Fac3703 Tut 501

FAC3703/501/3/2019
Tutorial Letter 501/3/2019

Specific Financial Reporting
FAC3703
Semesters 1 and 2
Department of Financial Accounting
IMPORTANT INFORMATION:
Please activate your myUnisa profile and myLife email address and ensure you have
regular access to the myUnisa module site for FAC3703 as well as to your group site.
This tutorial letter is your study guide for FAC3703.
BARCODE
© 2019 University of South Africa
All rights reserved
Printed and published by the

University of South Africa
Muckleneuk, Pretoria
FAC3703/501/3/2019
FAC3703/501
CONTENTS
1 INTRODUCTION AND OVERVIEW ................................................................................. iv
2 LECTURERS AND CONTACT DETAILS ....................................................................... vii
3 LEARNING UNIT 1 – FINANCIAL INSTRUMENTS .......................................................... 1
4 LEARNING UNIT 2 – LEASES ....................................................................................... 32
5 LEARNING UNIT 3 – EMPLOYEE BENEFITS ............................................................. 141
6 LEARNING UNIT 4 – BORROWING COSTS ............................................................... 163
7 LEARNING UNIT 5 – RELATED PARTIES .................................................................. 178
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1 INTRODUCTION AND OVERVIEW
1.1 PURPOSE OF YOUR STUDIES
The purpose of your study of financial accounting on third year level is to provide you with
knowledge and skills to enable you to prepare a set of financial statements for a company
or group of companies with specific reference to the requirements of International Financial
Reporting Standards (IFRS) as contained in the standards set out by the International
Accounting Standards Board (IASB).
You will be able to achieve this purpose after studying the following four modules:
FAC3701 – General Financial Reporting

FAC3702 – Distinctive Financial Reporting
FAC3703 – Specific Financial Reporting
FAC3704 – Group Financial Reporting
We hope that you will enjoy this module and wish you all the best!
1.2 PURPOSE OF THIS MODULE
Welcome to the FAC3703 module of your studies with the School of Accounting at UNISA.
The purpose of this module is to provide learners with knowledge and skills to enable them
to prepare the annual financial statements of companies in accordance with the
requirements of International Financial Reporting Standards with specific reference to:
 Financial instruments (IAS 32, IFRS 9 AND IFRS 7)

 Leases (IFRS 16)
 Employee benefits (IAS 19)
 Borrowing costs (IAS 23)
 Related parties (IAS 24)
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1.3 CRITICAL CROSS-FIELD OUTCOMES

The following critical cross-field outcomes are embedded appropriately in the module. They
are assessed within the context of the module. The open distance education context has
particular challenges that we attempt to meet.
These are the critical cross-field outcomes:
Students should be able to:

 work effectively by identifying, analysing and solving financial problems and making
decisions using critical and creative thinking in the financial accounting environment;
 organise and manage themselves and their activities responsibly and effectively in
order to cope with their studies and prospective career;
 collect, analyse, categorise and classifying information in order to develop an
entrepreneurial attitude, and understand and apply the ethics of business;
 communicate effectively, using literacy and numeracy skills in a written financial
medium to complete reading, writing and accounting tasks in the study guide,
assignments and examinations (particularly competency in using numbers to
communicate financial information);
 demonstrate an understanding of the world as a set of related systems by recognising
that problem-solving contexts do not exist in isolation by acknowledging their
responsibilities in the broader community.
1.4 MEANING OF WORDS

In this module we require you to understand the meaning of certain words to enable you to
interpret assessment criteria, and to interpret assignment and examination questions.
To indicate the length, scope and format of answers to study activities and questions, we
have deliberately built limits or restrictions into the questions by using action verbs. These
action verbs give you an indication of how to tackle the given problem and what style of
writing is required.
An analysis of the action verbs contained in a question will enable you to

 plan the answer systematically and organise your thoughts systematically, and
 ensure that you comply with the lecturer's requirements
You will also save yourself time and trouble by eliminating irrelevant material that falls
outside the scope of the answer.
For the purposes of this module the following meanings will be attached to the following
action words:
 Advise Give advice to; express an expert opinion.
 Apply Use in a practical manner; use as relevant or suitable.
 Calculate Figure out; determine by a mathematical procedure.
 Clarify/demonstrate This means expound; make the meaning clear; clarify; provide
proof of; argue the truth of.
 Compare Place side by side in order to observe similarities, relationships
and differences.
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 Complete Finish; accomplish; supply whatever is missing.
 Define Describe accurately; establish the exact meaning; explain the
inherent meaning; make clear; give an account of the overall
character.
 Describe Give an account of the respective particulars or essential
characteristics; describe clearly; give an accurate account.
 Determine Establish; reach a conclusion or decision.
 Discuss Examine; explain; examine by means of argument.
 Draft Prepare a provisional outline.
 Examine Inspect; investigate.
 Explain Make clear or comprehensible; elucidate; explain the meaning in
detail.
 Identify Establish through consideration; recognise; pick out.
 Illustrate Explain; shed light on; use an example to elucidate something.
 Interpret Explain the meaning of; explicate; construe; show the nature or
essence.
 List Note/specify matters or objects that are related to one another.
 Name/mention/state Specify by name; give names, characteristics, items, elements or
facts.
 Organise Divide into classes or groups according to certain characteristics;
place in particular order.
 Prepare Make ready in advance; finish; get something ready on the basis
of previous study.
 Record To put into writing; set down for reference and preservation.
 Substantiate Supply reasons or facts; support a view or argument.
 Summarise Give a brief account; briefly state the essence of a matter.
 Tabulate Arrange in tabular form.
1.5 MASTERING OF STUDY MATERIAL
This is a comprehensive module which requires careful and dedicated study. The student
must become totally proficient in the field of accounting, and this cannot be achieved in a
short period of time. A student must be diligent and thorough to be able to master this
module.
This study guide has been devised to guide you through your studies for this module. You
should bear in mind that your prescribed textbooks are the primary sources of information
that you must study. These are supplemented in the study guide where necessary with
further information, explanations, examples and questions, which are aimed at making the
study content of the module more easily understandable. The study guide also indicates the
level of mastery at which you are required to master the various study units included in the
study content. Utilise the study guide to work through the prescribed textbooks for maximum
advantage in your study approach.
You will be required to complete a series of assignments for this module. Details pertaining
to the completion and submission of assignments are contained in Tutorial Letter 101.
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1.6 PRESCRIBED BOOKS
The study material is based on the following prescribed book:
Koppeschaar, ZR et al. Descriptive Accounting IFRS Focus. Latest edition. LexisNexis.

Refer to tutorial letter 101 for more details regarding the prescribed book.
1.7 CALCULATOR
Students are required to use a non-programmable financial calculator for this module.
1.8 ABBREVIATIONS THAT ARE USED IN THIS GUIDE
 SFP Statement of Financial Position

 OCI Other Comprehensive Income
 P/L Profit or loss
 IFRS International Financial Reporting Standards
2 LECTURERS AND CONTACT DETAILS
Lecturers Office number

Ms M de Villiers AJH van der walt building 2-66
Mr A Steyn AJH van der walt building 2-70
Ms R van den Berg AJH van der walt building 2-64
Please make use of the following email address to contact your FAC3703 lecturers:
FAC3703@unisa.ac.za
You can also contact your lecturers telephonically by making use of the following FAC3703
contact number:
012 429-4246
If you do not get hold of your lecturer telephonicically, please send an email to
FAC3703@unisa.ac.za with your student number and contact number and one of the
lecturers will phone you back.
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FAC3703
LEARNING UNIT 1
FINANCIAL INSTRUMENTS

LEARNING OUTCOMES (IAS 32, IFRS 9 and IFRS 7)
Learners should be able to:
 describe financial instruments and indicate how it should be accounted for in the
financial statements of an entity in accordance with the requirements of International
Financial Reporting Standards (IFRS) and apply the theory in practice, and
 disclose financial assets and financial liabilities measured at amortised cost (with
specific reference to the capitalisation of borrowing costs and leases) in the financial
statements of companies, in terms of the requirements of the International Financial
Reporting Standards (IFRS).
TABLE OF CONTENTS
This learning unit is divided into the following:
1.1 Background and objectives ........................................................................................ 2

1.2 Definitions (IAS 32.11 and IFRS 9 Appendix A) ......................................................... 3
1.3 Classification. ............................................................................................................. 8
1.4 Recognition and derecognition................................................................................. 10
1.4.1 Initial recognition ...................................................................................................... 10
1.4.2 Derecognition of a financial asset ............................................................................ 11
1.4.3 Derecognition of a financial liability – IFRS 9.3.3 and B3.3.1-7 ............................... 11
1.5 Measurement ........................................................................................................... 11
1.5.1 Initial measurement of financial assets and financial liabilities (IFRS 9.5.1) ............ 11
1.5.2 Subsequent measurement of financial assets (IFRS 9.5.2) ..................................... 12
1.5.3 Subsequent measurement of financial liabilities (IFRS 9.5.3) .................................. 16
1.5.4 Gains and losses: Financial assets (IFRS 9.5.7). .................................................... 16
1.5.5 Gains and losses: Financial liabilities (IFRS 9.5.7) .................................................. 17
1.5.6 Impairment and uncollectibillity of financial assets (IFRS 9.5.5) .............................. 17
1.6 Presentation ............................................................................................................. 17
1.6.1 Liabilities and equity (IAS 32.15-28) ........................................................................ 17
1.6.2 Compound financial instruments (IAS 32.28-32)...................................................... 21
1.6.3 Treasury shares (IAS 32.33-34) ............................................................................... 25
1.6.4 Interest, dividends, losses and gains (IAS 32.35-41) ............................................... 26
1.6.5 Offsetting a financial asset and a financial liability (IAS 32.42-50) ........................... 26
1.7 Disclosure (IFRS 7).................................................................................................. 26
STUDY
PRESCRIBED TEXT BOOK:
Descriptive Accounting
Refer to the chapter relating to financial instruments in the prescribed textbook for this
module. The syllabus of FAC3703 encompasses only the basic elements of financial
instruments as indicated in this learning unit. You will be examined on these principles
only.
RECOMMENDED:
A Guide Through IFRS
Relevant sections of IFRS 7, IFRS 9 and IAS 32
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1.1 Background and objectives

The standards IFRS 9, IAS 32 and IFRS 7 discuss the recognition, measurement,
presentation and disclosure of financial instruments.
Financial markets use a variety of financial instruments ranging from traditional primary
financial instruments (for example trade debtors, trade creditors, loan, equity) to derivative
instruments (for example financial options, futures and forwards, interest rate swaps and
currency swaps).
The objective of IAS 32 Financial Instruments: Presentation is to establish principles for

presenting financial instruments as liabilities or equity and for offsetting financial assets
and financial liabilities. IAS 32 prescribes requirements for:
- presentation of financial instruments as liabilities or equity;
- offsetting financial assets and liabilities;
- classification of financial instruments into financial assets, financial liabilities and
equity instruments;
- classification of related interest, dividends, losses and gains; and
- circumstances in which financial assets and financial liabilities should be offset.
The objective of IFRS 7 Financial Instruments: Disclosures is to require entities to provide
disclosures in their financial statements that enable users to evaluate:
 the significance of financial instruments for the entity's financial position and
performance; and
 the nature and extent of risks arising from financial instruments to which the entity is
exposed during the period and at the reporting date, and how the entity manages
those risks.
The objective of IFRS 9 Financial Instruments is to establish principles for the financial
reporting of financial assets and financial liabilities that will present relevant and useful
information to users of financial statements for their assessment of the amounts, timing
and uncertainty of the entity’s future cash flows.
1.2 Definitions (IAS 32.11–14 and IFRS 9 Appendix A)

DEFINITIONS IN IAS 32.11–.14
A financial instrument is any contract that gives rise to a financial asset of one entity and
a financial liability or equity instrument of another entity. (IAS 32.11)
A financial asset is any asset that:
(a) is cash;
(b) is an equity instrument of another entity (example: investments);
(c) has a contractual right:
- to receive cash or another financial asset from another entity (example: accounts
receivables); or
- to exchange financial assets or financial liabilities with another entity under
conditions that are potentially favourable to the entity (example: purchased options);
or
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(d) is a contract that will or may be settled in the entity's own equity instruments and is:
- a non-derivative for which the entity is or may be obliged to receive a variable
number of the entity's own equity instruments; or
- a derivative that will or may be settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity's own equity
instruments. For this purpose the entity's own equity instruments do not include
instruments that are themselves contracts for the future receipt or delivery of the
entity's own equity instruments. (IAS 32.11)
A financial liability is any liability that is:
(a) a contractual obligation:

- to deliver cash or another financial asset to another entity (example: creditors); or
- to exchange financial assets or financial liabilities with another entity under
conditions that are potentially unfavourable to the entity (example: written options);
or
(b) a contract that will or may be settled in the entity's own equity instruments and is:
- a non-derivative for which the entity is or may be obliged to deliver a variable
number of the entity's own equity instruments; or
- a derivative that will or may be settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity's own equity
instruments. For this purpose the entity's own equity instruments do not include
instruments that are themselves contracts for the future receipt or delivery of the
entity's own equity instruments.
An equity instrument is any contract that evidences a residual interest in the assets of an
entity after deducting all of its liabilities.
EQUITY INSTRUMENTS
An entity's own equity instrument is not a financial asset or liability. If an
entity has an obligation to deliver its own equity instruments, or the right to
reacquire its own equity instruments, it is seen as a form of an equity
instrument, rather than financial assets or financial liabilities.
Fair value is the price that would be received to sell an asset or paid to transfer a liability
in an orderly transaction between market participants at the measurement date.
DEFINITIONS IN IFRS 9 Appendix A
A derivative is a financial instrument or other contract within the scope of this standard
with all three of the following characteristics:
- its value changes in response to the change in a specified interest rate, financial
instrument’s price, commodity price, foreign exchange rate, index of prices or rates,
credit rating or credit index, or other variable (sometimes called the “underlying”);
- it requires no initial net investment or an initial net investment that is smaller than
would be required for other types of contracts that would be expected to have a
similar response to changes in market factors; and
- it is settled at a future date.
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DERIVATIVES
An example of a derivative is a share option which is a contract that gives
the holder the option to purchase shares in future at a discount at a fixed
price.
Please note that derivative instruments do not form part of this syllabus.
Definitions relating to recognition and measurement
Derecognition is the removal of a previously recognised financial asset or financial liability
from an entity's statement of financial position.
Transaction costs are incremental costs that are directly attributable to the acquisition,
issue or disposal of a financial asset or financial liability. An incremental cost is one that
would not have been incurred if the entity had not acquired, issued or disposed of the
financial instrument.
The amortised cost of a financial asset or financial liability is the amount at which the
financial asset or financial liability is measured at initial recognition minus principal
repayments, plus or minus the cumulative amortisation using the effective interest method
of any difference between the initial amount and the maturity amount, and for financial
assets, adjusted for any loss allowance.
The effective interest method is a method of calculating the amortised cost of a financial
asset or a financial liability and of allocating the interest income or interest expense over
the relevant period.
The effective interest rate is the rate that exactly discounts estimated future cash
payments or receipts through the expected life of the financial instrument or, when
appropriate, a shorter period to the net carrying amount of the financial asset or financial
liability. When calculating the effective interest rate, an entity shall estimate cash flows
considering all contractual terms of the financial instrument (for example, prepayments,
call and similar options) but shall not consider future credit losses. The following amounts
must be considered:
- all fees and points paid or received between parties to the contract that are an
integral part of the effective interest rate,
- transaction costs, and
- all other premiums or discounts.
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EXAMPLE 1
Example of an effective interest rate calculation
Party Pops Ltd issued a bond on 1 January 20.10. The following information relates to the
bond:
 Nominal value R200 000
 Coupon rate (annually in arrears) 10%
 Date to be redeemed 31 December 20.12
THE DIFFERENCE BETWEEN A BOND AND A DEBENTURE

A bond is a loan that is secured by a specific physical asset, for example a
bond to purchase a house.
A debenture is secured only by the debenture issuer's promise to pay the
interest and loan principal.
The accounting treatment of debentures and bonds is the same.
The effective interest rate on this bond for Party Pops Ltd will be calculated by
using a financial calculator (HP 10BII financial calculator was used):
N = 3 (1 payment per year x 3 years)
PV = (200 000)
FV = 200 000
PMT = 200 000 x 10% = 20 000
P/YR = 1 (payment per year)
Comp i = 10% per annum
If the transaction costs incurred by Party Pops Ltd when issuing the bond
amounted to R5 000, the effective interest rate will change as follows:
N = 3
PV = (195 000) (200 000 – 5 000)
FV = 200 000
PMT = 200 000 x 10% = 20 000
Comp i = 11,02% per annum
If the transaction costs remained at R5 000, but the bond will be redeemed by Party
Pops Ltd at a premium of 5% of nominal value, the effective interest rate will change
as follows:
N = 3
PV = (195 000) (200 000 – 5 000)
FV = 210 000 (200 000 x 1,05)
PMT = 200 000 x 10% = 20 000
Comp i = 12,52% per annum
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EXAMPLE 2
Examples of financial assets and financial liabilities
(IAS 32 Appendix: Application Guidance (AG) 3–9)
Financial asset/financial liability Reason
 Currency (cash) is a financial asset It represents the medium of exchange and is

therefore the basis on which all transactions are
measured and recognised in financial
statements.
 A deposit of cash with a bank or similar It represents the contractual right of the depositor
financial institution is a financial asset to obtain cash from the institution or to draw a
cheque or similar instrument against the balance
in favour of a creditor in payment of a financial
liability.
 Common financial assets and financial In each case, one party's contractual right to
liabilities receive (or obligation to pay) cash is matched by
- trade accounts receivable and the other party's corresponding obligation to pay
(or right to receive).
payable
- notes receivable and payable
- loans receivable and payable
- bonds receivable and payable
 A note payable in government bonds It gives the holder the contractual right to receive
and the issuer the contractual obligation to
deliver government bonds, but not cash. The
bonds are financial assets because they
represent obligations of the issuing government
to pay cash. The note is, therefore, a financial
asset of the note holder and a financial liability of
the note issuer.
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WHAT IS A BOND?
When a bond is purchased by the bond holder, cash flows from the bond holder
to (for example) a government, municipality, federal agency, corporation or
other entity known as the issuer.
In return for the “loan”, the issuer promises to pay a specified rate of interest
over the term of the bond and to repay the “loan amount” (the principal) when it
"matures", or becomes due at the end of the term.
R100 lent to borrower

Borrower Investor
Coupon (interest 10%) (bond
(bond
R10 p.a. holder)
issuer)
R100 returned to investor
 Bonds are normally issued at or close to their face value. The face value
is calculated as follows:
- quoted as %, for example a bond selling for 94,25% of face value:
For a bond of R1 000 x 94,25% = R943
For a bond of R1 000 000 x 94,25% = R942 500.
 Bonds traded in the secondary market fluctuate in price in response to

changing interest rates.
- When the price of a bond increases above its face value, the bond is
selling at premium.
- When the price of a bond decreases below face value, it is selling at a
discount.
 A bond's maturity refers to the specific future date on which the

investor's principal amount will be repaid, for example a bond maturing in
2022 has a term of five years if the year of issue was 2017.
 Bonds pay interest that can be fixed, floating or payable at maturity.
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FAC3703/501
EXAMPLE 3
The following are NOT financial assets and financial liabilities (IAS 32.AG9–12)
Item Reason
 Physical assets Control of such physical and intangible assets

 Inventories creates an opportunity to generate an inflow of
cash or another financial asset, but it does not
 Property, plant and equipment
give rise to a present right to receive cash or
 Intangible assets another financial asset.
 Leased assets (operating lease) An operating lease is an uncompleted contract
committing the lessor to provide the use of an
asset in future periods, in exchange for
consideration similar to a fee for a service. The
lessor continues to account for the leased
asset itself (rather than any amount receivable
in the future under the contract, ie a finance
lease).
 Prepaid expenses The future economic benefit is the receipt of

goods or services, rather than the right to
receive cash or another financial asset.
 Deferred revenue and most warranty The outflow of economic benefits associated
obligations are not financial liabilities with them is the delivery of goods and services
rather than a contractual obligation to pay cash
or another financial asset.
 Income taxes created as a result of Liabilities or assets (such as income taxes) are
statutory requirements imposed by not contractual, therefore they are not financial
government assets or liabilities.
Definitions relating to hedge accounting (refer to FAC3702)
1.3 Classification
FINANCIAL ASSETS (IFRS 9.4.1)
Unless paragraph 4.1.5 of IFRS 9 applies, an entity shall classify financial assets as
subsequently measured at either amortised cost or fair value on the basis of both:
(a) An entity’s business model for managing financial assets, and
(b) The contractual cash flow characteristics of the financial asset (IFRS 9.4.1).
A financial asset shall be measured at amortised cost if both of the following conditions
are met: (IFRS 9.4.1.2)
(a) The asset is held within a business model whose objective is to hold assets in order to
collect contractual cash flows, and
(b) The contractual terms of the financial asset give rise on specified dates to cash flows
that are solely payments of principal and interest on the principal amount outstanding.
IFRS 9 paragraphs B4.1.1 – B4.1.26 gives guidance on how to apply these conditions.
A financial asset shall be measured at fair value unless it is measured at amortised cost in
accordance with paragraph 4.1.2 of IFRS 9.
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IFRS 9 allows an entity the option to designate a financial asset which otherwise qualifies
for amortised cost accounting, as measured at fair value through profit or loss (P/L) if:
 This treatment eliminates or significantly reduces a measurement or recognition
inconsistency that would otherwise arise from measuring assets or liabilities or
recognising the gains and losses on them on different bases (Refer to B4.1.29 –
B4.1.32 of IFRS 9).
At initial recognition, an entity may make an irrevocable election to present changes
in the fair value of an investment in equity instruments (that is not held for trading), in
other comprehensive income (OCI) (IFRS 9.5.7.5)
o This election is only available on initial recognition, is irrevocable and is done
on an instrument-by-instrument basis.
o Amounts included in other comprehensive income (OCI) shall not be
subsequently transferred to profit or loss (P/L).
o The entity may, however, transfer the cumulative gain or loss within equity.
o Dividends on such investments are recognised in profit or loss (P/L) in
accordance with IFRS 15: Revenue from contracts with customers, unless
the dividend clearly represents a recovery of part of the cost of an investment
(IFRS 9 B5.7.1).
FINANCIAL LIABILITIES (IFRS 9.4.2)

Financial liabilities will be classified at amortised cost using the effective interest method,
except for:
 Liabilities held for trading, including derivatives (measured at fair value).
 Financial liabilities designated upon initial recognition at fair value through profit or loss
(P/L) (measured at fair value).
 Liabilities that arise when a transfer of a financial asset does not qualify for
derecognition.
 Financial guarantee contracts.
 Commitments to provide a loan at a below market interest rate. (IFRS 9.4.2.1–2)
A financial liability is classified as held for trading if it is:

 acquired or incurred principally for the purpose of selling or repurchasing it in the near
term; or
 on initial recognition is part of a portfolio of identified financial instruments that are
managed together and for which there is evidence of a recent actual pattern of short-
term profit-taking; or
 a derivative (except for a derivative that is a financial guarantee contract or a
designated and effective hedging instrument). (IFRS 9 Appendix A)
The irrevocable designation of financial liabilities as measured at fair value through P/L,
will only be allowed at initial recognition when one of three conditions is met (see the three
bullets below). The three conditions can broadly be classified into two categories, namely,
where designation will result in more relevant information (IFRS 9.4.2.2(a) and (b)) and on
the other hand where such designation is justified on grounds of reducing complexity or
increasing measurement reliability (IFRS 9.4.3.5)
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More relevant information will arise when:

 designation at fair value through profit and loss will eliminate or significantly reduce a
measurement or recognition inconsistency (sometimes referred to as "an accounting
mismatch") that would otherwise arise from measuring liabilities or recognising the
gains and losses on them on different bases. (IFRS 9.4.2.2(a));
 a group of financial liabilities or financial assets is managed and its performance
evaluated on a fair value basis in accordance with a documented risk management or
investment strategy, and information about the group is provided internally on that
basis to the entity's key management personnel. (IFRS 9.4.2.2(b))
Complexity will be reduced or measurement reliability will be increased in instances:

 where an instrument contains one or more embedded derivatives and an entity
designate the entire combined contract as a financial liability at fair value through profit
or loss. (IFRS 9.4.3.5)
Investments in equity instruments that do not have a quoted market price in an active
market, and whose fair value cannot be reliably measured, shall not be designated as at
fair value through profit or loss (P/L).
1.4 Recognition and derecognition

