
Cr. Accumulated depreciation
Dr. Cash
Cr. Rental Income
PV of:
PV of:
Fixed payment + Variable payment + URGV +
Fixed payment + Variable payment.
purchase options + Penalties.
Interest rate implicit (i.e. IRR of lessor) or
Interest rate implicit (i.e. IRR of lessor) IRR od lessee if interest rate implicit not
available.
ROU = Lease liability - Incentives + initial
N/A
direct costs + dismantling cost.
Will be expensed out. Will be included in ROU.
Will be treated as per IFRS 15. Will be adjusted in ROU.

Adjustment #
Particulars
during solution
Decrease in scope -
Change in lease term
Decrease in scope -
decrease in assets
Modification leased
Change in discount rate
Change in rental
payment
Increase in scope -
Increase of assets
Increase in scope -
increase in lease term
Change in discount rate.
Reassessment Change in lease term
Change in lease
payments
Table 2
Lease liability
Calculate PV of lease rental as
1 per new term and adjust lease
liability accordingly
reduced term will be adjusted).
Lease liability will be adjusted
apportionately (i.e. Lease liability apportionately (i.e. depreciation
2
of reduced assets will be
adjusted).
Calculate PV of lease rental as
3 per new lease terms and adjust
lease liability accordingly.
Calculate PV of lease rental as
4 per new lease terms and adjust
lease liability accordingly.
Remaining /
ROU
balancing
ROU will be adjusted
apportionately to new lease Difference will be
terms (i.e. depreciation of the taken to P/L
ROU will be adjusted
Difference will be
of the reduced assets will be taken to P/L
adjusted).
ROU will be adjusted with the
same amount as that of Lease No difference
liability.
ROU will be adjusted with the
same amount as that of Lease No difference
liability.
 Table 3
Formulas