1.4.1 Initial recognition
An entity shall recognise a financial asset or a financial liability on its statement of financial
position when, and only when, the entity becomes a party to the contractual provisions of
the instrument. (IFRS 9.3.1.1)
EXAMPLE 4
At what stage shall an entity recognise the following items on its statement of
financial position?
A. Unconditional receivables and payables
Recognised as assets or liabilities when the entity becomes a party to the contract
and, as a consequence, has a legal right to receive or a legal obligation to pay cash.
B. Assets to be acquired and liabilities to be incurred as a result of a firm

commitment to purchase or sell goods or services
It is generally not recognised until at least one of the parties has performed under the
agreement. For example:
 An entity that receives a firm order does not generally recognise an asset (and the
entity that places the order does not recognise a liability) at the time of the
commitment but, rather, delays recognition until the ordered goods or services
have been shipped, delivered or rendered.
 If a firm commitment to buy or sell non-financial items is within the scope of this
standard, its net fair value is recognised as an asset or liability on the commitment
date.
 If a previously unrecognised firm commitment is designated as a hedged item in a
fair value hedge, any change in the net fair value attributable to the hedged risk is
recognised as an asset or liability after the inception of the hedge (refer to
FAC3702).
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C. A forward contract
It is recognised as an asset or a liability on the commitment date, rather than on the
date on which settlement takes place. When an entity becomes a party to a forward
contract, the fair values of the right and obligation are often equal, so that the net fair
value of the forward is zero. If the net fair value of the right and obligation is not zero,
the contract is recognised as an asset or liability (refer to FAC3702).
D. Planned future transactions

No matter how likely they are, they are not assets and liabilities because the entity
has not become a party to a contract. (IFRS 9 B3.1.2)
1.4.2 Derecognition of a financial asset
An entity shall derecognise a financial asset when, and only when:

(a) the contractual rights to the cash flows from the financial asset expire; or
(b) it transfers the financial asset and the transfer qualifies for derecognition. (IFRS
9.3.2.3)
1.4.3 Derecognition of a financial liability (IFRS 9.3.3 and B3.3.1–7)
An entity shall remove a financial liability (or a part of a financial liability) from its statement
of financial position (SFP) when, and only when, it is extinguished, that is, when the
obligation specified in the contract is:
(a) discharged; or
(b) cancelled; or
(c) expires.
A financial liability (or a part of it) is extinguished when the debtor:

(a) either discharges the liability (or part of it) by paying the creditor, normally with cash
other financial assets, goods or services; or
(b) is legally released from primary responsibility for the liability (or part of it) either by
process of law or by the creditor. (If the debtor has given a guarantee this condition
may still be met.)
1.5 Measurement
1.5.1 Initial measurement of financial assets and financial liabilities (IFRS 9.5.1)
At initial recognition, financial assets shall be measured at its fair value plus, in the case
of a financial asset not at fair value through profit or loss (P/L), transaction costs directly
attributable to the acquisition of a financial asset. (IFRS 9.5.1.1)
When a financial liability is recognised initially, an entity shall measure it at its fair value
plus, in the case of a financial liability not at fair value through profit or loss (P/L),
transaction costs that are directly attributable to the acquisition or issue of the financial
liability. (IFRS 9.5.1.1)
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FAC3703/501
In case of a financial asset or financial liability at fair value through profit or loss (P/L),
transaction costs that are directly attributable to the acquisition or issue of the liability are
excluded from initial measurement. The fair value of a financial instrument on initial
recognition is normally the transaction price (i.e. the fair value of the consideration given or
received). (IFRS 9.5.1.1)
When an entity uses settlement date accounting for an asset that is subsequently
measured at amortised cost, the asset is recognised initially at its fair value on the trade
date. (IFRS 9.5.1.2)
1.5.2 Subsequent measurement of financial assets (IFRS 9.5.2)
After initial recognition, an entity shall measure a financial asset at:

 Amortised cost;
 Fair value through profit or loss (P/L) (IFRS 9.4.1.1-5); or
 Fair value through other comprehensive income (OCI) (only when it is an investment in
an equity instrument and other comprehensive income (OCI) is elected by the entity at
initial recognition).(IFRS 9.5.7.5)
The accounting treatment of financial assets can be summarised as follows:
Financial asset Initial measurement Subsequent Gains and losses on

category measurement re-measurement
1. Financial assets at Cost (being fair value but Fair value Recognised in profit or
fair value through excluding transaction costs) loss (P/L)
profit or loss (P/L)
2. Amortised cost Cost (being fair value, Amortised cost Recognised in profit or
including transaction costs) loss (P/L)
3. Financial assets at Cost (being fair value, Fair value Recognised in other
fair value through including transaction costs) comprehensive income
other comprehen- (OCI)
sive income (OCI)
(Investments in
equity – not held for
trading)
EXAMPLE 5
Financial assets at fair value through profit or loss (settlement date accounting)
A Ltd bought 100 shares in B Ltd on 29 December 20.18 when the cost was R10 per
share. Costs to finalise the transaction amounted to R50. At year-end,
31 December 20.18, the share price was R10,02. On 1 January 20.19, when the amount
was paid by A Ltd to B Ltd in cash, the price was R10,03. The shares were purchased as
part of A Ltd's trading portfolio.
13
The journal entries in the accounting records of A Ltd to account for the above transaction
are as follows:
Dr Cr
R R
29 December 20.18
Investment in A Ltd shares (SFP) (R10 x 100 shares) 1 000
Creditor for shares acquisition (SFP) 1 000
Recognition of investment in shares
31 December 20.18
Investment in A Ltd shares (SFP) ((R10,02 – R10,00) x 100) 2
Fair value adjustment on trading portfolio (P/L) 2
Recognise movement in fair value at year-end
1 January 20.19
Investment in A Ltd shares (SFP) ((R10,03 – R10,02) x 100) 1
Fair value adjustment on trading portfolio (P/L) 1
1 January 20.19
Creditor for A Ltd shares acquisition (SFP) 1 000
Transactions costs (P/L) 50
Bank (SFP) 1 050
Settlement of purchase price of investment in A Ltd shares
Recognise transaction costs separately in P/L
EXAMPLE 6
Financial assets at amortised cost
On 1 January 20.19 Mon Ltd purchased a bond from Day Ltd for R914 350. The date of
maturity is 31 December 20.22. The following details are applicable to the bond:
Market rate 15% per annum
Coupon rate 12% per annum
Nominal value R1 000 000
Future value R1 000 000
Period 4 years
Interest per annum R120 000 (payable annually in arrears on 31 December)
EXPLANATION OF TERMINOLOGY USED IN THIS EXAMPLE

 coupon rate – the interest rate used to calculate the fixed annual payment
of interest on the bond each year (R1 000 000 x 12% = R120 000);
 discounted bond – a bond where the coupon interest rate (12% per annum)
is less than the applicable market rate (15% per annum);
 amortised cost – refers to the difference between the coupon interest
income of R120 000 (received in cash every year) and the interest
calculated at market interest rate (R150 000) that is amortised over the
term of the bond;
 effective interest rate – this is the rate (market rate) which, when multiplied
by the present value of the bond, will arrive at the amortised interest
income of the bond.
14
FAC3703/501
REQUIRED
1. Prepare the amortisation table for Mon Ltd for the investment in the
above bond.
2. Prepare the journal entries to account for the bond in the accounting
records of Mon Ltd for the period of the investment.
SOLUTION 6
1. Calculation of the initial measurement (present value) of the investment in bond:
N = 4 (1 payment x 4 years)
i = 15% per annum (market rate)
PMT = 120 000 (1 000 000 x 12%) The payment will always be based on the coupon rate.
FV = 1 000 000
Comp PV = (914 350)
Amortisation table:
Instalment
(Coupon Effective
Opening Interest) at interest at Capital Closing
balance 12% p.a. 15% p.a. (growth) balance
R R R R R
a
31 December 20.19 914 350 120 000 137 153 17 153 931 503
31 December 20.20 931 503 120 000 139 726 19 726 951 229
31 December 20.21 951 229 120 000 142 684 22 684 973 913
31 December 20.22 973 913 120 000 146 087 26 087 1 000 000
a 137 153 – 120 000 = 17 173
2. Journal entries
Dr Cr
R R
Initial measurement
1 January 20.19
Investment in bond (SFP) 914 350
Bank (SFP) 914 350
Recognise investment in bond
Subsequent measurement
31 December 20.19
Bank (SFP) (see amortisation table) 120 000
Interest income (P/L) 137 153
Recognise coupon interest received and amortised interest
31 December 20.20
Bank (SFP) 120 000
15
Dr Cr
R R
31 December 20.21
Bank (SFP) 120 000
31 December 20.22
Bank (SFP) 120 000
31 December 20.22 (Date of maturity of bond)

Bank (SFP) 1 000 000
Investment in bond (SFP) 1 000 000
Mon Ltd receive nominal/future value back on maturity date
EXAMPLE 7
Viva-Voo Ltd acquired 1 000 shares in Waterloo Ltd at a price of R15,00 per share. The
shares were acquired on 1 July 20.19 and are held for trading. Transaction costs
amounted to R1 000. At year-end, 31 December 20.19, the market value of one
Waterloo Ltd share was R17,00.
The journal entries to account for the above transactions in the accounting records of Viva-
Voo Ltd are as follows:
Dr Cr
R R
Initial measurement - 1 July 20.19
Investment in Waterloo Ltd shares (SFP) (R15 x 1 000 shares) 15 000
Transaction costs (P/L) 1 000
Bank (SFP) 16 000
Recognise investment in shares and recognise transaction costs
separately in P/L
Subsequent measurement
31 December 20.19
Investment in Waterloo Ltd shares (SFP)((R17–R15) x 1000 shares) 2 000
Fair value adjustment on trading portfolio (P/L) 2 000
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FAC3703/501
1.5.3 Subsequent measurement of financial liabilities (IFRS 9.5.3)
The accounting treatment of financial liabilities can be summarised as follows:
Financial liability Initial measurement Subsequent Gains and losses on

category measurement remeasurement
1.Financial liability at At cost (being fair Fair value Recognised in profit or

fair value through value but excluding loss (unless the fair value
profit or loss transaction costs) changes are due to credit
risk, then in other com-
prehensive income)
2.Amortised cost At cost (being fair Amortised cost Not applicable, but an
value including interest component will be
transaction costs) recognised in profit or loss
(P/L).
1.5.4 Gains and losses: Financial assets (IFRS 9.5.7)
A gain or loss (P/L) on financial assets that are measured at fair value and is not part of a
hedging relationship, shall be recognised:
 In profit or loss (P/L);
 Unless the financial asset is an investment in an equity instrument and the entity has
elected to present gains and losses in other comprehensive income (OCI) in
accordance with IFRS 9.5.7.1.
A gain or loss on a financial asset that is measured at amortised cost and is not part of a
hedging relationship, shall be recognised in profit or loss (P/L), when the financial asset is:
o derecognised;
o impaired; or
o reclassified; and
o through the amortisation process.
If an entity recognises financial assets using settlement date accounting, any change in
the fair value of the asset to be received during the period between the trade date and the
settlement date is not recognised for assets carried at cost or amortised cost (other than
impairment losses). For assets carried at fair value, however, the change in fair value shall
be recognised in profit or loss or in equity, as appropriate under this section.
1.5.5 Gains and losses: Financial liabilities (IFRS 9.5.7)

A gain or loss arising from a change in the fair value of a financial liability measured at fair
value through profit or loss (P/L) that is not part of a hedging relationship, shall be
recognised in profit or loss. If the change in fair value is attributable to changes in the
credit risk of that liability, the gain or loss shall be presented in other comprehensive
income.
For financial liabilities measured at amortised cost, a gain or loss is recognised in profit or
loss (P/L) when the financial liability is derecognised and through the amortisation process.
For financial assets or financial liabilities that are hedged items, the accounting for the
gain or loss shall follow hedge accounting. (Refer to FAC3702)
17
1.5.6 Impairment and uncollectibility of financial assets (IFRS 9.5.5)
In terms of IFRS 9.5.5.1, an entity shall recognise a loss allowance for expected credit
losses on financial assets.
Except for when the simplified approach is followed, at each reporting date, an entity shall
measure the loss allowance for a financial instrument at an amount equal to the lifetime
expected credit losses if the credit risk on that financial instrument has increased
significantly since initial recognition. (IFRS 9.5.5.3)
The objective of the impairment requirements is to recognise lifetime expected credit

losses for all financial instruments for which there have been significant increases in credit
risk since initial recognition considering all reasonable and supportable information,
including that which is forward-looking. (IFRS 9.5.5.4)
At each reporting date, an entity shall assess whether the credit risk on a financial
instrument has increased significantly since initial recognition. When making the
assessment, an entity shall use the change in the risk of a default occurring over the
expected life of the financial instrument (instead of the change in the amount of expected
credit losses). To make that assessment, an entity shall compare the risk of a default
occurring on the financial instrument as at the reporting date with the risk of a default
occurring on the financial instrument as at the date of initial recognition and consider
reasonable and supportable information. (IFRS 9.5.5.9)
An entity may assume that the credit risk on a financial instrument has not increased
significantly since initial recognition if the financial instrument is determined to have low
credit risk at the reporting date. (IFRS 9.5.5.10)
IFRS 9.5.5.15-16 allows a simplified approach when assessing the expected credit
losses for trade receivables, lease receivables and contract assets. The entity is not
required to determine whether the credit risk has increased significantly since initial
recognition. The entity is allowed to recognise a loss allowance equal to the lifetime
expected credit losses at each reporting date.
EXAMPLE 8
Loss allowance using the simplified approach
Cab Ltd has trade receivables amounting to R5 000 000 at reporting date. Trade
receivables does not include a significant financing component.
Age analysis of trade receivables R
Current 3 000 000
30 days 2 000 000
5 000 000
Based on past experience (that is adjusted for forward looking estimates) Cab Ltd expects
that over the lifetime of the trade receivables, the default rate of the current trade
receivables to be 0,5% and the 30-days trade receivables to be 1%.
18
FAC3703/501
The journal at reporting date to account for the loss allowance on trade receivables is as
follows:
Dr Cr
R R
Expected credit loss (P/L) 35 000
Loss allowance on trade receivables (SFP) 35 000
CALCULATION
Current: R3 000 000 x 0,5% 15 000
30 days: R2 000 000 x 1% 20 000
35 000
1.6 Presentation
1.6.1 Liabilities and equity (IAS 32.15-28)
The issuer of a financial instrument shall classify the instrument, or its component parts, on
initial recognition as a financial liability, a financial asset or an equity instrument in
accordance with:
- the substance of the contractual arrangement, and
- the definitions of a financial liability, a financial asset and an equity instrument.
(IAS 32.15)
In terms of IFRS 9.11, a financial liability is any liability that is:

 a contractual obligation to deliver cash of another financial asset or to exchange
financial assets or liabilities under conditions that are potentially unfavourable to the
to the entity, or
 a contract that will or may be settled in the entity’s own equity instruments and is:
o a non-derivative for which the entity is or may be obliged to deliver a variable
number of the entity’s own equity instruments; or
o a derivative that will be settled other than by the exchange of a fixed amount
of cash or another financial asset for a fixed number of the entity’s own equity
instruments.
An equity instrument is any contract that evidences a residual interest in the assets of an
entity after deducting all of its liabilities (IFRS 9.11). An instrument is an equity instrument
if (IFRS 9.16):
 The instrument includes no contractual obligation to deliver cash or another
financial asset to another entity; or to exchange financial assets or financial
liabilities with another entity under conditions that are potentially unfavourable to the
issuer, and
 it is a contract that will or may be settled by exchanging a fixed number of the
issuer's own equity instruments for a fixed amount of cash of a financial asset.
These two requirements for an equity instrument will be discussed in

detail in 1.6.1.1. and 1.6.1.2 below.
‘
19
1.6.1.1 No contractual obligation to deliver cash or another financial asset
A critical feature in differentiating a financial liability from an equity instrument is the

existence of a contractual obligation of one party to the financial instrument (the issuer)
either to:
 deliver cash or another financial asset to the other party (the holder), or
 to exchange financial assets or financial liabilities with the holder under conditions that
are potentially unfavourable to the issuer.
Although the holder of an equity instrument may be entitled to receive a pro rata share of
any dividends or other distributions of equity, the issuer does not have a contractual
obligation to make such distributions because it cannot be required to deliver cash or
another financial asset to another party (IAS 32.17).
The substance of a financial instrument, rather than its legal form, governs its classification
on the entity's statement of financial position (IAS 32.18). This stipulation has the effect
that some items that would appear to be equity, would actually constitute a liability.
For example, a preference share that provides for mandatory redemption by the issuer for
a fixed or determinable amount at a fixed or determinable future date, or gives the holder
the right to request the issuer to redeem the instrument at or after a particular date for a
fixed or determinable amount, is a financial liability (IAS 32.18(a)).
EXAMPLE 9
Lula-Lee Ltd issued 1 000 redeemable preference shares on 1 January 20.19. The
preference shares are redeemable in cash at the option (choice) of the preference share
holder until 31 December 20.22. If the preference shares have not been redeemed before
31 December 20.22, the preference shares will be redeemed by Lula-Lee Ltd on
31 December 20.22.
Should the redeemable preference shares be presented as a financial liability or
equity in the financial statements of Lula-Lee Ltd?
The preference shares are redeemable in cash at the option of the preference
shareholders, or redeemable by the issuer (Lula-Lee Ltd) on 31 December 20.12. As a
result there is a contractual obligation on the part of the issuer (Lula-Lee Ltd) to deliver
cash to the preference shareholders. Therefore it meets the definition of a financial liability.
EXAMPLE 10
Lula-Lee Ltd issued 1 000 redeemable preference shares on 1 January 20.19. Lula-
Lee Ltd has the option (choice) to redeem the shares at any time.
Should the preference shares be presented as a financial liability or equity in the
financial statements of Lula-Lee Ltd?
Lula-Lee Ltd does not have a contractual obligation to transfer cash or financial assets to
the preference shareholder and therefore it does not meet the definition of a financial
liability. The preference shares will be presented as equity in the financial statements of
Lula-Lee Ltd.
20
FAC3703/501
EXAMPLE 11
Lula-Lee Ltd issued 1 000 convertible preference shares on 1 January 20.19. The shares
will be converted to 1 000 ordinary shares on 31 December 20.22.
Should the preference shares be presented as a financial liability or equity in the
financial statements of Lula-Lee Ltd?
If the criteria for classification of an equity instrument is applied:
 the instrument includes no contractual obligation to deliver cash or another financial

asset, or to exchange a financial asset, or to exchange financial asset or liabilities; and
 the instrument will be settled in the entity's own equity instruments (ordinary shares).
As a result, the convertible preference shares are equity instruments.

If any entity does not have an unconditional right to avoid delivering cash or another
financial asset to settle a contractual obligation, the obligation meets the definition of a
financial liability. (IAS 32.19)
A financial instrument that does not explicitly establish a contractual obligation to deliver
cash or another financial asset may establish an obligation indirectly through its terms
and conditions.
For example:
A financial instrument may contain a non-financial obligation that must be settled if, and
only if:
- the entity fails to make distributions, or
- to redeem the instrument.
If the entity can avoid a transfer of cash or another financial obligation only by settling the
non-financial obligation, the financial instrument is still a financial liability.
Another example:
A financial instrument is a financial liability if it provides that on settlement, the entity will
deliver either:
- cash or another financial asset, or
its own shares whose value is determined to exceed substantially the value of the cash or
other financial asset. (IAS 32.20)
1.6.1.2 Settlement in the entity's own equity instruments
A contract is not an equity instrument solely because it may result in the receipt or delivery
of the entity's own equity instruments.
An entity may have a contractual right or obligation to receive/deliver a number of its own
shares or other equity instruments that varies so, that the fair value of the entity's own
equity instruments to be received/delivered equals the amount of the contractual right or
obligation.
Such a contractual right or obligation may be for a fixed amount or an amount that
fluctuates in part or in full in response to changes in a variable other than the market price
of the entity's own equity instruments (eg an interest rate, a commodity price or a financial
instrument price). The following are examples of such a contract. It is a financial liability
21
of the entity even though the entity must or can settle it by delivering its own equity
instruments, for example:
 a contract to deliver as many of the entity's own equity instruments as are equal in
value to R100;
 a contract to deliver as many of the entity's own equity instruments as are equal in
value to the value of 100 ounces of gold.
The contract is not an equity instrument because the entity uses a variable number of its
own equity instruments as a means to settle the contract. Accordingly, the contract does
not evidence a residual interest in the entity's assets after deducting all of its liabilities.
(IAS 32.21)
A contract that will be settled by the entity receiving/delivering a fixed number of its own
equity instruments in exchange for a fixed amount of cash or another financial asset is an
equity instrument, for example:
 an issued share option that gives the option holder the option to buy a fixed number of
the entity's shares for a fixed price is an equity instrument. (IAS 32.22)
The difference between the above two situations can be summarised as follows:
Financial liability Settlement equals the amount of the contractual right/obligation and may
be affected by changes in the fair value of the contract.
Equity instrument The amount of settlement is fixed and is not affected by changes in the
fair value of a contract.
1.6.1.3 Contingent settlement provisions
A financial instrument may require the entity to deliver cash or another financial asset, or
otherwise to settle it in such a way that it would be a financial liability, in the event of the
occurrence or non-occurrence of uncertain future events (or on the outcome of uncertain
circumstances) that are beyond the control of both the issuer and the holder of the
instrument, such as a change in:
 a stock market index;
 consumer price index;
 interest rate;
 taxation requirements;
 the issuer's future revenues;
 net income; or
 debt-to-equity ratio.
The issuer of such an instrument does not have the unconditional right to avoid delivering
cash or another financial asset (or otherwise to settle it in such a way that it would be a
financial liability). Therefore, it is a financial liability of the issuer, unless:
- the part of the contingent settlement provision that could require settlement in cash or
another financial asset (or otherwise in such a way that it would be a financial liability)
is not genuine; or
- the issuer can be required to settle the obligation in cash or another financial asset (or
otherwise to settle it in such a way that it would be a financial liability) only in the event
of liquidation of the issuer. (IAS 32.25)
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FAC3703/501
If a part of a contingent settlement provision that could require settlement in cash or

another financial asset (or in another way that would result in the instrument being a
financial liability) is not genuine, the settlement provision does not affect the classification
of a financial instrument. Thus, a contract that requires settlement in cash or a variable
number of the entity's own shares only on the occurrence of an event that is extremely
rare, highly abnormal and very unlikely to occur is an equity instrument. (IAS 32 AG 28)
1.6.2 Compound financial instruments (IAS 32.28–32)
The issuer of a non-derivative financial instrument shall evaluate the terms of the financial
instrument to determine whether it contains both a liability and an equity component. Such
components shall be classified separately as financial liabilities, financial assets or equity
instruments. (IAS 32.28)
An entity recognises separately the components of a financial instrument that:
(a) creates a financial liability of the entity; and
(b) grants an option to the holder of the instrument to convert it into an equity instrument
of the entity.
An example of a compound financial instrument is a bond or similar debt instrument
convertible by the holder into a fixed number of ordinary shares of the entity. (IAS 32.29)
Transaction costs relating to the issue of compound financial instruments are allocated in
proportion to the liability and equity components.
EXAMPLE 12
Debentures convertible at the option of either the issuer or holder

Zen Ltd issues 2 000 convertible debentures at the start of year 1. The debentures have a
three-year term and are issued at face value of R1 000 per debenture totalling
R2 000 000. Interest is payable annually in arrears at a nominal annual interest rate of
6% per annum. At the end of year 3, each debenture is convertible into 250 ordinary
shares or the debentures can be redeemed at face value of R1 000 each. When the
debentures were issued, the prevailing market interest rate for similar debt without a
conversion option was 9% per annum.
Convertible debentures
The annual interest payments and the option to redeem the debentures in cash
at face value at the end of year 3, give rise to a financial liability for Zen Ltd.
The option to convert the debentures into ordinary shares gives rise to equity
for Zen Ltd. As both a financial liability and equity are present, the convertible
debentures are compound financial instruments.
23
SOLUTION 12
When recognising compound financial instruments, the liability component is measured
first, and the difference between the proceeds of the debentures issue and the fair value of
the liability is assigned to the equity component.
The present value of the liability component is calculated using a discount rate of 9% per
annum, the market interest rate for similar debentures without no conversion rights:
Set HP and Sharp EL-738 calculators to 1P/YR as there is one interest payment per year.
Calculation
Option 1:
Present value of the liability component (debentures including interest):
n = 3 (1 payment per year x 3 years)

PMT = 120 000 (2 000 000 x 6% per annum) (coupon rate)
FV = 2 000 000 (2 000 000 payable at the end of three years) R
PV ? Present value of the liability component 1 848 122
Equity component (balancing figure) 151 878
Proceeds of the debentures issue 2 000 000
OR
Option 2:
Present value of the capital/principle component (debentures excluding
interest):
PMT = 0 (no capital repayments during the three years)
FV = 2 000 000 (2 000 000 payable at the end of three years)
PV ? Present value of the capital component excluding interest 1 544 367
Present value of the interest only:

PMT = 120 000 (2 000 000 x 6% per annum)
FV = 0 (all interest payments take place during the three years) 303 755
Total liability component (PV of capital and PV of interest) 1 848 122
Equity component (balancing figure) 151 878
Amortisation table
Effective Instalment
Opening interest at (Coupon Interest) Capital Closing
balance 9% p.a. at 6% p.a. (growth) balance
R R R R R
Year 1 1 848 122 166 331 120 000 46 331 1 894 453
Year 2 1 894 453 170 501 120 000 50 501 1 944 954
Year 3 1 944 954 175 046 120 000 55 046 2 000 000
24
FAC3703/501
Journal entries Dr Cr
R R
Year 1
Bank (SFP) 2 000 000
Equity component of convertible debentures (SFP) 151 878
Liability component of convertible debentures (SFP) 1 848 122
Initial recognition of convertible debentures
Finance costs (P/L) 166 331
Liability component of convertible debentures (SFP) 46 331
Bank (SFP) 120 000
Recognition of finance cost, interest paid and amortisation of liability
Year 2
Bank (SFP) 120 000
Year 3
Liability component convertible debentures (SFP) 55 046
Bank (SFP) 120 000
Amortisation of convertible debentures

The liability component was initially recognised at R1 848 122. This amount
inicreases annually (as a result of the difference in the market rate and coupon
rate) until it amounts to R2 000 000 at the end of year 3 (1 848 122 + 46 331 +
50 501 + 55 046 = 2 000 000).
If the holder/issuer wishes to redeem the debentures by repaying the cash at the end of
year 3, the following journal entry will be made:
Dr Cr
R R
Bank (SFP) 2 000 000
Redeem convertible debentures in cash
If the holder/issuer wishes to redeem the debentures by converting the debentures into
ordinary shares at the end of year 3, the following journal entry will be made:
Dr Cr
R R
Stated capital (SFP) 2 000 000
Convert debentures to ordinary shares
In both redemption instances explained above, the original equity component of R151 878
remains as equity although it may be transferred from one line item within equity to
another. There is no gain or loss on conversion at maturity (IAS32.AG32).
25
EXAMPLE 13
Automatically convertible debentures
Zapper Ltd issues 2 000 automatically convertible debentures at the start of year 1. The
debentures have a three-year term and are issued at face value of R1 000 per debenture,
totalling R2 000 000. Interest is payable annually in arrears at a nominal annual interest
rate of 6% per annum. At the end of year 3, each debenture will automatically be
converted into 250 ordinary shares. When the debentures were issued, the prevailing
market interest rate for similar debt without conversion option was 9% per annum.
Automatically convertible debentures

The annual interest payments give rise to a financial liability for Zen Ltd.
The automatic conversion of the debentures into ordinary shares gives rise to
equity for Zen Ltd. As both a financial liability and equity are present, the
convertible debentures are compound financial instruments as in
Example 12.
SOLUTION 13
The present value of the liability component is calculated using a discount rate of 9% per
annum, the market interest rate for similar debentures without no conversion rights:
Set HP and Sharp EL-738 calculators to 1P/YR as there is one interest payment per year.
Option 1:
Present value of the liability component (debentures including interest):
FV = 0 (The capital amount is not repayable at the end of year 3 and
the debentures automatically convert into ordinary shares.) R
PV ? Present value of the liability component 303 755
Equity component (balancing figure) 1 696 245
OR
Option 2:
Present value of the capital/principle component (debentures excluding
interest):
The capital amount is not repayable at the end of year 3 and the debentures
automatically convert into ordinary shares.
Present value of the capital component excluding interest Nil
Present value of the interest only:

FV = 0 (all interest payments take place during the three years) 303 755
Total liability component (PV of capital and PV of interest) 303 755
Equity component (balancing figure) 1 696 245
26
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Amortisation table
Effective Instalment
Opening interest at (Coupon Interest) Capital Closing
balance 9% p.a. at 6% p.a. (growth) balance
R R R R R
Year 1 303 755 27 338 120 000 92 662 211 093
Year 2 211 093 18 998 120 000 101 002 110 092
Year 3 110 092 9 908 120 000 110 092 -
Journal entries
Dr Cr
R R
Year 1
Bank (SFP) 2 000 000
Equity component of convertible debentures (SFP) 1 696 245
Initial recognition of convertible debentures
Bank (SFP) 120 000
Year 2
Bank (SFP) 120 000
Year 3
Bank (SFP) 120 000
Equity component of convertible debentures 1 696 245
Stated capital (SFP) 1 696 245
Convert debentures to ordinary shares
1.6.3 Treasury shares (IAS 32.33-34)
If an entity reacquires its own equity instruments, those instruments are called treasury
shares. Treasury shares shall be accounted for as follows:
 it shall be deducted from equity;
 no gain or loss shall be recognised in profit or loss on the purchase, sale, issue or
cancellation of an entity's own equity instruments; and
 consideration paid or received shall be recognised directly in equity.
Treasury shares may be acquired and held by the entity or by other members of the
consolidated group.
Treasury shares held shall be disclosed separately either on the face of the statement of
financial position or in the notes, in accordance with IAS 1, Presentation of financial
statements. An entity must provide disclosure in accordance with IAS 24, Related party
disclosures if the entity reacquires its own equity instruments from related parties. (IAS
32.33–34)
27
1.6.4 Interest, dividends, losses and gains (IAS 32.35-41)
(a) Items such as interest, dividends, losses and gains relating to a financial instrument or
a component that is a financial liability shall be recognised as income or expense in
profit or loss.
Dividend payments on shares wholly recognised as liabilities are recognised as
expenses in the same way as interest on a bond.
Gains and losses associated with redemption or refinancing of financial liabilities are
recognised in profit or loss.
(b) Distributions to holders of an equity instrument shall be debited by the entity directly to
equity, net of any related income tax benefit. Transaction costs of an equity
transaction, other than costs of issuing an equity instrument that are directly
attributable to the acquisition of a business (which shall be accounted for under IFRS 3
Business Combinations) shall be accounted for as a deduction from equity, net of any
related income tax benefit.
Redemption or refinancing of equity instruments are recognised as changes in equity.
Changes in fair value of an equity instrument are not recognised in the financial
statements. (IAS 32.35–36)
1.6.5 Offsetting a financial asset and a financial liability (IAS 32.42-50)
A financial asset and a financial liability shall be offset and the net amount presented in the
statement of financial position when, and only when, an entity:
 currently has a legally enforceable right to set off the recognised amounts, and
 intends either to settle on a net basis, or to realise the asset and settle the liability
simultaneously. (IAS 32.42)
1.7 Disclosure (IFRS 7)

IFRS 7, Financial Instruments: Disclosures require specific disclosures for financial assets
and liabilities. Examples of the disclosure required for financial assets and liabilities
measured at amortised cost are provided below, as these disclosures are relevant to
learning units 2 and 4:
 Learning unit 2 – Leases: Financial lease liabilities are financial liabilities and net
investment in finance leases are financial assets.
 Learning unit 4 – Borrowing costs: Loans obtained to finance the acquisition of
assets are financial liabilities.
The remainder of the disclosures required by IFRS 7 will only be lectured on post-graduate
level.
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EXAMPLES OF DISCLOSURES
NOTES FOR THE YEAR ENDED 31 DECEMBER 20.18
6. Categories of financial liabilities 20.18
R
Non-current financial liabilities
Financial liabilities measured at amortised cost xxx
Loan payable to Bank xxx
Finance lease liability 4 xxx
Current financial liabilities

Financial liabilities measured at amortised cost xxx
Loan payable to Bank xxx
Finance lease liability 4 xxx
Trade and other payables xxx
Concentration of interest rate risk on financial liabilities measured at amortised cost

The company has no exposure to interest rate changes with regard to the loan payable to
Big Bank at the reporting date as the interest rate is fixed (example).
The company has no exposure to interest rate changes with regard to finance lease
liability at the reporting date as the interest rate is fixed.
Concentration of liquidity risk on financial liabilities

The exposure of the company's financial liabilities to liquidity risk and the contractual
repayment dates are as follows:
Loan Finance
payable to lease
Bank liability
R R
Less than 1 year xxx xxx
Between 1 and 2 years xxx xxx
More than 10 years xxx xxx
xxx xxx
The company manages its liquidity risk by ensuring that the maturities of its assets and
liabilities match according to cash flow needs and that the company has adequate access
to credit. Expected cash flow requirements are monitored with rolling cash flow budgets.
29
7. Categories of financial assets
20.18
R
Non-current financial assets
Financial assets at fair value through profit or loss xxx
Financial assets at fair value through other comprehensive income xxx
Financial assets at amortised cost xxx
Gross amount xxx
Net investment in finance lease xxx
Loan to AB Ltd xxx
Allowance account for credit losses xxx
Net investment in finance lease xxx
Loan to AB Ltd (xxx)
xxx
Current financial assets
Financial assets at fair value through profit or loss xxx
Financial assets at fair value through other comprehensive income xxx
Financial assets at amortised cost xxx
Gross amount
Current portion of net investment in finance lease xxx
Loan to AB Ltd xxx
Trade and other receivables xxx
Allowance account for credit losses
Current portion of net investment in finance lease (xxx)
Current portion of loan to AB Ltd (xxx)
Trade and other receivables (xxx)
xxx
Reconciliation of the allowance account for credit losses
Net investment Loan to AB Trade and

in finance Ltd other
31 December 20.18 lease receivables
Balance at the beginning of the year xxx xxx xxx
Additional impairment losses xxx xxx xxx
Allowance utilised during the year (xxx) (xxx) (xxx)
Reversal of impairment losses (xxx) (xxx) (xxx)
Balance at the end of the year xxx xxx xxx
Credit risk in financial assets
(a) Maximum exposure to credit risk
Financial assets at fair value through profit or loss xxx xxx

Financial assets at fair value through other
comprehensive income xxx xxx
Financial assets at amortised cost xxx xxx
Net investment in finance lease xxx xxx
Other financial assets at amortised cost xxx xxx
xxx xxx
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(b) Credit quality of financial assets that are neither past due nor impaired
At fair value At amortised cost

Net
Through Through other
investment
profit or comprehensive
in finance
loss income
lease Other
High credit rating xxx xxx xxx xxx
Medium credit rating xxx xxx xxx xxx
Low credit rating xxx xxx xxx xxx
xxx xxx xxx xxx
(c) Age analysis of past due but not impaired assets

At amortised cost
Trade and
Net investment Loan to AB other
in finance lease Ltd receivables
30 days xxx xxx xxx
60 days xxx xxx xxx
90 days xxx xxx xxx
More than 90 days xxx xxx xxx
xxx xxx xxx
(d) Analysis of financial assets which are individually impaired

Net
investment Trade and
in finance other
lease receivables
Carrying amount before impairment xxx xxx
Amount of impairment loss xxx xxx
Fair value of collateral held xxx xxx
ASSESSMENT CRITERIA
After having studied this learning unit you should be able to:
 State the definitions contained in IFRS 7, IFRS 9 and IAS 32 and be
able to apply them to problems posed.
 Describe the classifications of financial instruments.
 Describe the principles for the recognition, measurement and
derecognition of financial instruments.
 disclose financial assets and financial liabilities at amortised cost in
terms of IAS 32, IFRS 9 and IFRS 7.
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FAC3703
LEARNING UNIT 2
LEASES

FAC3703/501
LEARNING OUTCOMES (IFRS 16)

Learners should be able to account for and disclose leases, taking into account the tax
implications, in the financial statements of lessees and lessors in accordance with the
International Financial Reporting Standards (IFRS).
TABLE OF CONTENTS
2.1 Definitions (IFRS 16 Appendix A) ............................................................................34

2.2 Identifying a lease (IFRS 16.9-17) ...........................................................................37
2.2.1 Steps to follow to determine whether a contract contains a lease. ..........................38
2.2.2 Separating components of a contract (IFRS 16.12) .................................................41
2.2.3 Lease term (IFRS 16.18-21) ....................................................................................41
2.3 Amortisation tables, interest rate and present value calculations ............................42
2.4 Leases in the financial statements of lessees (IFRS 16.22–60) ..............................42
2.4.1 Recognition exemptions (IFRS 16.5-8) ....................................................................43
2.4.2 Initial recognition of a lease (IFRS 16.23-28)...........................................................47
2.4.3 Subsequent measurement (IFRS 16.29-38) ............................................................48
2.4.4 Finance costs ..........................................................................................................50
2.4.5 Impairment (IFRS 16.33) .........................................................................................50
2.4.6 Separate components of a contract (IFRS 16.12-17) ..............................................53
2.4.7 Reassessment of lease liability of the lessee (IFRS 16.39-46) ................................56
2.4.8 Lease modifications (IFRS 16.44–46) .....................................................................61
2.4.9 Tax effect of an underlying right-of-use asset ..........................................................63
2.4.10 Disclosure - Lessee .................................................................................................69
2.4.11 Comprehensive examples for lessees .....................................................................71
2.5 Classification of leases – Lessors (IFRS 16:61-66) .................................................92
2.6 Finance leases in the financial statements of lessors ..............................................93
2.6.1 Initial recognition – finance leases (IFRS 16.68-70) ................................................93
2.6.2 Subsequent measurement (IFRS 16.75-78) ............................................................94
2.6.3 Initial recognition – manufacturer or dealer lessors (IFRS 16.71-74)......................97
2.6.4 Change in interest rate ..........................................................................................100
2.6.5 Residual values .....................................................................................................103
2.6.6 Finance lease modifications ..................................................................................107
2.6.7 Tax effect of finance leases for the lessor .............................................................108
2.6.8 Operating leases in the financial statements of lessors (IFRS16.81-86) ...............112
2.6.9 Tax effect of operating lease for the lessor ............................................................114
2.6.10 Disclosure – Lessor (IFRS 16.89-97) ....................................................................114
2.7 Annexure A: Basic examples on how to prepare an amortisation table .................135
33
STUDY
Refer to the chapter relating to leases (IFRS 16) in the prescribed textbook for this module.
EFFECTIVE DATE
Entities are required to apply IFRS 16 for all reporting periods beginning on or after
1 January 2019. IFRS 16 does however, allow a company to early adopt IFRS 16.
For purposes of studying leases, it is assumed that all companies in the examples
and questions early adopted IFRS 16.
2.1 Definitions (IFRS 16 Appendix A)

The definitions below are listed in IFRS 16. Refer back to these definitions when working
through examples.
A contract is an agreement between two or more parties that creates enforceable rights and
obligations.
A lease is a contract, or part of a contract, that conveys the right to use an asset (the
underlying asset) for a period of time in exchange for consideration.
An underlying asset is an asset that is the subject of a lease, for which the right to use that
asset has been provided by a lessor to a lessee.
A lessee is an entity that obtains the right to use an underlying asset for a period of time in
exchange for consideration.
A lessor is an entity that provides the right to use an underlying asset for a period of time in
exchange for consideration.
A finance lease is a lease that transfers substantially all risks and rewards incidental to
ownership of the underlying asset.
An operating lease is a lease that does not transfer substantially all the risks and rewards
incidental to ownership of an underlying asset.
The inception of the lease is the earlier of the date of the lease agreement and the date of a
commitment by the parties to the principal terms and conditions of the lease.
The commencement of the lease term is the date on which a lessor makes an underlying
asset available for use by a lessee.
The lease term is the non-cancellable period for which the lessee has the right to use an
underlying asset, together with both:
 Periods covered by an option to extend the lease if the lessee is reasonably certain to
exercise that option; and
 Periods covered by an option to terminate the lease if the lessee is reasonably certain not
to exercise that option.
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FAC3703/501
Lease payments are the payments by a lessee to a lessor relating to the right to use an
underlying asset during the lease term, comprising the following:
 Fixed payments (including in-substance fixed payments), less any lease incentives;
 Variable lease payments that depend on an index or a rate;
 The exercise price of a purchase option if the lessee is reasonably certain to exercise that
option; and
 Payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease.
LEASE PAYMENTS
For the lessee, lease payments also include amounts expected to be payable by the lessee
under residual value guarantees. Lease payments do not include payments allocated to non-
lease components of a contract unless the lessee elects to combine non-lease components
with a lease component and to account for them as single lease component.
For the lessor, lease payments also include any residual value guarantees provided to the
lessor by the lessee, a party related to the lessee or a third party unrelated to the lessor that
is financially capable of discharging the obligations under the guarantee. Lease payments do
not include payments allocated to non-lease components.
Variable lease payments is the portion of payments made by a lessee to a lessor for the
right to use an underlying asset during the lease term that varies because of changes in facts
or circumstances occurring after the commencement date, other than the passage of time.
Fixed payments are payments made by the lessee to a lessor for the right to use an
underlying asset during the lease term, excluding variable lease payments.
Optional lease payments are payments made by the lessee to a lessor for the right to use
an underlying asset during periods covered by an option to extend or terminate a lease that
are not included in the lease term.
Fair value for purposes of applying the lessor accounting requirements in IFRS 16, the
amount for which an asset could be exchanged or a liability settled, between knowledgeable,
willing parties in an arm’s length transaction.
Economic life is either:
 the period over which an asset is expected to be economically usable by one or more
users, or
 the number of production or similar units expected to be obtained from the asset by one or
more users.
Period of use is the total period of time that an asset is used to fulfil a contract with a
customer (including any non-consecutive periods of time).
Useful life is the period over which an asset is expected to be available for use by an entity;
or the number of production or similar units expected to be obtained from an asset by an
entity.
35
The residual value guarantee is a guarantee made to a lessor by a party unrelated to the
lessor that the value (or part of the value) of an underlying asset at the end of a lease will be
at least a specified amount.
The unguaranteed residual value is that portion of the residual value of the underlying
asset, the realisation of which by the lessor is not assured or is guaranteed solely by a party
related to the lessor.
The interest rate implicit in the lease (IRIL) is 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
the fair value of the underlying asset and any initial direct costs incurred by the lessor. This
definition can be summarised as follows:
Present value of: Fair value of leased asset

IRIL = Lease payments + = +
Unguaranteed residual value Initial direct costs of lessor
The lessee's incremental borrowing rate is the rate of interest the lessee would have to pay
to borrow over a similar term, and with a similar security, the funds necessary to obtain an
asset of similar value to the right-of-use asset in a similar economic environment.
The right-of-use asset is an asset that represents a lessee’s right to use an underlying asset
for the lease term.
A short-term lease is a lease that, at the commencement date, has a lease term of
12 months or less. A lease that contains a purchase option is not a short-term lease.
Initial direct costs are incremental costs of obtaining a lease that would not have been
incurred if the lease had not been obtained, except for such costs incurred by a manufacturer
or dealer lessor in connection with a finance lease.
A lease modification is a change in the scope of a lease, or the consideration for a lease,
that was not part of the original terms and conditions of the lease (for example, adding or
terminating the right to use one or more underlying assets, or extending or shortening the
contractual lease term).
Effective date of the modification is the date when both parties agree to a lease
modification.
A sublease is a transaction for which an underlying asset is re-leased by a lessee

(‘intermediate lessor’) to a third party, and the lease (‘head lease’) between the head lessor
and the lessee remains in effect.
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FAC3703/501
LESSORS
Please note that the following four definitions relate only to a lessor.
Gross investment in the lease is the sum of:
 the lease payments receivable by the lessor under a finance lease (which includes the
guaranteed residual value), and
 any unguaranteed residual value accruing to the lessor.
Net investment in the lease is the gross investment in the lease discounted at the interest
rate implicit in the lease.
Unearned finance income is the difference between:
 the gross investment in the lease, and

 the net investment in the lease.
Lease incentives are payments made by a lessor to a lessee associated with a lease, or the
reimbursement or assumption by a lessor of costs of a lessee.
SCOPE OF IFRS 16
IFRS 16, Leases should be applied in accounting for all leases, including lease of right-of-use
assets in a sublease, except for:
 lease agreements to explore or use natural resources, such as oil, gas, timber, metals and
other mineral rights;
 leases of biological assets within the scope of IAS 41 Agriculture held by a lessee;
 service concession arrangements within the scope of IFRIC 12 Service Concession
Arrangements;
 Licences of intellectual property granted by a lessor within the scope of IFRS 15 Revenue
from contract with Customers; and
 Rights held by a lessee under licensing agreements within the scope of IAS 38 Intangible
Assets for such items as motion picture rights, video recordings, plays, manuscripts,
patents and copyrights.
2.2 Identifying a lease (IFRS 16.9-17)

IFRS 16, Leases will be applied if a contract contains a lease.
Therefore, at inception of a contract, an entity will need to determine whether a contract is or

contains a lease. As per the lease definition a contract is or will contain a lease when the
contract conveys the:
 The right to control the use of an identified asset,

 for a period of time,
 in exchange for consideration.
37
A contract conveys the right to control the use of an identified asset for a period of time
when the customer (lessee) has both of the following:
 The right to obtain substantially all economic benefits from the identified asset; and
 The right to direct the use of the identified asset.
If a customer only has the right to control the use of an asset for a portion of the term of the
contract, only that portion of the contract will contain a lease.
A period of time refers to the time or amount of use of an identified asset (for example the
number of production units that the equipment will be used to produce).
An entity is only required to reassess whether a contract is or contains a lease when the
terms or conditions of the lease have changed.
2.2.1 Steps to follow to determine whether a contract contains a lease
No
Is there an identified asset?
Yes
Does the customer have the right to obtain

No
substantially all of the economic benefits from use
of the asset throughout the period of use?
Yes
Does the customer, the supplier or neither party
Customer have the right to direct how and for what purpose Supplier
the asset is used throughout the period of use.
Neither; how and for

what purpose the asset
will be used is
predetermined
Does the customer have the right to operate the
Yes asset throughout the period of use, without the
supplier having the right to change those
operating instructions?
No
Did the customer design the asset in a way that

No
predetermines how and for what purpose the
asset will be used throughout the period of use?
Yes
The contract The contract does

contains a lease not contain a lease
Source: IFRS 16.B34
lease lease
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FAC3703/501
EXAMPLE 1 (Based on IFRS 16 Illustrative example 2)
Meattle Ltd entered into a contract with KKL International Airport to use a space of 10m 2 in the
airport for a three year period to sell its goods. KKL International has the right to change the
location allocated to Meattle Ltd at any time during the period of use. There are minimal costs
to KKL International Airport associated with changing the space used by Meattle Ltd.
Meattle Ltd makes use of a kiosk to sell goods (that it owns) that can be easily moved as
there are many areas in the airport that meet the specifications of the space required for the
kiosk. Meattle will pay KKL International Airport R10 000 per month to make use of the space
in the airport.
REQUIRED
Discuss if the contract between Meattle Ltd and KKL international airport
contains a lease.
SOLUTION 1
Per IFRS 16, Leases, a contract contains a lease when the contract conveys the following:
 The right to control the use of an identified asset,
 for a period of time,
 in exchange for consideration
Discussion of lease definition components:

Right to control the use of an identified asset
Per IFRS 16, Leases, a contract conveys the right to control the use of an identified asset
The contract specifies the amount of space that Meattle Ltd is entitled to use at the airport.
However, the space is not fixed and as a result there is no identified asset.
Even though Meattle Ltd controls its owned kiosk, the contract is for space in the airport and
KKL International has the right to change the space allocated at any time. Meattle Ltd does
not control the asset because:
- Meattle Ltd does not have substantially all the economic benefits from the space.
KKL International could benefit economically from substituting the space as there are
minimum costs involved in moving the kiosk used by Meattle Ltd. KKL International
benefits from substituting the space in the airport because substitution allows KKL
international to make the most effective use of the space at boarding areas in the
airport to meet changing circumstances.
- KKL International has the right and practical ability to change the space used by
Meattle Ltd anytime during the entire period as there are many suitable areas (thereby
directing the use).
For a period of time

 The contract is for a three period
39
In exchange for consideration
 Meattle Ltd will pay KKL International Airport an amount of R10 000 per month.
Conclusion:
There is no identified asset and Meattle does not have the right to control an identified asset.
All the conditions have not been met and as a result the contract does not contain a lease.
EXAMPLE 2 (Based on IFRS 16 Illustrative example 4)
Sea Basket Ltd entered into a contract with Propco Ltd to use retail unit A for a five year
period. Retail unit A is part of a larger retail space with many retail units.
Sea Basket Ltd has the right to use retail unit A but Propco Ltd can require Sea Basket Ltd to
relocate to another retail unit. Propco Ltd would in this case be required to provide Sea
Basket Ltd with a retail unit of similar quality and specifications to retail unit A and would be
required to pay for Sea Basket Ltd’s reallocation costs. It would only benefit Propco Ltd
financially or economically to reallocate Sea Basket Ltd if a major new tenant wants to occupy
a large amount of retail space that includes unit A at a rate sufficiently favourable to cover the
costs of reallocating Sea Basket Ltd and other tenants in the retail space.
The contract stipulates that Sea Basket will use retail unit A to operate its well-known store
brand to sell its goods during the hours that the larger retail space is open for business. Sea
Basket Ltd makes all the decisions about the use of the retail unit during the period of use and
controls physical access to the unit throughout the five-year period of use.
The contract requires Sea Basket Ltd to make fixed payments to Propco Ltd, as well as
variable payments that are a percentage of sales from retail unit A.
All cleaning, security and advertising services are provided by Propco Ltd as part of the
contract.
REQUIRED
Discuss if the contract between Sea Basket Ltd and Propco Ltd contains a
lease.
SOLUTION 2
Per IFRS 16, Leases, a contract contains a lease when the contract conveys the following:
 Right to control the use of an identified asset,
 For a period of time,
 In exchange for consideration.
Discussion of lease definition components:

Right to control the use of an identified asset
Per IFRS 16, Leases, a contract conveys the right to control the use of an identified asset
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FAC3703/501
Propco Ltd has the practical ability to substitute the retail unit but could only benefit
economically in specific circumstances, which at inception of the lease are unlikely to arise.
Sea Basket has the right to control the use of retail unit A throughout the five year period of
use because:
 The space is an identified asset, retail unit A.
 Sea Basket Ltd has the right to obtain substantially all of the economic benefits
from the use of retail unit A over the five-year period of use. Sea Basket Ltd has
exclusive use of retail unit A throughout the period of use.
 Within the scope of its right of use defined in the contract. Sea Basket Ltd makes the
relevant decisions about how and for what purpose retail unit A is used by being
able to decide, for example, the mix of products that will be sold in the retail unit and
the price at which these units will be sold. Sea Basket has the right to change these
decisions during the five-year period of use.
Even though cleaning, security and advertising services are essential to the efficient use of
retail unit A, these services do not give Propco Ltd the right to direct how and for what
purpose retail unit A is used.
Therefore, Propco does not control the use of retail unit A during the period of use and
Propco Ltd’s decisions do not affect Sea Basket Ltd’s control of the use of retail unit A.
Therefore Sea Basket Ltd has the right to benefit economically from retail unit A and has the
right to direct the use thereof.
For a period of time
 The contract is for a five year period.
In exchange for consideration
 Meattle Ltd will pay KKL International Airport an amount of R10 000 per month.
Conclusion:
All the conditions of the lease definition have been met. Therefore, the contract contains a
lease in terms of IFRS 16, Leases.
2.2.2 Separating components of a contract (IFRS 16.12)

Each lease component within a contract that is, or contains, a lease must be accounted for as
a lease separately from the non-lease components of the contract. This does not apply to
entities applying the practical expedient (this will be discussed in more detail when dealing
with lessees and lessors).
2.2.3 Lease term (IFRS 16.18-21)
An entity will determine the lease term as the non-cancellable period of a lease together with
both the:
 period covered by an option to extend the lease if it is reasonably certain the lessee
will exercise that option; and
 periods covered by an option to terminate the lease if it is reasonably certain the
lessee will not exercise that option.
41
ASSESSING REASONABLE CERTAINTY
Consider all relevant facts and circumstances that create economic

incentives for the lessee to extend or terminate the lease.
A lessee will only reassess whether it is reasonably certain to exercise an extension of an

option or terminate an option, upon the occurrence of either a significant event or
significant change in circumstances that:
 is within the control of the lessee; and
 affects whether the lessee is reasonably certain to exercise an option not previously
included in the lease term.
If there is a change in the non-cancellable period of lease, the entity is required to revise the
lease term. The following are examples that will result in a change in the non-cancellable
period of the lease:
 The lessee exercises an option not previously included in the entity’s determination of
the lease term;
 The lessee does not exercise an option previously included in the entity’s
determination of the lease term;
 An event occurs that contractually obliges the lessee to exercise an option not
previously included in the entity’s determination of the lease term; or
 An event occurs that contractually prohibits the lessee from exercising an option
previously included in the entity’s determination of the lease term.
2.3 Amortisation tables, interest rate and present value calculations

See annexure A (at the end of this learning unit) for examples and explanations on
amortisation tables, interest rates and present value calculations.
2.4 Leases in the financial statements of lessees (IFRS 16.22 – 60)
For contracts that contain a lease the lessee will use a single lease accounting model and
apply the principles in 2.4.2 – 2.4.10. The only exception is for leases relating to low-value
assets and short-term leases for which the recognition exemption was elected in 2.4.1.
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FAC3703/501
2.4.1 Recognition exemptions (IFRS 16.5-8)
A lessee may elect to not apply the lease requirements as set out in 2.4.2- 2.4.8 to:
 Short-term leases (lease term ≤ 12 months); and
 Leases for which the underlying assets are low-value assets.
Low value = IFRS 16.BC100 states that assets when new with a value of $5 000 would be
considered low-value assets. Examples include personal computers, small
items of office furniture and telephones.
Assets that are highly dependent, highly interrelated with other assets will not qualify as low-
value assets.
FOR THE EXAM
We will always state in a question if an asset is a low-value asset and

whether or not the company applies the recognition exemption to its low-
value and short-term assets.
When the recognition exemption is considered, low-value assets should elect the exemption
on a lease by lease basis and short-term assets by class of underlying assets.
When the recognition exemption is elected, the accounting treatment for this specific short-
term and low-value assets are as follows:
Recognition of lease payments
The lessee will recognise the lease payments associated with leases as an expense on:
- Straight-line basis over the lease term; or
- Another systematic basis if it is more representative of the pattern of the lessee’s
benefit.
The lessee will consider the lease to be a new lease when:
- There is a lease modification; or
- There is any change in the lease term.
Disclosure
 A lessee must disclose the following amounts in a tabular format for the reporting period,
unless another format is more appropriate:
 The expense relating to the short-term lease, this expense may exclude leases with a
lease term of one month or less;
 The expense relating to leases of low-value assets, excluding expenses relating to
short-term leases included above;
 Total cash outflow for leases.
 A lessee shall disclose additional qualitative and quantitative information about its
leasing activities necessary to give users of the Annual Financial Statements a basis to
assess the effect of the lease on the lessee.
43
 A lessee that accounts for short-term leases or leases of low-value assets applying the
exemption criteria of 2.4.1 must state that fact.
 A lessee is required to disclose the amount of its lease commitments for short-term
leases if the portfolio of short-term leases to which it is committed at the end of the
reporting period is different to the portfolio of short-term leases to which the short-term
lease expense is already disclosed in terms of the disclosure above.
EXAMPLE 3
Klip Ltd entered into a contract with Techlog SA Ltd to make use of a specialised printer and
computer starting on 1 January 20.17. The contract meets the requirements of a lease in
terms of IFRS 16, Leases. The asset is classified as a low-value asset. Klip Ltd makes use of
the recognition exemption in terms of IFRS 16, Leases for all short-term and low-value assets.
The terms of the lease are as follows:

Lease term 4 years
Initial payment R1 440
Instalment payable monthly in arrears:
Months 1–24 R800
Months 25–48 R600
The lessee incurred R500 legal fees for negotiating the lease.
Useful life of computer and the printer: 3 years
REQUIRED
(a) Discuss the accounting treatment of Klip Ltd for the year ended
31 December 20.17
(b) Calculate:
1. Equalised monthly instalments
2. Prepaid expense or accrued expense as at 31 December 20.17
3. Prepaid expense or accrued expense as at 31 December 20.18
(c) Disclose the low-value lease asset in the following notes to the annual
financial statements of Klip Ltd for the year ended 31 December 20.18.
 Prepaid expense
 IFRS 16, leases (low-value assets)
Your answers must comply with the International Financial Reporting

Standards (IFRS).
Ignore any income tax and VAT implications.
Round all amounts to the nearest Rand.
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FAC3703/501
SOLUTION 3
(a) Discussion of accounting treatment
As per IFRS 16, Leases a lessee may elect to apply the recognition exemption to short-term
leases (less than 12 months) and low-value assets (less than $5 000). It is the policy of Klip
Ltd to apply the recognition exemption to all short-term and low-value assets.
As per IFRS 16, Leases low-value assets are accounted for on a lease by lease basis.
Recognition
When the recognition exemption is applied, the lessee will recognise the lease payments on a
low-value asset lease as an expense on:
 A straight-line basis over the lease term; or
 Another systematic basis if it is more representative of the pattern of the lessee’s
benefit.
The lessee will only consider the lease to be a new lease when:
 There is a lease modification; or
 There is any change in lease term.
Conclusion
The lease payments for low-value assets must be recognised as an expense on a straight-
line basis over the lease term of four years as Klip Ltd elected to make use of the recognition
exemption.
(b) Calculations
1. The equalised monthly instalment is calculated as follows:

R
Initial payment 1 440
Instalments: 1–24 months (24 x 800) Lease term 19 200
= 48 months
Instalments: 25–48 months (24 x 600) 14 400
35 040
Equalisation of lease instalments per month (35 040/48) 730
The implication of the equalisation of lease payments is that a portion of lease payments will
be a prepaid expense or accrued expense in the statement of financial position.
2. At the end of the first year (31 December 20.17):

R
Initial payment 1 440
Instalments paid (12 x 800) 9 600
Total lease instalments paid in cash for the first year 11 040
Equalised lease expense per year (730 [C1] x 12 months) 8 760
Prepaid expense (asset) (SFP) (11 040 – 8 760) 2 280
The initial direct cost of R500 is expensed immediately in profit or loss (P/L).
45
3. At the end of the second year (31 December 20.18):
R
Instalments paid (12 x 800) 9 600
Equalised lease expense per year (730 [C1] x 12 months) 8 760
Prepaid expense (asset) (9 600 – 8 760) 840
Prepaid expense balance 20.17 2 280
Prepaid expense asset (SFP) 20.18 3 120
PREPAID EXPENSE VERSUS ACCRUED EXPENSE
A company will recognise a prepaid expense for lease payments when the actual
annual lease payment paid exceeds the annual equalised lease payment.
A company will recognise an accrued expense for lease payments when the
actual annual lease payment paid is less than the annual equalised lease
payment.
If the monthly instalments from Example 3 were changed as follows:
1 - 24 months R 600
25 - 48 months R 800
The equalised lease payment would still be R730 per month, however the
equalised lease payment of R8 760 (R730 x 12) would be more than the actual
lease expense of R8 640 (1 440 + 600 x 12). This difference of R120 is an
accrued expense for the year ended 31 December 20.17.
(c) Disclosure
KLIP LTD
NOTES TO THE ANNUAL FINANCIAL STATEMENTS FOR THE YEAR ENDED
31 DECEMBER 20.18.
2. Prepaid expenses
20.18 20.17
R R
Low-value asset lease: prepaid expense [C2 & C3] 3 120 2 280
3. Leases
The expense is the
3.1 Income and expenses related to leases equalised instalment
Expenses
Low-value lease expense – recognition exemption [C2] 8 760 8 760
Klip Ltd elected the recognition exemption on low-value leases of office equipment.
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FAC3703/501
20.18 20.17
3.2 Total cash outflows relating to leases R R
Presented under operating activities

Cash payments for short-term leases (1 440 + (800 x 12) + 500) 11 540
(800 x 12) 9 600
IMPORTANT
The computer and printer are not recognised as right-of-use assets. As a result,
no depreciation is recognised for the low-value.
2.4.2 Initial recognition of a lease (IFRS 16.23-28)

At commencement of the lease, a lessee shall recognise a right-of-use asset (for example
machinery) and a lease liability (future lease instalments payable) in its statement of financial
position.
LESSEES
RIGHT-OF-USE OF ASSET LEASE LIABILITY
Initial recognition: Initial recognition:
At commencement date, the lessee will recognise the At commencement date, the lessee will recognise
right-of-use asset at cost. the lease liability at the present value (using the
interest rate implicit in the lease of the lease
payments not paid at that date).
Lease payments used to measure the lease

Cost comprises of: liability comprise of:
 The amount at which the lease liability is initially  Fixed payments (includes in-substance fixed
measured; payments) less lease incentives receivable;
 Any lease payments made at or before the  Variable lease payments that depend on an index
commencement date, excluding any lease or a specific rate, initially to be measured using
incentives received; the index or rate as at commencement date;
 Initial direct costs incurred by the lessee; and  Amounts payable in terms of residual value
 An estimate of the costs that will be incurred by guarantees;
the lessee to dismantle or remove the underlying  Exercise price of a purchase option if it is
asset, restoring the site on which the asset is reasonably certain that the lessee will exercise
located or restoring the underlying asset to the that option; and
condition required in terms of the lease, unless  Penalty payments for terminating the lease.
those costs are incurred to produce inventory.
47
2.4.3 Subsequent measurement (IFRS 16.29-38)
RIGHT-OF-USE OF ASSET LEASE LIABILITY
Subsequent measurement: Subsequent measurement:
After commencement date of the lease, the lessee After commencement date, the lease liability is
will measure the right-of-use asset applying the measured by:
cost model UNLESS another measurement
model applies.
Cost  Adding the interest expense (2.4.4) on the lease to the

carrying amount of the lease liability;
Right-of-use asset measured at cost.  Deducting payments made on the lease from the
 Less accumulated depreciation; carrying amount of the lease liability; and
 Less accumulated impairment (IAS 36);  Remeasuring the carrying amount to reflect any
AND reassessments (2.4.7) or lease modifications (2.4.8).
 Adjusted for any remeasurement of the
lease liability.
The following will be included in profit/loss, UNLESS it
Other measurement models is included in the carrying amount of another asset:
Right-of-use asset measured at fair value if:  Interest on the lease liability; AND
 Right-of-use assets meets IAS 40  Variable lease payments not included in the
Investment property definition; AND measurement of the liability in the period in which the
 Lessee accounts for investment property event or condition that triggers those payments occur.
on the fair value model.
DR Finance costs (P/L) xx
Right-of-asset measured on revaluation model if: DR Lease liability (SFP) xx
 The right-of-use assets relates to a class CR Bank (SFP) xx
of property, plant and equipment to which Payment of lease instalment on….
the lessee has applied the revaluation
model. OR
 A lessee may elect to apply the
DR Finance costs (P/L) xx
revaluation model to all right-of-use
CR Bank (SFP) xx
assets relating to that class of property,
DR Lease liability (SFP) xx
plant and equipment.
CR Bank (SFP xx
Payment of lease instalment on….
DR Variable lease payments expenses (P/L) xx

CR Bank (SFP) xx
Payment of variable lease payments on …..
A lease gives rise to a depreciation expense for the leased asset (for example, depreciation on machinery) as well as a finance cost for
each accounting period. The depreciation policy for depreciable leased assets should be consistent with that for depreciable assets
which are owned, and the depreciation recognised shall be calculated in accordance with IAS 16, Property, Plant and Equipment,
IAS 38, Intangible Assets and IAS 40, Investment Property.
The right-of-use asset is depreciated over its useful life if ownership transfers at the end of the lease term. If the transfer of
ownership is not certain, the right-of-use asset shall be depreciated over the shorter of its useful life or lease term.
EXAMPLE 4
Beetle Ltd entered into a contract with Apple Ltd on 1 January 20.17 whereby Apple Ltd will
lease a machine for a period of four years. The cash selling price and fair value of the
machine was R400 000 on 1 January 20.17 and the instalments amount to R132 000 and are
payable annually in arrears. The interest rate implicit in the lease is 12.1104% per year.
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FAC3703/501
Ownership of the machine will transfer to Apple Ltd at the end of the lease term at no
additional cost. The contract is classified as a lease in terms of IFRS 16, Leases.
The machine has a useful life of five years and it is the company’s policy to depreciate the
machine over its useful life on the straight-line basis.
The company financial year-end is 31 December.
REQUIRED
(a) Calculate the value of the right-of-use asset and the corresponding
liability for Apple Ltd.
(b) Prepare the journals entries in the accounting records of Apple Limited
for the year ended 31 December 2017.

Standards (IFRS).
SOLUTION 4
(a) Calculations:
Right-of-use asset (Machine) R

Initial measurement of the lease liability *400 000
Initial direct costs of lessee -
Plus lease payments made at or before commencement date less any -
incentive received
Estimate of dismantling costs -
400 000
Lease liability
Present value of lease liability at inception of the lease 400 000
Minus payments made on or before commencement date -
Present value of lease payments not paid at lease commencement date *400 000
* The present value of the lease payments is calculated as follows:

Set HP and Sharp EL-738 calculators on 1P/YR as
N = 4 (1 payment per year x 4 years) there is one instalment payable per year.
PMT = 132 000
FV = 0 + 0 (guaranteed and unguaranteed residual values)
I = 12,1104% p.a.
Present value is equal to the fair value of the
PV = ? 400 000 machine.
EXAM TECHNIQUE
Please show calculations for all the amounts used in the journals or disclosure so
that the marker can follow your calculations and award the marks!
49
(b) Journals as at:
DR CR
1 January 2017 R R
Right-of-use asset: Machine (SFP) 400 000

Lease liability (SFP) 400 000
Recognition of right-of-use asset and lease liability
The lessee obtains ownership at the end of

the lease term therefore use the remaining
31 December 2017 useful life.
Depreciation (P/L) 80 000

Accumulated depreciation (SFP) (400 000/5) 80 000
Recognition of depreciation for the year
Lease liability (SFP) (400 000 x 12,1104% x 12/12) 48 442
Recognition of finance costs that accrued from 1 January 2017 –
31 December 2017

Bank (SFP) 132 000
Payment of lease instalment on 31 December 20.17
OR

Lease Liability (SFP) 83 558
Bank (SFP) 132 000
Payment of lease instalment on 31 December 20.17
2.4.4 Finance costs

Lease instalments should be split between the finance costs and the reduction of the
outstanding lease liability. The finance costs should be allocated to periods during the lease
term to produce a constant periodic rate of interest on the remaining balance of the liability for
each period.
An amortisation table is prepared to calculate the split between capital and finance costs. It is
very important that you are able to calculate the interest rate implicit in the lease on your
financial calculator. You must also be able to extract the amortisation table from your financial
calculator as shown in Example 5.
2.4.5 Impairment (IFRS 16.33)

To determine whether a right-of-use asset has become impaired, that is when the expected
future economic benefits from that asset is lower than its carrying amount, an entity applies
IAS 36, Impairment of Assets. This standard sets out the requirements for how an entity
should perform the review of the carrying amount of its assets, how it should determine the
recoverable amount of an asset and when it should recognise, or reverse, an impairment loss.
(Impairment of assets does not form part of this module.)
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FAC3703/501
EXAMPLE 5
SAXCO Ltd entered into a contract with Bakery SA Ltd on 1 March 20.16 whereby
Bakery SA Ltd will lease a specialised oven to SAXCO Ltd. The contract meets the
requirements of a lease in terms of IFRS 16, Leases.
Lease term 4 years
Instalment payable monthly in arrears R20 000
Useful life of oven 6 years
The lessee’s incremental borrowing rate on 1 March 20.16: 8% per annum
The lessee incurred R4 800 legal fees for negotiating the lease. It is impracticable for the
lessee to calculate the costs incurred by the lessor and as a result cannot calculate the
interest rate implicit in the lease.
REQUIRED
(a) Calculate the value of the right-of-use asset and the corresponding
lease liability for SAXCO Ltd at initial recognition.
(b) Prepare the journals entries in the accounting records of
SAXCO Limited for the year ended 28 February 20.17.
Standards (IFRS).
SOLUTION 5
(a) Calculations:
Right-of-use asset (Oven) R
Initial measurement of the lease liability *819 238
Initial direct costs of the lessee 4 800
Plus lease payments made at or before commencement date less any
incentive received 144 000
Plus estimate of dismantling costs -
968 038
Lease liability
Present value of lease liability at inception of the lease 819 238
Present value of lease payments not paid at lease commencement date *819 238

N = 48 (12 payments per year x 4 years) there are twelve instalments payable per year.
PMT = 20 000
FV = 0 (residual values guarantee)
I = 8% p.a.
PV = ? 819 238
The lessee’s incremental borrowing rate is used as the interest rate implicit in the lease cannot be readily
determined.
51
(b) Journals for the year ended 28 February 20.17:
DR CR
1 March 20.16 R R
Right-of-use asset: Oven (SFP) 819 238
Recognise asset and liability

Bank (SFP) 4 800
Recognise initial direct costs (legal fees) as part of cost of asset

Bank (SFP) 144 000
Recognise deposit as part of cost of asset
OR

Bank (SFP) (4 800 + 144 400) 148 800
Recognise asset, liability and cost of asset paid in cash
There is no reasonable certainty that the lessee will

28 February 20.17 obtain ownership at the end of the lease term therefore
use the shorter of the lease term or it’s useful life.

Accumulated depreciation (SFP) (968 038/4) 242 010
Depreciation for the year
Finance costs (P/L) [C1] 58 998

Lease liability (SFP) [C1] 58 998
Total finance costs for the year
Bank (SFP) [C1] 240 000
The total of 12 lease payments for the year
OR

Bank (SFP) [C1] 240 000
The total of 12 lease payments for the year
The total of all 12 instalments are combined and shown in

one journal. Alternatively, the journal can be repeated at
the end of every month taking into account the 12-monthly
instalments.
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FAC3703/501
C1. Amortisation table
Payment date Instalment Capital Interest Balance

at 8%
R R R R
1 March 20.16 819 238
31 March 20.16 20 000 14 538 5 462 804 700
30 April 20.16 20 000 14 635 5 365 790 064
31 May 20.16 20 000 14 733 5 267 775 331
30 June 20.16 20 000 14 831 5 169 760 500
31 July 20.16 20 000 14 930 5 070 745 570
31 August 20.16 20 000 15 030 4 970 730 541
30 September 20.16 20 000 15 130 4 870 715 411
31 October 20.16 20 000 15 231 4 769 700 180
30 November 20.16 20 000 15 332 4 668 684 848
31 December 20.16 20 000 15 434 4 566 669 414
31 January 20.17 20 000 15 537 4 463 653 877
28 February 20.17 20 000 15 641 4 359 638 236
240 000 181 002 58 998
AMORTISATION TABLE
The complete amortisation table includes 48 months/payments. Only the

first 12 months were done as only the first 12 months are required to do
the journals at 28 February 20.17.
The totals of the amortisation table above can also be retrieved from your
financial calculator as follows:
Interest 58 988, Capital 181 002, Balance 638 236
SHARP EL738 HP SHARP (OLD)

Amort – P1 = 1 enter 1 Amort 12 enter 1 P1/P2 12 account = capital
Arrow down 1 P1/P2 12 account = Interest
P2 = 12 enter, arrow 12 amort = balance
down
2.4.6 Separate components of a contract (IFRS 16.12-17)

Contracts may include different kinds of obligations/components. These obligations must be
identified as lease components and non-lease components.
a) The right to use an underlying asset is a separate lease component if both:

 The lessee can benefit from the use of the underlying asset either on its own OR
together with other resources that are readily available to the lessee; and
Readily available resources are goods and services that are sold or leased separately or resources that the lessee has already obtained.
 The underlying asset is neither highly dependent on, NOR highly interrelated with the
other underlying assets in the contract.
53
b) If a component does not meet the requirements of (a), it will be a non-lease
component.
ITEMS THAT DO NOT GIVE RISE TO SEPARATE LEASE

COMPONENTS
Administrative charges do not transfer a good or service to the lessee and

therefore will not give rise to a separate component of the contract. The
administrative charges will form part of the total consideration allocated to
the separately identified components of the contract.
Example: A contract to lease machinery that includes the maintenance of

the machine and administrative charges.
The contract will have two separate components:
 Lease component: lease of the machine
 Non-lease component: maintenance costs included in lease
The admin charges will be added proportionately to the separate
components being the machine and maintenance costs.
The lessee may elect (as a practical expedient), by class of underlying asset, not to separate
the non-lease components from the lease component.
Components of contract
Lessee does not elect practical expedient Lessee elects practical expedient
For contracts that contain a lease The lessee accounts for lease and non-
component and one or more additional lease lease components as a single lease
or non-lease components, the lessee is component.
required to:  Lease liability will increase with the
 Allocate the consideration in the non-lease components (which will
contract to each lease component on result in an increase in the right-of-
the basis of the relative stand-alone use-asset).
price of the non-lease components.  Lessee cannot apply practical
 Account for non-lease components expedient to embedded derivatives
applying other applicable standards. in terms of IFRS 9 Financial
Instruments paragraph 4.3.3.
(Not examinable on 3rd level)
RELATIVE STAND-ALONE PRICES
The relative stand-alone price of lease and non-lease components is

determined on the basis of the price the lessor, or a similar supplier, would
charge an entity for that component, or a similar component.
IF an observable stand-alone price is not available, the lessee will

estimate the stand-alone price, maximising the use of observable
information.
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FAC3703/501
EXAMPLE 6 (based on IFRS 16 Illustrative example 12)
PART A
Rubble Ltd leases a bulldozer to Kider Ltd to be used in Kider Ltd’s construction operations
for four years. The contract contains a lease in terms of IFRS 16, Leases. Rubble Ltd agrees
to maintain the bulldozer throughout the lease term.
The total consideration of the contract is R202 000, payable in annual instalments of R50 500.
The consideration of the lease includes the cost of all maintenance services for the bulldozer.
REQUIRED PART A
Discuss the various components of the lease agreement.
SOLUTION - PART A
As per IFRS 16, Leases the right to use an underlying asset is a separate lease component if:
 The lessee can benefit from the use of the underlying asset either on it’s own or
together with other resources that are readily available to the lessee, and
 The underlying asset is neither highly dependent on, NOR highly interrelated with the
other underlying assets in the contract.
The lease of the bulldozer is a lease component because:

 Kider Ltd can benefit from the use the bulldozer on its own or together with other readily
available resources; and
 The bulldozer is neither highly dependent on, nor highly interrelated with any other item
of property, plant and equipment.
If a component does not meet the requirements above it will be a non-lease component:
The maintenance services included in the lease agreement will be a separate non-lease
component as it would be highly dependent on the bulldozer and Kider Ltd cannot benefit
from the use of the maintenance services without the bulldozer.
Conclusion
There is one lease component (the lease of the bulldozer) and one non-lease component
(maintenance services) in the contract. These two components must be recognised
separately, unless K Ltd has elected to make use of the practical expedient.
PART B
Several suppliers provide maintenance services for a similar bulldozer, therefore Kider Ltd is
able to establish observable stand-alone prices for the maintenance of the bulldozer
amounting to a total R32 000, assuming similar payment terms to those in the contract with
Rubble Ltd.
Kider Ltd is able to establish an observable stand-alone price for the leasing of the bulldozer
amounting to R170 000.
55
REQUIRED PART B
Assume that Kider Ltd did not elect the practical expedient. Allocate the
consideration in the contract to the lease and non-lease components (if
applicable).
SOLUTION - PART B
Kider Ltd allocates the fixed consideration in the contract to the lease and non-lease
components as follows:
R
Lease component (lease of the bulldozer) 170 000
Non-lease component (maintenance services) 32 000
Total 202 000
PLEASE NOTE
Kider Ltd will account for the lease component of R170 000 by applying
IFRS 16, Leases. The consideration allocated to the maintenance services
of the bulldozer of R32 000 will not form part of the lease and will be
accounded for by applying other applicable Standards.
2.4.7 Reassessment of lease liability of the lessee (IFRS 16.39-46)
There are instances where the terms of lease can change during the lease term, in which
case the lease liability must be reassessed.
A lessee shall remeasure the lease liability in the following circumstances:
1. There is a change in the lease term, or 1. There is a change in the amounts

2. There is a change in the assessment of expected to be paid under a residual
an option to purchase the underlying value guarantee.
asset. 2. There is a change in future lease
payments due to a change in an index or
rate used to determine those payments.
Discount the revised lease payments using a Discount the revised lease payments using
revised discount rate. the unchanged discount rate.
The revised discount rate = interest rate An unchanged discount rate is used.
implicit in the lease for the remainder of the UNLESS
lease term (if it can be readily determined).
The change in the lease payments is as a
result of floating interest rates. In this case,
If the IRIL it cannot be readily determined: a revised discount rate, that reflects
changes in the interest rate, must be used.
The revised discount rate = lessee’s
incremental borrowing rate at the date of
reassessment.
Lease liabilities are also remeasured due to lease modifications (2.4.8) that result in an
increase in the scope of the lease.
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FAC3703/501
Property On Call Ltd leased a retail store to Glimmer Ltd on 1 January 20.13. The lease is for
a period of five years with annual instalments amounting to R60 000 payable in arrears. The
contract has the option to be extended for an additional four years with annual instalments
amounting to R60 000. At commencement of the lease, Glimmer Ltd concluded that it was not
reasonably certain that it will exercise the option to extend the lease and therefore determined
the lease term to be five years. Ownership will not be transferred at the end of the lease term.
Glimmer Ltd incurred legal fees of R14 000 to secure the lease. Property On Call Ltd paid
commission of R8 000 to Rent a prop Ltd.
On 1 January 20.16, Glimmer Ltd entered into a second lease with Property On Call Ltd to
lease an office space above the retail store for six years to allow the retail store to be used
only for the selling of fashion accessories and the office for administrative functions and
storage of fashion accessories to prevent major stock shortages. As a result it is now
reasonably certain on 1 January 20.16 that Glimmer Ltd will extend the original lease of the
retail store that was entered into on 1 January 20.13.
Both lease contracts contain a lease in terms of IFRS 16, Leases. Glimmer Ltd’s incremental
borrowing rate is 6% per annum on 1 January 20.13. On 1 January 20.16, Glimmer Ltd has
an incremental borrowing rate of 7% per annum. It is impractical for Glimmer Ltd to calculate
the interest rate implicit in the lease for the two lease contracts.
The retail store and office space have a useful life of twenty years and a residual value of Rnil
for Glimmer Ltd and is depreciated over its useful life using the straight-line method.
REQUIRED
(a) Prepare the journal entries to account for the lease of the retail store
for the year ended 31 December 20.13 in the accounting records of
Glimmer Ltd.
(b) Prepare the journal entries to account for the lease of the retail store
for the year ended 31 December 20.16 in the accounting records of
Glimmer Ltd.

Standards (IFRS).
57
SOLUTION 7
(a) Journals for the year ended 31 December 20.13
DR CR
1 January 20.13 R R
Right-of-use asset: Retail store (SFP) [C1] 252 742
Recognise asset and liability

Bank (SFP) 14 000
Recognise legal fees by increasing right-of-use asset
31 December 20.13

Accumulated depreciation ((252 742 + 14 000)/5 years) (SFP) 53 348

Bank (SFP) 60 000
Recognise payment of first lease liability instalment
Ownership of asset will not be transferred to Glimmer Ltd,

therefore depreciate the asset over the shorter of the lease term
(five years) or its useful life (twenty years).
CALCULATIONS
C1. Right-of-use asset and lease liability
Right-of-use asset (Retail store) R
Initial amount of the lease liability [C2] 252 742
Initial direct costs of the lessee 14 000
Plus lease payments made at or before commencement date less any
incentive received -
266 742
Lease liability
Present value of lease liability at inception of the lease [C2] 252 742
Present value of lease payments not paid at lease commencement date 252 742
C2. Present value of lease payments

PMT = 60 000
FV = 0 (only residual value guarantee)
I = 6% p.a. The lessee’s incremental borrowing rate is used as the interest rate implicit in the lease
PV = ? 252 742 cannot be readily determined.
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Interest at Closing
Payment date Instalment 6% p.a Capital balance
R R R R
1 January 20.13 252 742
31 December 20.13 60 000 15 165 44 835 207 906
31 December 20.14 60 000 12 474 47 526 160 381
31 December 20.15 60 000 9 623 50 377 110 004
31 December 20.16 60 000 6 600 53 400 56 604
31 December 20.17 60 000 3 396 56 604 -
Starting balance
252 742 x 6% = 15 165 = PV of lease
liability
(b) Journals for the year ended 31 December 20.16
DR CR
1 January 20.16 R R
Lease Liability (SFP) [C4] 175 988
Remeasurement of lease liability due to change in
lease term
31 December 20.16
Accumulated depreciation (SFP) (282 686 [C4] / 6 yrs) 47 114

Bank (SFP) 60 000
Take note that from 1 January 2016, the asset is

depreciated over six years as the new lease term after
the remeasurement is six years.
CALCULATIONS
CHANGE IN LEASE TERM
As from 1 January 20.16, it is reasonably certain that the lease of the retail space
will be extended. Glimmer Ltd must remeasure the lease liability by including the
additional four years and using the revised incremental borrowing rate of 7% p.a.
(the rate on date of remeasurement).
At 31 December 2015, the lease liability was R110 004 and the right-of-use asset
had a carrying amount of R106 698 before the change in the lease term.
59
C4. Remeasurement of right-of-use asset and liability on 1 January 20.16
Lease liability R
Lease liability as at 31 December 20.15 before change in lease term C3 110 004
Present value of lease payments at remeasurement date (1 January 20.16) C5 285 992
Remeasurement of lease liability (285 992 – 110 004) 175 988
At 31 December 20.15 the lease

liability is R110 004 before the change
in the lease term (see C3).
Right-of-use asset (Retail store)

Carrying amount as at 31 December 20.15 (266 742 – (53 348 x 3 years)) 106 698
Adjustment to cost of right-of-use asset (Remeasurement of lease liability) 175 988
New carrying amount of right-of-use-asset as at 1 January 20.16 282 686
N = 6 (2 years original lease + 4 years option to extend)

(1 payment per year x 6 years)
PMT = 60 000
I = 7% p.a. (incremental borrowing rate at 1 Jan 20.16 – date of reassessment)
PV = ? 285 992
C6. Amortisation table (after lease term change)
Interest Closing
Payment date Instalment (7% p.a) Capital balance
R R R R
1 January 20.16 285 992
31 December 20.16 60 000 20 019 39 981 246 012
31 December 20.17 60 000 17 221 42 779 203 233
31 December 20.18 60 000 14 226 45 774 157 459
31 December 20.19 60 000 11 022 48 978 108 481
31 December 20.20 60 000 7 594 52 406 56 075
31 December 20.21 60 000 3 925 56 075 -
Two years remaining of 285 992 x 7% x 12/12 = 20 019
The additional four
the original lease of five
years lease option
years. Amort table starts
extension taken into
with new PV calculated
account.
1 January 20.16
REVISED DISCOUNT RATE

The lessee’s incremental borrowing rate at date of reassessment is used as the
interest rate implicit in the lease cannot be readily determined.
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2.4.8 Lease modifications (IFRS 16.44 – 46)
LEASE MODIFICATIONS
For exam purposes, FAC3703 students should have a basic knowledge and
awareness of lease modifications. For lease modifications, students must only
study the theory below and Example 8.
A modification in a lease arises when there is a change in the scope of the lease, for example
the consideration of the leases changes during the lease term, or a change in lease term as
well as the addition of extra underlying assets.
A lease modification is accounted for as a separate lease when:
1) The modification increases the scope of the lease by adding the right to use one or
more underlying assets; AND
2) The consideration for the lease increases by an amount in proportion to the stand-
alone price for the increase in scope and any appropriate adjustments to that stand-
alone price to reflect the circumstances of that contract.
For a lease modification that is NOT treated as a separate lease, the lessee shall do
the following at effective date of the lease modification:
Step 1 - Allocate the consideration in the contract applying the principles of:
Separate components of a lease (refer to 2.4.6):
 Allocate the consideration in the contract to each lease component on the
basis of the relative stand-alone price of the non-lease components.
 Lessee accounts for non-lease components applying other applicable
standards.
Step 2 - Determine the lease term of the modified lease applying the principles of:
Lease term (refer to 2.2.3):
An entity will determine the lease term as the non-cancellable period of a lease
together with both:
 Period covered by an option to extend the lease if it is reasonably certain
the lessee will exercise that option; and
 Periods covered by an option to terminate the lease if it is reasonably
certain the lessee will not exercise that option.
Step 3 - Remeasure the lease liability by discounting the lease payments
using a revised discount rate.
The revised discount rate is determined as follows:
 The interest rate implicit in the lease for the remainder of the lease term.
 If the interest rate implicit in the lease cannot be readily determined, use
the lessee’s incremental borrowing rate at effective date of the lease
modification.
61
The remeasurement of the lease liability is accounted for as follows:
Lease modifications that decrease the scope of the lease:
 Decrease the carrying amount of the right-of-use asset to reflect the partial or full
termination of the lease, and
 Gain or losses related to the partial or full termination of the lease to be
recognised in profit or loss.
For all other modifications, a corresponding adjustment to the right-of-use asset is made.
Change in lease term or consideration
When there is a change in the lease term or consideration of the lease as a result of a lease
modification and there is no change in the number of right-of-use assets within that lease (for
example, if the lease term of a lease changed and before the change “modification” there was
only one right-of-use asset, after adjusting for the modification there will still only be one right-
of-use asset).
You will not recognise a separate lease for the modification and in this case the modification
is treated the same as a remeasurement of a lease (Refer to Example 7 above).
Bubbles Ltd entered into a 10 year lease for 2 000 square metres of office space from
Golden Ltd. At the beginning of the sixth year, Bubbles Ltd and Golden Ltd agreed to amend
the original lease for the remaining five years to include an additional 3 000 square metres of
office space in the same building.
The additional space is available for use by Bubbles Ltd at the end of the second quarter of
year six. The increase in the consideration for the lease is commensurate with the current
market rate for the additional 3 000 square metres of office space, adjusted for the discount
that Bubbles Ltd receives reflecting that Golden Ltd does not incur cost that would otherwise
be incurred leasing the same space to a new tenant.
REQUIRED
Discuss whether the modification to the existing lease would be a

separate lease or an extension of the existing lease.
SOLUTION 8
Per IFRS 16, Leases a lease modification is accounted for as a separate lease when:
 The modification increases the scope of the lease by adding the right to use one of
 The consideration for the leases increases by an amount commensurate with the
stand-alone price for the increase in scope and any appropriate adjustments to that
stand-alone price to reflect the circumstances of that contract.
 Bubbles Ltd has the right to use an underlying asset, being the additional 3 000 square
metres of office, and
 The increase in consideration for the lease is in line with the stand-alone price of the
additional right-of-use asset adjusted to reflect the circumstances of the contract.
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Conclusion
As the two requirements above are met, Bubbles Ltd will account for the lease of the
additional 3 000 square metres as a separate lease.
At commencement date of the new lease, Bubbles Ltd will recognise a right-of-use asset and
a lease liability relating to the lease of the additional 3 000 square metres of office space.
Therefore, Bubbles Ltd will not make any adjustments to the original lease of 2 000 square
metres of office space as a result of this modification.
2.4.9 Tax effect of an underlying right-of-use asset

(a) Current tax
The total instalments paid (finance cost and capital) by the lessee is deductible for tax
purposes if the lessee qualifies for a section 11(a) deduction in terms of the Income Tax Act.
The legal costs incurred by the lessee in acquiring a capital asset are not deductible for tax
purposes as it is of a capital nature. Other initial costs, such as commission paid are
deductible. Bona fide lease premiums are also deductible over the term of the lease in terms
of Section 11(f) of the Income Tax Act.
The lessee does not qualify for capital deductions or tax allowances on the leased asset (for
example machinery), as the tax treatment is based on the legal ownership of the machinery.
Legal ownership normally remains with the lessor until the end of the lease term. When legal
ownership passes at the end of the lease term at no cost or for an inadequate consideration,
the lessee will be taxed on the recoupment in terms of section 8(5) of the Income Tax Act.
(b) Deferred tax

For accounting purposes, the lessee recognises a lease liability (outstanding capital and
finance costs) and the right-of-use asset. Depreciation is recognised on the right-of-use asset.
For tax purposes, as explained in (a) above, no tax allowances are available and the full
instalment (capital and finance costs) is deductible.
Temporary differences arise as a result of the different treatments for accounting and tax
purposes. In order to calculate the deferred tax balance, it is very important that you know the
definitions of the tax base for assets and liabilities as per IAS 12, Income Taxes.
The definitions are summarised in the diagram below:
Amount deductible in future for tax If future economic benefits are not
Tax base of an asset: = purposes against taxable economic taxable, the tax base = carrying
benefits of the asset amount, i.e. no temporary difference
Carrying amount minus amount

Tax base of a liability: =
deductible in future for this liability
Tax base of revenue Carrying amount minus amount of

=
received in advance: revenue not taxable in future
63
Right-of-use asset:
The carrying amount of the right-of-use asset for deferred tax purposes will be the carrying
amount disclosed as per the financial statements (i.e. Property, Plant and Equipment note) of
the lessee at the relevant year end.
The tax base for deferred tax purposes will be Rnil, as the right-of-use asset is for tax
purposes still accounted for in the books of the lessor and the lessor is therefore allowed to
deduct tax allowances for the asset. For instalment sale agreements, the right-of-use asset is
accounted for in the lessee’s books for tax purposes as legal ownership transfers at
commencement of the lease. As a result the tax base will be the cost less tax allowances
received until year end.
Legal costs (capitalised to the asset) are not deductible for tax purposes and will be an
exempt temporary difference. Commission paid (capitalised to the asset) is deductible for tax
purposes and will give rise to a temporary difference.
Accounting vs tax treatment of an underlying leased right-of-use asset.
Accounting treatment Tax treatment

In profit or loss: In profit or loss:
Deduct depreciation No wear and tear deduction allowed
Deduct finance costs of lessee Deduct full instalment of lease
(finance costs + capital portion)
Statement of financial position: Statement of financial position:
Present value of lease liability at year- Carrying amount of the lease liability at year end
end. – amounts deductible in future therefore = R0
Carrying value of right-of-use asset at No asset recognised therefore = R0
year-end.
Lease liability:
The lessee will include the carrying amount (amortised cost balance) of the financial lease
liability as per the lessee’s financial statements at year-end in the deferred tax calculation.
The tax base will be Rnil, being the carrying amount less amounts deductible in future in the
form of lease instalments. (Note: Where the lease agreement contains VAT, the tax base will
be the VAT amount contained in the future lease instalments – see below for section on VAT.)
(c) Value-added tax (VAT)
On signing of the lease agreement, VAT is payable by the lessor on the cash selling price if
the lessor is a registered VAT vendor. The lessee may claim the VAT input credit if the asset
(for example machinery or commercial vehicles) is used to produce taxable supplies (you
cannot claim a VAT input credit on a motor car).
When a lessee finances VAT:
When leasing an asset, the lessee has the option to finance the VAT. When the VAT is
financed, it is added to the cost price (the VAT is financed) and in this case the lease
instalments are calculated on the VAT inclusive amount. The lease liability should be
disclosed at the amount inclusive of VAT and therefore includes VAT.
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FAC3703/501
The instalment deductible for income tax purposes must exclude this VAT portion to avoid
the same amount being claimed as VAT and as a tax deduction for income tax purposes
(section 23C of the Income Tax Act). The VAT to be excluded from each instalment is
calculated on the outstanding capital balance.
When a lessee does not finance VAT:
The lessee can decide to pay the VAT in cash to the lessor at the beginning of the lease in
which case the future instalments will exclude VAT. The lease liability will then exclude VAT
as the lessor does not finance the VAT.
EXAMPLE 9
Cat Ltd, a company registered as a VAT vendor, entered into a contract on 1 January 20.15
whereby it leases a machine, from Hubble Ltd. The contract contains a lease in terms of
IFRS 16, Leases. Hubble Ltd did not incur any initial direct costs. The terms of the lease are
as follows:
Cost of machine: R115 000 (including R15 000 VAT)

Instalment: R75 272.73 (including VAT, payable annually in arrears)
Interest rate: 20% per annum
Lease term: 2 years
Ownership will transfer to Cat Ltd at the end of the lease term at no additional cost. Cat Ltd
will finance the cost of the machine inclusive of VAT.
The estimated useful life of the machine is two years.
The profit before tax of Cat Ltd amounted to R500 000 before the above transactions were
taken into account.
REQUIRED
(a) Prepare the journal entries of Cat Ltd for years ended
31 December 20.15 and 31 December 20.16.
(b) Calculate the current tax expense and deferred tax balance of
Cat Ltd for the year ended 31 December 20.15.

Standards (IFRS).
65
SOLUTION 9
(a) Journals for the year ended 31 December 20.15

DR CR
1 January 20.15 R R
Right-of-use asset: Machine (SFP) [C2] 100 000
VAT control account (input) (SFP) [C2] 15 000
Recognition of lease agreement
31 December 20.15
Bank (SFP) [C3] 75 273
Payment of lease instalment on 31 December 2015
Accumulated depreciation (SFP) (100 000/2 years) 50 000
Depreciation charge for the year ended 31 December 2015
31 December 2016
Bank (SFP) [C3] 75 273
Payment of lease instalment 31 December 2016

Accumulated depreciation (SFP) (100 000 /2 years) 50 000
Depreciation charge for the year ended 31 December 2016
JOURNAL NARRATIONS
There is no fixed rule to the wording used in journal narrations. The only
requirement is that the narration must explain the purpose of the journal.
CALCULATIONS
C1. Calculate interest rate implicit in the lease


PMT = 75 272.73
PV = 115 000
I = ? 20% p.a.
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FAC3703/501
INTEREST RATE IMPLICIT IN THE LEASE
Remember that the lease liability must be recognised at its present value
which is determined by discounting the lease payments using the interest
rate implicit in the lease.
When the interest rate implicit in the lease cannot be readily determined,
the lessee will use its incremental borrowing rate of interest which is the rate
of interest the lessee would have to pay to borrow over a similar term, with
similar security.
Right-of-use asset (Machine) R

Initial amount of the lease liability *115 000
Initial direct costs of the lessee -
Minus VAT (the lessee may claim the VAT) (15 000)
Plus lease payments made at or before commencement date -
100 000
Lease liability
Present value of lease payments at lease commencement date *115 000
Minus lease payments made at or before commencement date -
Present value of lease payments not paid at lease commencement date 115 000

PMT = 75 272.73
FV = 0 (guaranteed residual values guarantee)
I = 20% p.a.
PV = 115 000

Interest Closing
Payment date Instalment (20% p.a.) Capital balance
R R R R
1 January 20.15 115 000
31 December 20.15 75 272.73 23 000 52 273 62 727
31 December 20.16 75 272.73 12 546 62 727 -
Starting opening
115 000 x 20% = 23 000
balance = PV of
lease liability
67
(b) Income tax expense
R
Profit before tax (given) 500 000
Finance costs [C3] (23 000)
Depreciation (see part (a)) (50 000)
Accounting profit 427 000
Movement in temporary differences (see deferred tax calculation below) 4 546
Taxable profit 431 746
Current tax @ 28% (431 746 x 28%) 120 889
Proof of temporary differences: 4 545

Deduct capital portion of instalment paid excluding VAT (52 273 x 100/115) (45 455)
Add back depreciation 50 000
For tax purposes, the full instalment (capital and interest) is deductible.
The finance costs of R23 000 has already been deducted above when the accounting
profit was calculated. The capital portion of R52 273 is then deducted to ensure that
the full instalment of R75 273 is deducted for tax purposes.
The deferred tax balance for the year ended 31 December 20.15 will be as follows:
Deferred
tax at
Carrying Temporary 28%
amount Tax base difference asset/
R R R (liability)
31 December 20.15
Machinery 50 000 *- 50 000 (14 000)
Lease liability (62 727) * (8 182) (54 545) 15 273
Net deferred tax asset (4 545) 1 273
*TAX BASE
Machinery
The tax base of the machinery is Rnil as the machinery is still owned by the
lessor for tax purposes; therefore no future tax deductions are available to
the lessee (Cat Ltd).
Lease liability
The carrying amount of R62 727 represents the capital portion outstanding
(amortised cost balance) at 31 December 20.15.
The capital balance (exclusive of VAT) is deductible for tax purposes. The
tax base of the lease liability is the carrying amount (R62 727) minus
amounts deductible in future (R62 727 x 100/115 = R54 545).
R62 727 – R54 545 = R8 182.
As a result, the VAT of R8 182 on the capital balance will be the tax base
(R62 727 x 15/115 = R8 182).
Remember, the VAT has already been claimed as input VAT, therefore it
cannot be claimed again.
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2.4.10 Disclosure - Lessee
IFRS 16, Leases requires an entity to disclose information relating to its leases for which it is
a lessee in a separate note or section in the financial statements. However, lessees are not
required to duplicate information disclosed elsewhere, provided that the information is cross
referenced in the single note or separate section.
 A lessee must disclose the following amounts in a tabular format for the reporting period,
unless another format is more appropriate.
a) Depreciation charge for right-of-use assets by class of underlying asset;

b) Interest expense on lease liabilities;
c) Expenses relating to variable payments not included in the measurement of the
lease liabilities;
d) Income from subleasing right-of-use assets;
e) Total cash outflow for leases;
f) Additions to right-of-use assets;
g) Gains or losses arising from sale and leaseback transactions (only examinable on
post graduate level); and
h) The carrying amount of right-of-use assets at the end of the reporting period.
Please refer to 2.4.1 for the disclosure required when the lessee has elected to make use
of recognition exemptions for the lease of low-value assets and short-term leases.
 For right-of-use assets that meet the definition of investment property, a lessee will apply
IAS 40 Investment Property disclosure requirements. In this case the disclosures above
[a,d,f,h] are not required.
 For right-of-use assets revalued amounts applying IAS 16 Property, plant and equipment,
the lessee will apply IAS 16 disclosure requirements relating to revalued assets.
 A lessee must disclose a maturity analysis of lease liabilities applying IFRS 7 Financial
instruments: Disclosures separately from the maturity analyses of other financial liabilities
that show the remaining contractual maturities.
 A lessee shall disclose additional qualitative and quantitative information about its leasing
activities. This information may include, but is not limited to, information that help users of
financial statements to assess:
 The nature of the lessee’s leasing activities;
 Future cash outflows to which the lessee is potentially exposed that are not
reflected in the measurement of lease liabilities. This includes exposure arising
from:
 Variable lease payments;
 Extension and termination options;
 Residual value guarantees; and
 Lease not yet commenced to which the lessee is committed.
 Restrictions or covenants imposed by leases; and
 Sale and leaseback transactions.
69
DISCLOSURE EXAMPLE – LESSEE
1. Leases
1.1 Right-of-use assets Machinery Total

R R
Carrying amount at beginning of year xxx Xxx
Additions xxx Xxx
Depreciation for the year xxx Xxx
Adjustments for lease remeasurements xxx Xxx
Adjustments for lease modifications xxx Xxx
Carrying amount at end of year xxx Xxx
1.2 Maturity analysis of future lease payments outstanding at the reporting date
20.16
Future lease payments (undiscounted) R
- For 20.17 Xxx
- For 20.18 Xxx
- For 20.19 Xxx
- For 20.20 Xxx
- Remaining years after 20.20 Xxx
Total future lease payments Xxx
Total future finance costs (xxx)
Lease liability Xxx
Short-term portion presented under current liabilities Xxx
Long-term portion presented under non-current liabilities Xxx
1.3 Potential future lease payments relating to periods following the exercise date of
termination options are summarised below:
Lease Payable Total
liabilities Payable during during
recognised 20.20 – 20.21 20.22
(discounted) (undiscounted)
Business segment xxxx xxxx xxxx Xxxx
Business segment A xxx xxx xxx Xxx
Business segment B xxx xxx xxx Xxx
Total xxxx xxxx xxxx Xxxx
1.4 Income and expenses related to leases

Income
Income from subleasing right-of-use assets Xxx
Gain from sale and leaseback (will only be tested on postgraduate level) Xxx
Expenses
Variable lease payments Xxx
Short-term lease expense – recognition exemption Xxx
Low-value lease expense – recognition exemption Xxx
X Ltd elected the recognition exemption on short-term leases of office equipment (example)
and low-value leases of office furniture (example).
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FAC3703/501
1.5 Total cash outflows relating to leases
Presented under financing activities
Cash payments for principal/capital portion of lease liabilities Xxx
Cash payments for interest portion of lease liabilities Xxx
Cash payments for short-term leases Xxx
Cash payments for low-value leases Xxx
Cash payments for variable lease payments Xxx
Total cash outflow relating to leases
2. Profit before tax R

Profit before tax includes the following items:
Expenses
Depreciation: Right-of-use assets Xxx
Net finance costs Xxx

Total finance costs Xxx
Borrowing costs capitalised (xxx)
Borrowing costs has been capitalised to qualifying assets using a capitalisation rate of
x,xx% per annum.
The portfolio of short-term leases to which X Ltd is committed at 31 December 20.16 is
similar to the portfolio of short-term leases expenses recognised during the year.
DISCLOSURE OF FINANCE COSTS

Finance costs can be disclosed as a separate note or as part of the profit before
tax note as shown above.
2.4.11 Comprehensive examples for lessees
EXAMPLE 10
A manufacturing company, Leasecon Ltd, entered into a contract on 1 January 20.16

whereby two machines with a total cash selling price of R362 000 (R416 300 inclusive of VAT
at 15%) would be leased from a finance company. The contract contains a lease in terms of
IFRS 16 Leases. The lessor did not incur any initial direct costs.
The period of the lease is three years and the lease payments of R45 654 (inclusive of VAT)
are payable quarterly in arrears. Leasecon Ltd will obtain ownership of the machines at the
end of the lease term at no additional cost. Leasecon Ltd paid R20 000 (R23 000 including
VAT) legal fees for negotiating the lease. For tax purposes, the legal fees incurred by
Leasecon Ltd are of a capital nature. The interest rate implicit in the lease is 18% per annum.
The profit before tax of Leasecon Ltd for the year ended 31 December 20.16 before the
above lease transactions, amounted to R300 000. The two machines have Rnil residual value
and will be depreciated over their expected useful lives of four years using the straight-line
method.
71
The deferred tax balance at 1 January 20.16 was Rnil and the only temporary differences are
those in connection with the leased assets. The income tax rate is 28%.
The company's reporting period ends on 31 December each year.
REQUIRED
(a) Prepare the journal entries of Leasecon Ltd for the abovementioned
lease for the financial year ended 31 December 20.16.
(b) Prepare the notes to the financial statements of Leasecon Ltd at
31 December 20.16 in respect of the above lease.
The following notes are not required:
Categories of financial assets and financial liabilities in terms of
IFRS 7, Financial Instruments: Disclosures, and
Accounting policy notes.
Standards (IFRS).
Comparative figures are not required.
SOLUTION 10
(a) Journal entries for the year ended 31 December 20.16

Dr Cr
1 January 20.16 R R
Right-of-use assets: Machinery (SFP) [C2] 20 000
VAT control account (SFP) 3 000
Bank (SFP) 23 000
Capitalise legal fees to the cost of the machinery
Right-of-use asset: Machinery (SFP) [C2] 362 000
VAT control account (SFP) (416 300 x 15/115) 54 300
Recognise right-of-use assets and the lease liability
Bank (SFP) (54 300 + 3 000) 57 300

VAT control account (SFP) 57 300
VAT input received from SARS
Bank (SFP) (4 x 45 654) [C4] 182 616
Recognition of four instalments paid during 20.16
Depreciation (P/L) (382 000/4 years) 95 500
Accumulated depreciation (SFP) 95 500
Recognise depreciation on right-of-use assets
Income tax expense (current tax) (P/L) [C7] 37 074
Other payables: SARS (SFP) 37 074
Recognise provision for income tax payable
Income tax expense (deferred tax) (P/L) [C6] 2 702
Deferred tax (SFP) 2 702
Recognise movement in deferred tax balance
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(b) Disclosure
LEASECON LTD
1. Profit before tax

20.16
Profit before tax is stated after taking into account the following items: R
Expenses
Depreciation: Right-of-use assets [C5] 95 500
Finance costs can be disclosed as a separate note or as

2. Finance costs part of the “Profit before tax” note. Both options are correct.
Finance cost on lease liabilities [C4] 67 445
3. Income tax expense
Major components of tax expense

SA normal tax
Current tax
– Current year [C7] 37 074
Deferred tax
– Movement in temporary differences [C3] (9 469 x 28%) 2 702
39 775
Tax reconciliation
Accounting profit [C5] 137 055
Tax at 28% (137 055 x 28%) 38 375
Tax effect of:
Legal fees that are not tax deductible (5 000 x 28%) [C3] 1 400
39 775
RECONCILING ITEM IN TAX RECONCILIATION

ONLY NON-TAXABLE AND NON-DEDUCTIBLE ITEMS THAT ARE INCLUDED
IN THE PROFIT FOR THE YEAR WILL BE RECONCILING ITEMS.
Only R5 000 of the R20 000 legal fees (that is not tax deductible) is included in the
profit for the year (as part of depreciation). As a result only R5 000 is a non-
deductible expense for tax purposes.
3. Deferred tax
20.16
Analysis of temporary differences R
Property, plant and equipment – Right-of-use assets
Accelerated deductions for tax purposes [C6] (76 020)
Lease liability [C6] 73 318
Net deferred tax liability (2 702)
73
4. Leases
20.16 20.16
4.1 Right-of-use assets Machinery Total
R R
Carrying amount at beginning of year — —
Additions [C2] 382 000 382 000
Depreciation for the year [C5] (95 500) (95 500)
Adjustments for lease remeasurements — —
Adjustments for lease modifications — —
Carrying amount at end of year 286 500 286 500
20.16
R
Future lease payments (undiscounted)
- For the year ended 31 December 20.17 (46 654 x 4) [C4] 182 616
- For the year ended 31 December 20.18 (46 654 x 4) [C4] 182 616
- For the year ended 31 December 20.19 —
- For the year ended 31 December 20.20 —
- Remaining years after 31 December 20.20 —
Total future lease payments 365 232
Total future finance costs [C4] (64 103)
Lease liability [C4] 301 129
Short-term portion presented under current liabilities [C4] 137 343
Long-term portion presented under non-current liabilities [C4] 163 786
4.3 Total cash outflows relating to leases

Cash payments for principal portion of lease liabilities (182 616 – 67 445) 115 171
Cash payments for legal fees 23 000
Cash payments for interest portion of lease liabilities [C4] 67 445
Total cash outflow relating to leases 205 616
CALCULATIONS
C1. Interest rate implicit in the lease
The interest rate implicit in the lease is given as 18% per annum.
Right-of-use assets (Machinery) R
Initial direct costs of the lessee – legal fees 23 000
Plus lease payments made at or before commencement date -
Minus VAT input claimed on right-of-use assets (54 300 + 3 000) (57 300)
382 000
Lease liability
Present value of lease payments at lease commencement date [C3] 416 300
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N = 12 (4 payment per year x 3 years) there are four instalments payable per year.
PMT = 45 654
FV = 0 (residual value guarantee)
I = 18% p.a.
PV = ? 416 300
Closing
Interest at balance
Payment dates Instalments Capital 24,00478% R
R R R
01.01.20.16 416 300
31.03.20.16 45 654 26 920 18 734 389 380
Finance
30.06.20.16 45 654 28 132 cost in 17 522 361 248
45 654 P/L
30.09.20.16 29 398 =67 445
16 256 331 850
31.12.20.16 (year end) 45 654 30 721 14 933 301 129
31.03.20.17 Future 45 654 32 103 13 551 269 026
lease
30.06.20.17 payments 45 654 33 548 12 106 235 478
30.09.20.17 20.17 45 654 35 057 10 597 200 421
=182 616 Future
31.12.20.17 45 654 36 635 finance 9 019 163 786
costs
31.03.20.18 Future
45 654 38 284 =64 103 7 370 125 502
30.06.20.18 lease 45 654 40 006 5 648 85 496
payments
30.09.20.18 20.18 45 654 41 807 3 847 43 689
=182 616
31.12.20.18 45 654 43 689 1 965 -
547 848 416 300 131 548
416 300 x 18% x 3/12 = 18 734
389 380 x 18% x 3/12 = 17 522
The carrying amount of the lease liability at 31 December 20.16 is R301 129 which is also used for tax purposes.
Long-term portion: R163 786

This is the closing balance one year AFTER the current year (31 Dec 20.16), which is 31 December 20.17.
Short-term portion: R301 129 – R163 786 = R137 343
This is the difference between the closing balance at year-end (R301 129) and the long-term portion (R163 786).
USE OF CALCULATOR FOR AMORTISATION TABLE
Remember the amortisation table is just a calculation. Therefore, remember to

use it in your disclosure. If it is not used in your answer, no marks will be awarded.
All the amounts in the amortisation table can be retrieved from you calculator.
Please refer to your calculator manual and ensure that you can retrieve the
interest, capital and capital balance from your calculator. For example, the finance
cost for the year (R89 860) can be retrieved from your calculator by calculating it
as follows:
HP: 1 (Input) 4 (2nd function) (Amort) = interest, = capital, = capital balance OR
SHARP EL 738: Amort payments 1 – 4.
If you only make use of your calculator during the exam, write down the inputs and
the steps you made use of to obtain the amounts disclosed.
75
C5. Accounting profit
R
Accounting profit (given) 300 000
Depreciation (362 000 + 20 000)/4 years) (95 500)
Finance costs [C1] (67 445)
Adjusted accounting profit 137 055
C6. Deferred tax calculation
Carrying Temporary Deferred tax
amount Tax base difference at 28%
R R R asset/(liability)
31 December 20.15 (given) - -
31 December 20.16
Right-of-use assets – cost a271 500 b- 271 500 (76 020)
Right-of-use assets – legal fee a15 000 c- Exempt (IAS 12.15(b))
Lease liability (301 129) d(39 278) (261 851) 73 318
Net deferred tax asset 9 649 (2 702)
Movement in temporary differences (9 649–0) (deductible) 9 649 (2 702)

a The total cost of the machinery is split between the original cost of R362 000 and the legal
cost of R20 000. R362 000 x ¾ years = R271 500. R20 000 x ¾ years = R15 000.
b The cost of the machines is not tax deductible as the machines are still owned by the
lessor for tax purposes.
c The legal cost is not deductible as it is of a capital nature. Per IAS 12.15(b), at initial
recognition, the legal costs capitalised does not affect the accounting profit or taxable
profit and therefore is exempt from deferred tax.
d The tax base is the carrying amount of the liability (R301 129) less capital balance
excluding VAT (R301 129 x 100/115 = R261 851). R301 129 – R261 851 = R39 278. The
R39 278 is the VAT on the capital balance (R301 129 x 15/115 = R39 278).
C7. Current tax
R
Non-taxable/non-deductible items:
Add back legal fees included in depreciation not tax deductible (20 000/4 yrs) 5 000
142 055
Movement in temporary differences (deductible) [C6] (9 649)
Taxable income 132 406
Current tax @ 28% (132 406 x 28%) 37 074
Proof of movement in temporary differences (9 649)
Add back depreciation without legal fees portion (95 460 – 5 000) 90 500
Deduct capital portion of instalments paid excluding VAT (e115 171 x 100/115) (100 149)
e 26 920 + 28 132 + 29 398 + 30 721 [C4] = 115 171
LEGAL FEES OF R20 000
The legal fees were capitalised (added) to the asset. Therefore, depreciation of
R95 500 (refer note 3 above) includes R5 000 that relates to legal fees (20 000/4
years). The balance of the legal fees that will form part of future depreciation
amounts to R15 000 (R20 000 – R5 000).
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EXAMPLE 11
Cleveland Ltd, a company registered as a vendor for VAT purposes, leased five passenger
vehicles from Finance Ltd on 1 January 20.15. The input VAT on passenger vehicles cannot
be claimed back. The leasing of the five passenger vehicles is a lease in terms of IFRS 16
Leases.
The conditions of the lease agreement were as follows:
 The cash price of each passenger vehicle is R43 043.50, excluding VAT at 15%. The
VAT is financed.
 Lease instalments of R56 100 (total instalment for five passenger vehicles) are made half
yearly in arrears, over a period of three years. The VAT on passenger vehicles cannot be
claimed back.
 The interest rate implicit in the lease is 19,12358% per annum.
 Cleveland Ltd will acquire ownership of the vehicles at the end of the lease term at no
additional cost.
The company provides for depreciation according to the straight-line method over the useful
life of the assets. The useful life of each passenger vehicle is considered to be five years and
has a residual value of Rnil.
The income tax rate is 28%.The company had a deferred tax liability at 1 July 20.15
amounting to R2 152. There are no items affecting deferred tax other than the above lease
agreement.
REQUIRED
(a) Present the lease transaction in the statement of financial position

for the year ended 30 June 20.17.
(b) Disclose the lease transaction in the notes to the financial
statements of Cleveland Ltd for the year ended 30 June 20.17.

Standards (IFRS).
Round all amounts to the nearest Rand
EXAM TECHNIQUE
As comparative figures are not specifically excluded, comparative figures are
required.
As no notes are specifically excluded, all notes that are affected by the lease
transaction need to be disclosed, including accounting policy notes and the
disclosure for categories of financial liabilities in terms of IFRS 7, Financial
Instruments: Disclosures.
77
SOLUTION 11
(a) CLEVELAND LTD

EXTRACT FROM THE STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20.17
Notes 20.17 20.16

R R
ASSETS
Non-current assets
Right-of-use assets 7.1 123 750 173 250
EQUITY AND LIABILITIES
Non-current liabilities
Lease liability 7.2 — 51 204
Deferred tax liability 5 20 313 9 143
Current liabilities
Lease liability 7.2 51 204 89 392
(c) CLEVELAND LTD
NOTES FOR THE YEAR ENDED 30 JUNE 20.17
1. Basis of preparation
The financial statements have been prepared in accordance with the International Financial
Reporting Standards (IFRS) issued by the International Accounting Standards Board. The
company's financial statements are prepared on the historical cost basis, as adjusted with the
revaluation of land and buildings, investment property and financial assets and financial
liabilities measured at fair value. The company applies the following accounting policies which
is consistent with prior years:
2. Accounting policies
2.1 Property, plant and equipment
Property, plant and equipment are shown at cost less accumulated depreciation and
accumulated impairment losses. Right-of-use assets leased under lease agreements are
capitalised and depreciated over their useful lives on the straight-line basis, as follows:
Right-of-use assets: Motor vehicles – five years

The residual values and useful lives of all items of property, plant and equipment are
reviewed and adjusted if necessary, at each reporting date.
Depreciation is charged to profit or loss. Gains or losses on disposal are determined by

comparing the proceeds with the carrying amount of the asset. The net amount is included in
profit or loss for the period.
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FAC3703/501
2.2 Leases
The company as lessee
Right-of-use assets and lease liabilities are recognised for contracts containing a lease. The
right-of-use at initial recognition will be recognised at cost and the company will recognise the
lease liability at the present value of the lease payments not paid at that date.
Right-of-use assets are depreciated in accordance with the accounting policy applicable to
property, plant and equipment (refer to 2.1). The corresponding rental obligations, net of
finance costs, are included in long-term borrowings. Lease finance costs are amortised to
profit or loss (unless they are directly attributable to qualifying assets) over the duration of the
leases so as to achieve a constant rate of interest on the remaining balance of the liability.
Short-term and low-value assets, in terms of the recognition exemption of IFRS 16 Leases,
are charged to profit or loss in equal instalments over the period of the lease, except when an
alternative method is more representative of the time pattern from which benefits are derived.
2.3 Taxation
Current and deferred tax are recognised as income or as an expense and included in profit or
loss for the period, except when the tax relates to items that are recognised outside profit or
loss or to a business combination. Tax that relates to items that are recognised in other
comprehensive income is also recognised in other comprehensive income. Tax that relates to
items that are recognised directly in equity is also recognised directly in equity.
Deferred taxation
Deferred tax is generally recognised for all temporary differences using the statement of
financial position approach and based on tax rates that have been enacted or substantively
enacted by the reporting date. The measurement of deferred tax reflects the tax
consequences that would follow from the manner in which the company expects to recover or
settle the carrying amount of its assets and liabilities at the reporting date.
Temporary differences are differences between the carrying amounts of assets and liabilities
(used in the financial statements) and the corresponding tax bases used in the calculation of
taxable profit.
Deferred tax liabilities are recognised for all taxable temporary differences, unless the
deferred tax liability arises from:
 the initial recognition of goodwill, or
 the initial recognition of an asset and liability in a transaction which:
 is not a business combination, and
 at the time of the transaction, affects neither accounting profit nor taxable profit/(tax
loss).
Deferred tax assets are recognised for all deductible temporary differences to the extent that
it is probable that taxable profit will be available against which the deductible temporary
difference can be utilised, unless the deferred tax asset arises on the initial recognition of an
asset and liability in a transaction which
 is not a business combination, and
 at the time of the transaction, affects neither accounting profit nor taxable profit/(tax loss).
79
A deferred tax asset is recognised for the carry forward of unused tax losses and unused tax
credits to the extent that it is probable that future taxable profit will be available against which
the unused tax losses and unused tax credits can be utilised.
Current tax
Current tax payable is based on the taxable profit for the year, calculated in terms of the
Income Tax Act. Taxable profit differs from the profit for the period as reported in the
statement of profit or loss and other comprehensive income, as it excludes items of income or
expense that are taxable or deductible in a different period or that are never taxable or
deductible. The liability for current tax is calculated using tax rates that have been enacted or
substantively enacted by the reporting date.
Profit before tax is stated after taking into account the following items:
20.17 20.16
R R
Expenses
Depreciation – Right-of-use assets [C5] 49 500 49 500
Please note that depreciation on right-of-use assets should be included as part of the total
depreciation charge for the year in respect of the relevant class of fixed assets.
4. Finance costs
Finance cost on lease liabilities [C4] 22 808 37 730

SA normal tax
Current tax expense
— Current year xxx xxx
Deferred tax expense
— Movement in temporary differences [C6] 11 170 6 991
Tax reconciliation
Accounting profit xxx xxx
Tax at 28% xxx xxx
6. Deferred tax
Analysis of temporary differences

Property, plant and equipment – Right-of-use assets
Accelerated deductions for tax purposes [C6] (43 650) (48 510)
Lease liability [C6] 14 337 39 367
Net deferred tax liability [C6] (20 313) (9 143)
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FAC3703/501
7. Leases
Motor Total
7.1 Right-of-use assets
vehicles
R R
20.17
Carrying amount at beginning of year (247 500 [C2] – 74 250 [C5]) 173 250 173 250
20.16
Carrying amount at beginning of year (247 500 [C2] – 24 750 [C5]) 222 750 222 750
20.17 20.16
Future lease payments (undiscounted) R R
- For the year ended June 20.17 [C4] - 56 100
- For the year ended June 20.18 [C4] 56 100 112 200
Total future lease payments 56 100 168 300
Total future finance costs (4 896) (27 704)
Lease liability 51 204 140 596
Short-term portion presented under current liabilities [C4] 51 204 89 392
Long-term portion presented under non-current liabilities [C4] - 51 204
7.3 Total cash outflows relating to leases Instalments that took place in the financial year.

Cash payments for principal portion of lease liabilities 89 392 74 470
Cash payments for interest portion of lease liabilities 22 808 37 730
Total cash outflow relating to leases 112 200 112 200
8. Categories of financial liabilities Will not always be equal to P/L as the

total cash outflows is on the CASH
BASIS. The interest in P/L includes
Non-current financial liabilities interest ACCRUED.
Financial liabilities measured at amortised cost
Finance lease liability - 51 204
Finance lease liability 51 204 89 392
Concentration of interest rate risk on financial liabilities measured at amortised cost
The company has no exposure to interest rate changes with regard to the finance lease
liability at the reporting date as the interest rate is fixed for the lease term.
Concentration of liquidity risk on financial liabilities
The exposure of the company’s financial liabilities to liquidity risk and the contractual
repayment dates are set out in the maturity analysis for lease liabilities in note 7.2 above.
81
liabilities match according to cash flow needs and that the company has adequate access to
credit.
IFRS 7 DISCLOSURE
Note 8 above, Categories of Financial Liabilities, are the disclosure required by
IFRS 7, Financial Instruments: Disclosures.
CALCULATIONS
C1. Calculate the interest rate implicit in the lease
The interest rate implicit in the lease is given as 19,12538% per annum.
Right-of-use assets (Motor vehicles) R
247 500
Lease liability

N = 6 (2 payment per year x 3 years) there are two instalments payable per year.
PMT = 56 100
FV = 0 (residual value guarantee)
I = 19,12538% p.a.
PV = ? 247 500
The order of the columns in the amortisation table below is different to the amortisation tables
in previous examples. You can set out the amortisation table according to your own
preference. The most important columns are interest, capital and the closing balance
outstanding.
Opening Interest at Closing
balance 19,12358% Capital Instalments balance
R R R R R
30.06.20.15 247 500 23 665 32 435 56 100 215 065
31.12.20.15 215 065 ① 20 564 35 536 56 100 179 529
30.06.20.16 179 529 ② 17 166 38 934 56 100 140 595
31.12.20.16 140 595 ③ 13 443 42 657 56 100 97 938

30.06.20.17 97 938 ④ 9 365 46 735 56 100 51 204
31.12.20.17 51 204 4 896 51 204 56 100 -
89 099 247 501 336 600
①+② = 37 730
The closing balances are used to calculate the short-term and
③+④ = 22 808 long-term portions of the lease liability that are disclosed in
note 7.2.
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AMORTISATION TABLE
Please note that the amortisation table has a rounding balance of R1 (the total
capital repaid is R247 501 and not R247 500). This is a result of the interest rate
implicit in the lease being rounded off to five decimals.
You will not be penalised for a small rounding difference as above. In the exam
you will be requested to round the interest rate to a specific number of decimals
to avoid a rounding difference.
C5. Depreciation
R
Right-of-use assets (motor vehicles) [C2] 247 500
Depreciation per year (R247 500 / 5 years) 49 500
Accumulated depreciation:
Year end: 1 January 20.15 to 30 June 20.15: 6 months (49 500 x 6/12) 24 750
1 January 20.15 to 30 June 20.16: 18 months (49 500 x 18/12) 74 250
1 January 20.15 to 30 June 20.17: 30 months (49 500 x 30/12) 123 750
Note that no VAT input is claimable on passenger vehicles. A a result the VAT is included in
the cost price. In the case of an asset on which VAT input is claimable, for example
machinery, the VAT will not be part of the cost price of the asset as it will be claimed back
from SARS.
C6. Deferred tax
Deferred
tax at
Carrying Temporary 28%
amount Tax base difference asset/
R R R (liability)
30 June 20.15 (given) (2 152/28%) 7 685 (2 152)
30 June 20.16
Right-of-use assets: Vehicles (note 6) 173 250 a- 173 250 (48 510)
Lease liability (note 7) (140 595) b- (140 595) 39 367
Net deferred tax liability 32 655 (9 143)
Movement in temporary differences (32 655 – 7 685) 24 970 (6 991)

(taxable)
30 June 20.17
Right-of-use assets: Vehicles (note 6) 123 750 a- 123 750 (43 650)
Lease liability (note 7) (51 204) b- (51 204) 14 337

(taxable)
a The tax base is amounts deductible in future. For tax purposes, the ownership of the
vehicles resides with the lessor, therefore no tax deductions.
b The tax base is the carrying amount (140 595) minus amounts deductible in future
(140 595). The full amount (VAT inclusive) is deductible for income tax purposes as the
VAT input was not claimed.
83
Carrying amount of asset > tax base of asset ∴ deferred tax liability
Carrying amount of liability > tax base of liability ∴ deferred tax asset
DEFERRED TAX AND VAT
Please take note of the difference between the deferred tax calculations for
examples 10 and 11. In example 11, VAT input had not been claimed up front
because VAT input is not claimable on passenger vehicles according to the VAT
Act. If VAT was claimed up front as a VAT input and the instalment was
adjusted to exclude VAT, then the VAT portion of the capital balance would be
recognised as the tax base.
EXAMPLE 12
Edmonton Ltd is a company that manufactures floor tiles. During the year ended
30 June 20.18 Edmonton Ltd entered into three separate contracts to lease the following
assets. Each of these contracts contains a lease as per IFRS 16, Leases.
The information relating to the contracts is as follows:
Ceramic mixer
Monthly instalments payable in advance R15 820
Cash price of asset R450 000
Period of lease 1 October 20.17 to 30 September 20.18
Tile oven
Commencement date of lease 1 August 20.17
Cash price of asset R320 000
Period of lease 3 years
Bi-annual instalments payable in arrears R71 228
Interest rate implicit in the lease 17,9% per annum
Lease payments for the tile oven are payable on 31 January and 31 July of each year.
Ownership of the tile oven will be transferred at the end of the lease term to Edmonton Ltd at
no additional cost.
Factory building
The lease commenced on 1 July 20.17 for a period of seven years. The lease provides for a
basic rental of R10 000 per month, in advance, plus 1% of the budgeted manufacturing cost
of tiles manufactured in excess of 1 000 000 tiles. The budgeted excess tiles production for
the year ended 30 June 20.18 amounts to 5 400 000 tiles. The manufacturing cost per tile
amounts to R1.
The interest rate implicit in the lease could not be determined reliably for the lease of the
factory building.
Additional information:
Edmonton Ltd’s incremental borrowing rates were as follows on the following dates:
1 July 20.17 15% per annum
1 August 20.17 16% per annum
30 June 20.18 14% per annum
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FAC3703/501
The company provides for depreciation according to the straight-line method over the useful
life of the assets. All three assets have residual values of Rnil and the useful life of each of
the leased items is as follows:
Ceramic mixer 5 years
Tile oven 6 years
Factory building 20 years
Edmonton Ltd makes use of the recognition exemption of IFRS 16, Leases for all short-term
and low-value assets.
The deferred tax balance at the beginning of the reporting period amounted to Rnil and the
only temporary differences are those apparent from the above information. The income tax
rate is 28%. The profit before tax, after taking above transactions into account amounted to
R1 050 000.
REQUIRED
Disclose the above lease agreements in the notes to the financial
statements of Edmonton Ltd for the reporting period ended
30 June 20.18.
Standards (IFRS). The accounting policy note and the disclosure of
categories of financial liabilities in terms of IFRS 7, Financial instruments:
Disclosures are not required.
Ignore any VAT implications.
SOLUTION 12
EXAM TECHNIQUE
When attempting a question that contains multiple transactions like Example 12,
break it down into smaller parts. For example, first do the calculations for the
ceramic mixer, then the tile oven and lastly for the factory building.
EDMONTON LTD
Profit before tax is stated after taking the following items into account:
20.18
Expenses R
Depreciation – Right-of-use assets (48 889 + 74 957) (see note 5.1) 123 846
Short-term lease expense – recognition exemption [C1] 142 380
The short-term lease expense can be disclosed in “Profit before
3. Finance costs tax” OR in the “Leases” note (see note 5.3).
Finance cost on lease liabilities (28 640 + 20 690) [C4] + 74 137 [C7] 123 467
85
Major components of tax expense 20.18
R
SA normal tax
Current taxation
— Current year [C8] 309 704
Deferred taxation
— Movement in temporary differences [C9] (15 704)
294 000
Tax reconciliation
Accounting profit [C8] 1 050 000
Tax at 28% (R1 050 000 x 28%) 294 000
5. Leases
5.1 Right-of-use assets Tile oven Building Total

20.18 R R R
Carrying amount at beginning of year - - -
Additions [C2 & C5] 320 000 524 700 844 700
Depreciation for the year (320 000/6 x 11/12) (48 889)
(524 700/7) (74 957) (123 846)
Carrying amount at end of year 271 111 449 743 720 854
20.18
Future lease payments (undiscounted) R
- For the year ended 30 June 20.19 (71 228 [C4] x 2) + (10 000 x 12) 262 456
- For the year ended 30 June 20.22 (10 000 x 12) 120 000
- Remaining years after 30 June 20.22 (10 000 x 12 x 2) 240 000
Total future lease payments 1 076 140
Total future finance costs (241 264 [C7] + 58 038 [C4]) (299 302)
Lease liability (298 102 [C4] + 478 837 [C7]) 776 838
Short-term portion presented under current liabilities
(104 183 [C4] + 53 237 [C7]) 157 319
Long-term portion presented under non-current liabilities
(193 919 [C4] + 425 600 [C7]) 619 517
5.3 Income and expenses related to leases
Expenses
Variable lease payments on factory building (5 400 000 x R1 x 1%) 54 000
Short-term lease expense – recognition exemption [C1] 142 380
Klip Ltd elected the recognition exemption on short-term leases for the ceramic mixer.
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FAC3703/501
5.4 Total cash outflows relating to leases 20.18
R
Cash payments for principal portion of lease liabilities 94 363
(42 588 [C4] + 51 775 [C7] = 94 363
Cash payments for interest portion of lease liabilities
(28 640 [C4] + (74 137 – 5 912 [C7]) = 96 865 96 865
Cash payments for short-term leases (see note 2 or note 5.3) 142 380
Cash payments for variable lease payments (see note 5.3) 54 000
Total cash outflow relating to leases 387 608
The portfolio of short-term leases to which Klip Ltd is committed at the end of
31 December 20.18 is similar to the portfolio of short-term leases expenses recognised during
the year. As a result the lease commitment for short-term leases is not disclosed.
6. Deferred tax
Right-of-use assets (75 911 + 125 928) [C9] (201 839)
Lease liabilities (83 469 + 134 074) [C9] 217 543
Deferred tax asset 15 704
CALCULATIONS
SHORT-TERM LEASE
The lease period for the ceramic mixer is 12 months and is therefore a short-term
lease. The company uses the recognition exemption of IFRS 16, Leases and as a
result, no right-of-use asset or lease liability is recognised.
C1. Short-term lease payments (ceramic mixer)
R
Short-term lease for the year ended 30 June 20.18 (15 820 x 9 months) 142 380
Short-term lease for the year ended 30 June 20.19 (15 820 x 3 months) 47 460
C2. Right-of-use asset and lease liability (Tile oven)
Right-of-use asset (Tile oven)
Initial direct costs -
Lease payments before or after lease not included in present value -
320 000
Lease liability (Tile oven)
C3. Present value of lease payments (Tile oven)

N = 6 (2 payments per year x 3 years) there are two instalments payable per year.
PMT = 71 228
I = 17,9% p.a. (Interest rate implicit in the lease given)
PV = ? 320 000
87
C4. Amortisation table (Tile oven)
Closing
Interest balance
Instalments
at 17,9% Capital outstanding
R
R R R
1 August 20.17 320 000
31 January 20.18 28 640 42 588 71 228 277 412
30 June 20.18 (year end) a 20 690 - - * 298 102
31 July 20.18 b 4 138 46 400 71 228 231 012
31 January 20.19 20 676 50 552 71 228 180 460
30 June 20.19 (year end) 13 459 - - ** 193 919
31 July 20.19 2 692 55 077 71 228 125 383
31 January 20.20 11 222 60 006 71 228 65 377
31 July 20.20 5 851 65 377 71 228 -
107 368 320 000 427 368
a 277 412 x 17.9% x 5/12 = 20 690. R20 690 is the portion of interest that accrued by
30 June 20.18 and is included in the instalment that will be paid after year end on
31 July 20.18. The total interest for the year ended 30 June 20.18 is 28 640 + 20 690.
b 277 412 x 17.9% x 1/12 = 4 138. R4 138 is the remaining portion of the interest that is
included in the instalment of R71 228 that will be paid after year end on 31 July 20.18.
The instalment paid on 31 July 20.18 includes interest of R24 828 (20 690 + 4 138) and
capital of R46 400. The finance costs of R4 138 will be recognised as finance costs in the
financial year ending 30 June 20.19.
Total future finance costs at 30 June 20.18:
 4 138 + 20 676 + 13 459 + 2 692 + 11 222 + 5 851 = 58 038 OR
 4 138 + 3 Amort 6 (interest) R53 900 = 58 038
SHORT-TERM AND LONG TERM PORTIONS OF THE LEASE LIABILITY

The short-term and long-term portions of the lease liability are calculated by
using the amortisation table above and can be calculated using a long method or
a short method as illustrated below.
The short-term portion is the first 12 months after the financial year-end. For the
tile oven, it is from 1 July 20.18 until 30 June 20.19.
The long-term portion is the period from the day after the short-term portion ends
until the end of the lease term. For the tile oven, the long-term portion is from
1 July 20.19 until 31 July 20.20.
Long method
Short-term Long-term
portion portion Total
Instalments a142 456 c213 684 356 140
Future finance costs b(38 273) d(19 765) (58 038)
Capital 104 183 193 919 298 102
a 71 228 x 2 = 142 456
b 4 138 + 20 676 + 13 459 = 38 273
c 71 228 x 3 = 213 684
d 2 692 + 11 222 + 5 851 = 19 765
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Short method Short-term Long-term
portion portion
* 298 102 – ** 193 919 104 183 (refer to amortisation table)
Balance as at 30 June 20.19 193 919 (refer to amortisation table)
EXAM TECHINIQUE
Both the long method and the short method are acceptable in the exam. It is
advisable to use the short method in order to save time.
You can also extract the capital balances from your financial calculator as follows:
1 Amort (balance) R277 412 + accrued interest of R20 690 = R298 102
3 Amort (balance) R180 460 + accrued interest of R13 459 = R193 919
Refer to your calculator manual for detailed instructions on how to use the
amortisation functions.
C5. Right-of-use asset and lease liability (Factory building)
Right-of-use asset (Factory building) R
Initial amount of the lease liability C6 524 700
524 700
Lease liability (Factory building)
Present value of lease payments at lease commencement date C6 524 700
C6. Present value of lease payments (Factory building)

N = 84 (12 payment per year x 7 years) there are twelve instalments payable per year. Set
PMT = 10 000 calculator on BEGIN mode.
I = 15% p.a. (Lessee’s incremental borrowing rate at inception of the lease)
PV = ? 524 700
C7. Amortisation table (factory building)
Closing
Interest at balance
15% p.a. Capital Instalments outstanding
R R R R
524 700
1July 20.17 - 10 000 10 000 514 700
1 August 20.17 6 434 3 566 10 000 511 134
1 September 20.17 6 389 3 611 10 000 507 523
1 October 20.17 6 344 3 656 10 000 503 867
1 November 20.17 6 298 3 702 10 000 500 165
1 December 20.17 6 252 3 748 10 000 496 417
1 January 20.18 6 205 3 795 10 000 492 623
1 February 20.18 6 158 3 842 10 000 488 780
1 March 20.18 6 110 3 890 10 000 484 890
1 April 20.18 6 061 3 939 10 000 480 951
1 May 20.18 6 012 3 988 10 000 476 963
1 June 20.18 5 962 4 038 10 000 472 925
30 June 20.18 (year-end) 5 912 - - 478 837
74 137 51 775 120 000
89
AMORTISATION TABLE
The amortisation table for this lease is 84 lines long. The amortisation table was
only prepared until year end (the first 13 lines). The entire amortisation table can
be extracted from a financial calculator and the amounts needed are extracted
from the financial calculator as follows:
Finance costs from 1 July 20.17 to 30 June 20.18:
1 Amort 13 (interest) = R74 137
Total future interest from 1 July 20.18 – 1 June 20.24:
14 Amort 84 (interest) = 241 164
Short-term and long-term portions of the lease liability:

Long method
Short-term Long-term
portion portion Total
Instalments a120 000 c600 000 720 000
Future finance costs b(66 764) d(174 400) (241 164)
Capital 53 236 425 600 478 836
a 10 000 x 12 = 120 000 (instalments 13 – 24)

b 14 Amort 25 (interest) 66 764
c 10 000 x 60 = 600 000 (instalments 25 – 84)
d 26 Amort 84 (interest) = 174 400
SHORT AND LONG-TERM PORTIONS USING FINANCIAL CALCULATOR
The balances are extracted from your financial calculator as follows:

Balance at 30 June 20.18 (12 Amort (balance)) R472 925
Accrued interest (13 Amort (interest)) R 5 912
Closing balance at 30 June 20.18 including accrued interest R478 837
Balance at 30 June 20.19 (24 Amort (balance)) R420 346
Accrued interest (25 Amort (interest)) R 5 254
Closing balance at 30 June 20.19 including accrued interest R425 600
(long-term portion)
Short-term portion (478 837 – 425 600) R 53 237
C8. Current tax

R
Profit before tax (given) 1 050 000
Accounting profit 1 050 000
Movement in temporary differences [C9] (see comment below) *56 085
Taxable profit 1 106 085
Current tax @ 28% (1 106 085 x 28%) 309 704
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R
Proof of temporary differences: (see comment below) *56 085
Add back depreciation: right-of-use asset: Tile oven 48 889
Tile oven: Add back accrued finance costs as it will only be tax deductible
when paid 20 690
Tile oven: Deduct capital portion of instalment paid (42 588)
Add back depreciation: right-of-use asset: Factory Building 74 957
Factory Building: Add back accrued finance costs as it will only be tax
deductible when paid 5 912
Factory building: Deduct capital portion of instalments paid (51 775)
* MOVEMENT IN TEMPORARY DIFFERENCES

The movement in temporary differences of R56 085 gives rise to a deferred tax
asset. Therefore it is a deductible temporary difference. The R56 085 is added to
the taxable profit [C8] as it is only deductible in future and not in the current
year.
ACCRUED FINANCE COSTS
For tax purposes, the instalments will only be deductible when paid. As a result,
accrued finance costs are not yet tax deductible and must be added back.
C9. Deferred tax
Deferred tax
Carrying Temporary at 28% asset/
amount Tax base differences (liability)
R R R R
30 June 20.17 (given) — —
30 June 20.18
Right-of-use asset: Tile oven 271 111 — 271 111 (75 911)
Lease liability: Tile oven (298 102) — (298 102) 83 469
Right-of-use asset: Building 449 743 — 449 743 (125 928)
Lease liability: Building (478 837) — (478 837) 134 074
Deferred tax asset (56 085) 15 704
Movement in temporary differences (-56 085 – 0) (deductible) (56 085) 15 704
CARRYING AMOUNT OF LEASE LIABILITIES USED FOR DEFERRED

TAX
The carrying amount of the lease liability used for deferred tax is the
balance outstanding at year end. Therefore, this will include interest that is
payable but not yet paid at year-end (i.e. the accrued interest is paid after
year-end when the instalment is paid).
Therefore the carrying amount of the lease liability (tile oven) at year-end is
R277 412 (opening balance at 30 June 20.8) + R20 690 (interest payable at
30 June 20.8) = R298 102
The carrying amount of the lease liability (building) at year-end is R472 925
(opening balance at 30 June 20.8) + R5 912 (interest payable at
30 June 20.8) = R478 837
91
2.5 Classification of leases – Lessors (IFRS 16:61-66)
A lessor shall classify each of its leases as either an operating lease or a finance lease. A
lease is classified as either a finance or operating lease at inception date and is only
reassessed when there is a lease modification.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards
incidental to ownership to the lessee. A lease is classified as an operating lease if it does not
transfer substantially all the risks and rewards incidental to ownership.
Whether a lease is a finance lease or an operating lease depends on the substance of the
transaction rather than the legal form of the contract.
Examples of situations that would normally lead to lease being classified as a finance lease
are:
 The lease transfers ownership of the underlying asset to the lessee by the end of the
lease term;
 The lessee has the option to purchase the underlying asset at a price that is expected to
be sufficiently lower than the fair value at the date the option becomes exercisable for it to
be reasonably certain, at the inception date, that the option will be exercised;
 The lease term is for a major part of the economic life of the underlying asset even if title is
not transferred;
 At inception date, the present value of the lease payments amount to at least substantially
all of the fair value of the underlying asset; and
 The underlying asset is of such a specialised nature that only the lessee can use it without
major modifications.
Indicators of situations which individually or in combination could also lead to a lease being
classified as a finance lease are:
 If the lessee can cancel the lease, the lessor's losses associated with the cancellation are
borne by the lessee.
 Gains or losses from the fluctuations in the fair value of the residual value fall to the lessee
(for example in the form of a rent rebate equalling most of the sales proceeds, at the end
of the lease).
 The lessee has the ability to continue with the lease for a secondary period at a rent which
is substantially lower than a market-related rent.
EXAMPLES AND INDICATORS

The examples and indicators above are not always conclusive. If the lease
does not transfer substantially all the risks and rewards incidental to
ownership of an underlying asset, the lease will be classified as an
operating lease.
For example:
 If ownership of an underlying asset transfers at the end of the lease
for a variable payment equal to its fair value; or
 There are variable payments, as a result of which the lessor does
not transfer substantially all such risks and rewards.
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IMPORTANT
The following do not give rise to a new classification of a lease for
accounting purposes:
Changes in estimates, for example:
 Changes in economic life of underlying asset; or
 Changes in the residual value of underlying asset.
Changes in circumstances, for example:
 Default on lease terms by the lessee
2.6 Finance leases in the financial statements of lessors

At commencement date, a lessor will recognise assets held under a finance lease in its
statement of financial position and present them as a receivable at an amount equal to the net
investment in the lease.
2.6.1 Initial measurement – finance leases (IFRS 16.68-70)
The lessor shall:

 Measure the net investment in the lease using the interest rate implicit in the lease.
Subleases: If an interest rate implicit in the lease cannot be readily determined, an

intermediate lessor may use the discount rate used for the head lease (adjusted for any
initial direct costs associated with the sublease) to measure the net investment.
 Include initial direct costs incurred by the lessor in the initial measurement of the lease
therefore reducing the amount of income that will be recognised over the lease term. This
does not apply if the lessor is a manufacturer or dealer lessor.
The interest rate implicit in the lease takes into account the initial direct costs of the lessor. As a
result, it is automatically included in the net investment in the lease.
INTEREST RATE IMPLICIT IN THE LEASE

The interest rate implicit in the lease is a very important rate as it is used
by the lessee and the lessor. Please refer to the beginning of this study
unit were the definition of the interest rate implicit in the lease (IRIL) is
given. The diagram of the definition is repeated below:
Initial measurement of lease payments included in the net investment of the lease:
At commencement date, the lease payments included in the measurement of the net
investment in the lease comprise the following payments for the right to use the underlying
asset during the lease term (that are not received at the commencement date):
93
 Fixed payments, less any lease incentives payable;
 Variable lease payments that depend on an index or a rate, initially measured using the
index or rate as at the commencement date;
 Any residual value guarantees provided to the lessor by the lessee, a party related to the
lessee or a third party unrelated to the lessor that is financially capable of discharging the
obligations under the guarantee;
 The exercise price of a purchase option if the lessee is reasonably certain to exercise that
option; and
 Payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease.
2.6.2 Subsequent measurement (IFRS 16.75-78)
A lessor shall recognise finance income over the lease term, based on a pattern reflecting a
constant periodic rate of return on the lessor’s net investment in the lease.
A lessors aim is to allocate finance income over the lease term on a systematic and
rational basis. A lessor shall apply the lease payments relating to the period against the
gross investment in the lease to reduce both the principal and the unearned finance
income.
A lessor shall apply the derecognition and impairment requirements in IFRS 9, Financial
Instruments to the net investment in the lease. A lessor shall review regularly estimated
unguaranteed residual values used in computing the gross investment in the lease. If there
has been a reduction in the estimated unguaranteed residual value, the lessor shall revise the
income allocation over the lease term and recognise immediately any reduction in respect of
amounts accrued.
A lessor that classifies an asset under a finance lease as held for sale (or includes it in a
disposal group that is classified as held for sale) applying IFRS 5 Non-current Assets Held for
Sale and Discontinued Operations shall account for the asset in accordance with that
standard.
EXAMPLE 13
Sharp Ltd entered into a finance lease on 1 January 20.17 whereby Sharp Ltd leases a
grader to Point Ltd. The lease is a finance lease in terms of IFRS 16, Leases.
Cost of the grader: R500 000

Estimated useful life of grader: 5 years with Rnil residual value
Period of lease agreement: 4 years
Annual instalment: R176 907 (first instalment on 31/12/20.17)
Sharp Ltd incurred legal fees of R10 000 to secure the lease agreement. Ignore depreciation,
income tax and VAT.
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FAC3703/501
REQUIRED
(a) Prepare the amortisation table of the abovementioned finance lease
agreement for the initial recognition on 1 January 20.17 of the lease
in the accounting records of Sharp Ltd.
(b) Prepare the journal entries for the recording of the lease over the
period of the lease agreement in the accounting records of Sharp Ltd.
Standards (IFRS).
SOLUTION 13
LESSOR: FINANCE LEASE

The lessor must account for the lease as a receivable at an amount equal to
the net investment in the lease.
Net investment in lease is the gross investment in the lease discounted at
the interest rate implicit in the lease.
It is very important that you study the definitions of these terms. The definitions
are provided at the beginning of the study unit.
Step 1: Calculate the interest rate implicit in the lease (IRIL).
Set HP and Sharp EL-738 calculators on 1P/YR.

PV = (500 000 + 10 000) (fair value + initial direct costs of lessor)
PMT = 176 907
I = ? 14,52090% per annum
INITIAL DIRECT COSTS

Only the initial direct costs of the lessor are taken into account when calculating
the interest rate implicit in the lease.
Step 2: Calculate the net investment in the lease using the interest rate implicit in the
lease.
I = 14,52090% per annum
PMT = 176 907
FV = 0 (guaranteed and unguaranteed residual values)
PV = ? (510 000)
NET INVESTMENT IN THE LEASE
The net investment in the lease (R510 000) will normally be equal to the fair
value of the asset (R500 000) plus initial direct costs of the lessor (R10 000).
95
Step 3: Calculate unearned finance income.
R
Gross investment in the lease (4 x 176 907) + 0 + 0 707 628
Unearned finance income (707 628 – 510 000) (balancing figure) (197 628)
Net investment in the lease (step 2) 510 000
Step 4: Prepare the amortisation table at R510 000.

(a) Amortisation table
Interest at Closing
Payment date 14,5209% Instalment Capital balance
R R R R
01/01/20.17 510 000
31/12/20.17 74 057 176 907 102 850 407 150
31/12/20.18 59 122 176 907 117 785 289 365
31/12/20.19 42 018 176 907 134 889 154 476
31/12/20.20 22 431 176 907 154 476 —
197 628 707 628 510 000
(b) Journal entries

Dr Cr
R R
01/01/20.17 Gross investment in finance lease (SFP) 707 628
Bank (SFP) 10 000
Unearned finance income (SFP) 197 628
Equipment (SFP) 500 000
Recognise lease receivable and initial direct
costs and derecognise equipment (grader)
31/12/20.17 Bank (SFP) 176 907
Gross investment in finance lease (SFP) 176 907
Recognise first instalment received
Finance income (P/L) 74 057
Recognise finance income as profit
31/12/20.18 Bank (SFP) 176 907
31/12/20.19 Bank (SFP) 176 907
31/12/20.20 Bank (SFP) 176 907
The two journals on 31 December 20.17 is repeated on 31 December 20.18, 20.19 and
20.20.
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2.6.3 Initial recognition – manufacturer or dealer lessors (IFRS 16.71-74)
Identifying when to use initial recognition relating to manufacturer or dealer lessor
Is the lessor manufacturing products or a dealer?
(The information will be provided in the question).
No Yes
The lessor is a general lessor, Is the asset being leased one that is sold or
because the lessor disposes of its manufactured and sold by the lessor in the ordinary
Property, plant and equipment course of business as INVENTORY?
No Yes
Only the general lease Manufacturer / dealer
requirements will apply to the lessor requirements
lease, as Property, plant and below will apply in
equipment is sold. addition to the
general requirements
above.
At commencement date, a manufacturer or dealer lessor shall recognise the following for
each of its finance leases.
 Revenue being the fair value of the underlying asset or, if lower, the present value of
the lease payments accruing to the lessor, discounted using a market rate of interest;
 The cost of sale being the cost, or carrying amount if different, of the underlying asset
less the present value of the unguaranteed residual value; and
 Selling profit or loss (being the difference between revenue and the cost of sale) in
accordance with its policy for outright sales to which IFRS 15, Revenue from contracts
with customers applies.
A manufacturer or dealer lessor shall recognise selling profit or loss on a finance lease
at the commencement date, regardless of whether the lessor transfers the underlying
asset as described in IFRS 15, Revenue from contracts with customers.
Manufacturers or dealers often offer customers the choice of either buying the asset cash or
leasing the asset from them. A finance lease of an asset by a manufacturer or dealer lessor
gives rise to the following:
 the profit or loss resulting from the outright sale of the asset which is then leased, at
normal selling prices (adjusted for any applicable volume or trade discounts), and
 Finance income from providing credit over the period of the lease.
A manufacturer or dealer (the lessor) may quote a below market interest rate in order to
attract customers and thereby make sales. If this is the case, the asset has effectively been
sold at a discount in order to earn future finance income. If such a rate was applied an
excessive portion of the total income from the transaction would be recognised at the time of
the sale. If artificially low rates of interest are quoted, the selling profit is limited to the profit
that would be applicable if a market-related rate of interest were charged to the lessee over
the finance lease term.
A manufacturer or dealer lessor shall expense costs that are incurred in connection with
obtaining a finance lease at the commencement date, because they are mainly related to
earning the manufacturer’s or dealer’s selling profit. Therefore, these costs are excluded from
the definition of initial direct costs and therefore excluded from the net investment in the
lease. These costs are all tax deductible.
97
General lessor: Initial direct costs (such as legal fees or commission)
incurred with obtaining the lease meet the definition of initial direct costs
and are included in the interest rate implicit in the lease (IRIL) and the
initial measurement of the net investment in the lease.
Manufacturing or dealer lessor: These costs are expensed as they are
specifically excluded from the initial direct cost definition and IRIL therefore
they will not be included in the initial measurement of the net investment in
the lease.
SUBSEQUENT MEASUREMENT OF NET INVESTMENT IN THE LEASE

The subsequent measurement of the net investment in the lease of a
manufacturing and/or dealer lessor is exactly the same as that of a general
lessor (Refer to 2.6.2)
EXAMPLE 14
Blazer Ltd manufactures machinery and sells or leases it to customers. Blazer Ltd leased
machinery to Truckers Ltd on 1 January 20.16. The lease is a finance lease in terms of
IFRS 16, Leases.
The following information regarding the lease is applicable:
Cost of leased machinery R95 000

Selling price of leased machinery R160 000
Lease period 5 years
Lease instalments (payable annually in arrears) R46 605
The interest rate implicit in the lease is 14% per annum while the market-related interest rate
implicit in the lease for such a transaction is 18% per annum.
Blazer Ltd incurred R25 000 legal fees to secure the lease agreement. At the end of the lease
period the machinery will be transferred to Truckers Ltd at no additional cost.
REQUIRED
(a) Prepare the amortisation table to account for the lease in the records
of Blazer Ltd.
(b) Prepare the journal entries in the records of Blazer Ltd to record the
lease over the lease term. Ignore all tax implications. Journal
narrations are not required.
Your answer must comply with the International Financial Reporting

Standards (IFRS).
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FAC3703/501
SOLUTION 14
CALCULATIONS
As the interest rate is less than the market rate at inception of the lease, it is necessary to
calculate what the selling price would be if a normal market-related interest rate had been
charged.
C1. Present value of lease at a market-related rate of 18% per annum:
N = 5 (5 years x 1 payment per year)
I = 18% per annum
PMT = 46 605
PV = ? R145 742 (fair value excluding initial direct costs)
The fair value is therefore R145 742 and not R160 000. The amortisation table must be
prepared with a present value of R145 742 and an interest rate of 18% per annum.
The initial direct costs of a manufacturer or dealer lessor are specifically excluded
from the definition of initial direct costs in IFRS 16, Leases. As a result, the legal
fees of R25 000 incurred by Blazer Ltd are not included in the present value of
R145 742.
C2. Calculation of unearned finance income

R
Gross investment in the lease (5 x 46 605) 233 025
Unearned finance income (233 025 – 145 742) (balancing figure) 87 283
Net investment in the lease [C1] 145 742
a) Amortisation table
Interest Closing
Instalment Capital
Date at 18% balance
R R
R R
1 January 20.16 145 742
31 December 20.16 46 605 26 234 20 371 125 371
31 December 20.17 46 605 22 567 24 038 101 332
31 December 20.18 46 605 18 240 28 365 72 967
31 December 20.19 46 605 13 134 33 471 39 496
31 December 20.20 46 605 7 109 39 496 —
233 025 87 283 145 792
(b) Journal entries

Dr Cr
1 January 20.16 R R
Legal expenses (P/L) 25 000
Bank (SFP) 25 000
Gross investment in finance lease (SFP) (46 605 x 5) 233 025
Revenue (P/L) 145 742
99
Dr Cr
R R
Cost of sales (P/L) 95 000
Inventory (SFP) 95 000
31 December 20.16
Bank (SFP) 46 605
31 December 20.17
Bank (SFP) 46 605
31 December 20.18
Bank (SFP) 46 605
31 December 20.19
Bank (SFP) 46 605
31 December 20.20
Bank (SFP) 46 605
GROSS PROFIT AND UNEARNED FINANCE INCOME
The revenue recognised amounts to R145 742 (instead of R160 000) as the
market-related rate of 18% per annum was used (and not 14%).
2.6.4 Change in interest rate
A change in interest rate will result in a change in the instalments receivable. A change in
interest rates produces no immediate gain or loss to the lessor, but simply a higher or lower
return over the remaining period of the lease.
The new interest rate is applied from the date on which there was a change in interest rate.
Therefore, it is necessary to prepare a new amortisation table from the date that the change
took place. If the new instalments (the instalments calculated at the new interest rate) are
discounted at the revised interest rate, the discounted value will be equal to the capital
outstanding on the date of the change in interest rate.
The lessor must process a journal entry to recognise the change in the gross investment in
the lease and the unearned finance income.
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FAC3703/501
Increase in interest rate will increase unearned finance income:
Debit: Gross investment in finance lease
Credit: Unearned finance income
Decrease in interest rate will decrease unearned finance income:

Debit: Unearned finance income
Credit: Gross investment in finance lease
EXAMPLE 15
Val Ltd leased an asset to Pré Ltd on 1 January 20.15. The cash price of the asset is
R500 000 and the lease is a finance lease, in terms of IFRS 16, Leases. In terms of the
agreement, five instalments of R149 158 will be payable annually in arrears. The first
payment will be made on 31 December 20.15. The interest rate implicit in the lease is 15%
per annum.
On 1 January 20.17 the interest rate implicit in the lease increased to 16% per annum. As a
result the instalment increased to R151 637.
Ignore income tax and VAT.
REQUIRED
(a) Prepare the amortisation table in the books of Val Ltd for the initial
recognition of the lease and the amortisation table after the increase
in interest rates has taken place.
(b) Prepare the journal entries for the recording of the lease over the
period of the lease agreement in the books of Val Ltd. Journal
narrations are not required.

Standards (IFRS).
SOLUTION 15
Step 1: Calculate the interest rate implicit in the lease.
Provided as 15% per annum and changes to 16% per annum on 1 January 20.17.
Step 2: Calculate the net investment in the lease using the interest rate implicit in the
lease.
The interest rate implicit in the lease, by definition, will discount the gross investment to the
fair value of the asset including initial direct costs of the lessor. As there are no initial direct
costs, it amounts to R500 000.
101
(a)(i) Amortisation table before change in interest rate
Payment date Interest at Closing

15% Instalment Capital balance
R R R R
1 January 20.15 500 000
31 December 20.15 75 000 149 158 74 158 425 842
31 December 20.16 63 876 149 158 85 282 340 560
31 December 20.17 51 084 149 158 98 074 242 486
31 December 20.18 36 373 149 158 112 785 129 701
31 December 20.19 19 457 149 158 129 701 —
245 790 745 790 500 000
(a)(ii) Amortisation table AFTER change in interest rate
Interest at Closing
Payment date 16% Instalment Capital balance
R R R R
1 January 20.155 500 000
31 December 20.11 a75 000 149 158 74 158 425 842
31 December 20.16 a63 876 149 158 85 282 340 560
31 December 20.17 b54 490 151 637 97 147 243 413
31 December 20.18 38 946 151 637 112 691 130 722
31 December 20.19 20 915 151 637 130 722 —
253 227 753 227 500 000
a The amounts for the 20.15 and 20.16 years remain unchanged and reflects 15% per
annum. Only the amounts after 1 January 20.17 has been changed to reflect 16% per
annum.
b 340 560 x 16% = 54 490. The amortisation table from 1 January 20.17 onwards has been
recalculated based on an interest rate of 16% per annum and an instalment of R151 637.
Calculation of adjustment due to the change in interest rate
Calculation alternative 1: R
Gross investment in finance lease balance on 1 January 20.17

Based on old interest rate of 15% (3 x 149 158) 454 911
Based on new interest rate of 16% (3 x 151 637) 447 474
Increase in balance 7 437
Calculation alternative 2:
Unearned finance income balance on 1 January 20.17

Based on old interest rate of 15% (51 084 + 36 373 +19 457) 106 914
Based on new interest rate of 16% (54 490 + 38 946 + 20 915) 114 351
Decrease in balance (7 437)
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(b) Journal entries
Dr Cr
R R
31/12/20.15 Bank (SFP) 149 158
31/12/20.16 Bank (SFP) 149 158
Unearned finance income (SFP) (calc above) 7 437
Adjustment due to increase in interest rate
31/12/20.17 Bank (SFP) 151 637
31/12/20.18 Bank (SFP) 151 637
31/12/20.18 Bank (SFP) 151 637
2.6.5 Residual values

Two categories of residual values for leases can be identified for leases, namely guaranteed
and unguaranteed. These terms are defined in IFRS 16, Appendix A.
The residual value guarantee is a guarantee made to a lessor by a party unrelated to the
lessor that the value (or part of the value) of an underlying asset at the end of a lease will be
at least a specified amount.
Therefore, it is the final lease instalment receivable by the lessor and is treated in the same
manner as a lease instalment. This amount is then shown as the final outstanding balance on
the amortisation table of the lessor.
The unguaranteed residual value is that portion of the residual value of the underlying
asset, the realisation of which by the lessor is not assured or is guaranteed solely by a party
related to the lessor.
The lessor has no guarantee that an amount equal to the unguaranteed residual value will be
received (it is an estimate). However, it is still included in the gross investment of the lease in
the records of the lessor. The estimated unguaranteed residual values used in calculating the
lessor's gross investment in a lease should be reviewed regularly. If there has been a
reduction in the estimated unguaranteed residual values, the income allocation over the
103
lease term is revised and any reduction in respect of amounts already accrued is recognised
immediately. An increase in unguaranteed residual values is ignored for accounting purposes,
i.e. no adjustments are made.
Provision should be made for any permanent reduction in the unguaranteed residual value in
the reporting period in which it arises. When the unguaranteed residual value is reduced, the
gross investment in the lease is reduced accordingly. As a result, the amortisation table must
be re-prepared.
Since the unguaranteed residual value is not guaranteed by the lessee, it forms only part of
the final outstanding amount shown in the amortisation table of the lessor.
EXAMPLE 16
Rose Ltd entered into a finance lease agreement with Thorn Ltd whereby Rose Ltd would
lease a machine from Thorn Ltd. Thorn Ltd is not a manufacturer or dealer of machines. The
lease was entered into on 1 January 20.16. The lease agreement is a finance lease in terms
of IFRS 16, Leases.
Details of the lease agreement are as follows:
Cash price of the machine: R125 000

Lease instalment (payable annually in arrears): R50 427
Period of lease: 3 years
Date of first instalment: 31 December 20.16
Nominal interest rate: 15% per annum
Guaranteed residual value: R15 000
Thorn Ltd paid commission of R5 000 to enter into the lease agreement. Ignore income tax
and VAT.
REQUIRED
(a) Prepare the amortisation table for the accounting of the lease in the
records of Thorn Ltd.
(b) Prepare the journal entries in the records of Thorn Ltd for the recording
of the lease over the period of the lease agreement. Journal narrations
are not required.

Standards (IFRS).
SOLUTION 16

104
FAC3703/501
PV = (125 000 + 5 000) (fair value + initial direct costs)
PMT = 50 427
FV = 15 000 + 0 (guaranteed and unguaranteed residual values)
I = ? 12,76649% per annum

R
Gross investment in the lease (3 x 50 427) + 15 000 + 0 166 281
Unearned finance income (166 281 – 130 000) (36 281)
Net investment in the lease (Present value of step 1) 130 000
Step 3: Prepare amortisation table at R130 000.
Interest at Closing
Payment date Instalment 12,76649% Capital balance
R R R R
1 January 20.16 130 000
31 December 20.16 50 427 16 596 33 831 96 169
31 December 20.17 50 427 12 277 38 150 58 019
31 December 20.17 50 427 7 408 43 019 15 000
151 281 36 281 115 000
(b) Journal entries

Dr Cr
R R
Bank (SFP) 5 000
31/12/20.16 Bank (SFP) 50 427
31/12/20.17 Bank (SFP) 50 427
31/12/20.18 Bank (SFP) 50 427
31/12/20.18 Bank (SFP) *15 000
* Thorn Ltd receives cash in terms of guaranteed and unguaranteed residual value.
105
EXAMPLE 17
Bush Ltd entered into a lease agreement with Tea Ltd whereby Bush Ltd is leasing a machine
to Tea Ltd. The lease was entered into on 1 January 20.17. The lease agreement is a finance
lease in terms of IFRS 16, Leases.
Details of the lease agreement are as follows:

Cash selling price of the machine: R125 000
Lease instalment (payable annually in arrears): R51 003
Date of first instalment: 31 December 20.17
Guaranteed residual value: R8 000
Unguaranteed residual value: R5 000
At the end of the lease term Tea Ltd paid R13 000 to acquire ownership of the machine.
REQUIRED
(a) Prepare the amortisation table for the accounting of the lease in the
books of Bush Ltd.
(b) Prepare the journal entries in the books of Bush Ltd for the accounting
of the lease over the period of the lease agreement. Journal narrations
are not required.

Standards (IFRS).
SOLUTION 17


PV = (125 000 + 0) (fair value + initial direct costs)
PMT = 51 003
FV = 8 000 + 5 000 = 13 000 (guaranteed + unguaranteed residual values)
I = ? 15% per annum
Gross investment in the lease (3 x 51 003) + 8 000 + 5 000 166 009

Net investment in the lease (Present value in step 1) 125 000
106
FAC3703/501
Interest Closing
Date Instalment at 15% Capital balance
R R R R
1 January 20.17 125 000
31 December 20.17 51 003 18 749 32 254 92 746
31 December 20.18 51 003 13 912 37 091 55 655
31 December 20.19 51 003 8 348 42 655 13 000
153 009 41 009 112 000
(b) Journal entries

Dr Cr
R R
01/01/20.17 Gross investment in finance lease (SFP)
((51 003 x 3) + 8 000 + 5 000) 166 009
31/12/20.17 Bank (SFP) 51 003
31/12/20.18 Bank (SFP) 51 003
31/12/20.19 Bank (SFP) 51 003
31/12/20.19 Bank (SFP) *13 000
* Bush Ltd receives cash in terms of guaranteed and unguaranteed residual value
2.6.6 Finance lease modifications
On third year level, students should only have a basic knowledge of and awareness of lease
modifications.
A lessor shall account for a modification to a finance lease as a separate lease if both:
1) The modification increases the scope of the lease by adding the right to use one or
2) The consideration for the lease increases by an amount commensurate with the stand
alone price for the increase in scope and any appropriate adjustments to that stand-
alone price to reflect the circumstances of the particular contract.
107
For a modification to a finance lease that is NOT treated as a separate lease, the
lessor shall account for the modification as follows:
1) If the lease would have been classified as an operating lease had the modification
been in effect at inception date, the lessor shall:
- Account for the lease modification as a new lease from the effective date of the
modification; and
- Measure the carrying amount of the underlying asset as the net investment in
the lease immediately before the effective date of the lease modification.
2) Otherwise, the lessor shall apply the requirements of IFRS 9.
2.6.7 Tax effect of finance leases for the lessor

The lessor is taxed on the finance lease instalments received or accrued which includes both
the interest and capital components of the lease instalments. SARS honours the legal
ownership of the asset, therefore the normal tax allowances may be claimed as deductions by
the lessor, as legal ownership of the underlying asset remains with the lessor.
The lessor pays the full VAT output to SARS when entering into the lease agreement. If the
lessee finances the VAT, each instalment received by the lessor will include a portion of VAT
(which must be removed when the lessor’s taxable income is calculated). If the lessee pays
the VAT upfront, VAT is not financed and the instalments exclude VAT.
Initial direct costs such as legal fees and commission are deductible for tax purposes as it is
incurred by the lessor in the production of income (s11(a) and s11(c) of the Income tax Act).
EXAMPLE 18
Bide Ltd ordered a machine on 1 October 20.10. When the machine arrived on
31 December 20.10, Bide Ltd decided to discontinue the product that the machine was
supposed to manufacture. As a result, the machine was not brought into use. On
1 January 20.11, Bide Ltd leased the machine to Time Ltd. Time Ltd has a high credit rating.
The lease agreement is a lease in terms of IFRS 16, Leases.
The terms of the lease agreement were as follows:
Open market value of the machine at commencement of lease: R339 000
Instalments payable annually in arrears: R126 020
Date of first payment: 31 December 20.11
Bide Ltd incurred R10 000 in legal fees to secure the lease agreement. The legal fees are
deductible for tax purposes.
The estimated useful life of the machine is five years with a residual value of Rnil. Time Ltd
will take ownership of the machine at the end of the lease term at no additional cost.
The income tax rate is 28%. Ignore VAT. A tax deduction of 40% is granted for the machine
during the first year and 20% for the remaining three years not apportioned for part of a year.
The deferred tax balance at 1 January 20.11 was Rnil.
108
FAC3703/501
Assume that the gross profit of Bide Ltd for the reporting periods ended 31 December 20.11
and 20.12, before taking the lease agreement into account, was R400 000 and R500 000
respectively.
REQUIRED
(a) Prepare the amortisation table for the above lease for Bide Ltd on
commencement date of the lease.
(b) Calculate the deferred tax balance of Bide Ltd for the reporting
periods ended 31 December 20.11 to 31 December 20.15.
(c) Calculate the current tax payable by Bide Ltd for the reporting periods
31 December 20.11 and 20.12.
(d) Prepare the journal entries for the years ended 31 December 20.11
and 20.12 to account for current and deferred tax. Journal narrations
are required.
Standards (IFRS).
The interest rate must be rounded to five decimal places.
SOLUTION 18
PV = (339 000 + 10 000) (fair value + initial direct costs)
PMT = 126 020
I = ? 16,51966% per annum
R
Unearned finance income (504 080 – 349 000) (balancing figure) (155 080)
Net investment in the lease (present value in step 1) 349 000
Interest at Closing
Date 16,51966% Instalment Capital balance
R R R R
1 January 20.11 349 000
31 December 20.11 57 654 126 020 68 366 280 634
31 December 20.12 46 360 126 020 79 660 200 974
31 December 20.13 33 200 126 020 92 820 108 154
31 December 20.14 17 866 126 020 108 154 —
155 080 504 080 349 000
109
(b) Deferred tax balance from 31 December 20.11 until 20.15
Deferred
tax at
28%
Carrying Tax Temporary asset/
amount base differences (liability)
R R R R
31 December 20.10 (given) — —
31 December 20.11
Machine [C1] — 203 400 (203 400) 56 952
Net investment in finance leases 280 634 — 280 634 (78 578)
Movement in temporary differences (77 234 – 0) 77 234 (21 626)
31 December 20.12
Machine [C1] — 135 600 (135 600) 37 968
Movement in temporary differences (65 374 – 77 234) (11 860) 3 321
31 December 20.13
Machine [C1] — 67 800 (67 800) 18 984
Movement in temporary differences (40 354 – 65 374) (25 020) 7 006
31 December 20.14
Machine [C1] — — — —
Net investment in finance leases — — — —
Deferred tax asset — —
Movement in temporary differences (0 – 40 354) (40 354) 11 299
31 December 20.15
Machine [C1] — — — —
Net investment in finance leases — — — —
Deferred tax — —
Movement in temporary differences 0 – 0 — —
110
FAC3703/501
CALCULATIONS
C1. Tax base of machine (for tax purposes)
The tax deductions only start on 1 January 20.11 as the asset was only brought
into use on 1 January 20.11 (by the lessee).
R
Cost (excluding legal fees) (See comment below) 339 000
Tax deduction (339 000 x 40%) (135 600)
Tax base at 31 December 20.11 203 400
Tax deduction (339 000 x 20%) (67 800)
Tax deduction (339 000 x 20%) (67 800)
Tax deduction (339 000 x 20%) (67 800)
Tax base at 31 December 20.14 –
LEGAL FEES INCURRED BY BIDE LTD

For tax purposes, SARS allows a section 11(c) deduction for the legal fees (see
current tax calculation below). As a result, the legal fees do not form part of the
cost of the asset for tax purposes and is excluded from the tax base of the
machine.
(c) Current tax
CURRENT TAX CALCULATION

It is advisable to start your current tax calculation with the adjusted accounting
profit* for the year. Please note that the movement in temporary differences
below is equal to the movement in temporary differences calculated in (c)
above.
20.12 20.11
R R
Gross profit (before lease) (given) 500 000 400 000

Finance income 46 360 57 654
Adjusted accounting profit* 546 360 457 654
Movement in temporary differences (agrees to deferred tax
calculation in (b) above) 11 860 (77 234)
Taxable profit 558 220 380 420
Current tax at 28% 156 302 106 518
Proof of temporary differences: 11 860 (77 234)

Deduct legal fees - (10 000)
Include capital portion of finance lease instalments paid 79 660 68 366
Tax allowance on machine (C1 above) (67 800) (135 600)
111
(d) Tax journal entries on 31 December 20.11 and 20.12
Dr Cr
31 December 20.11 R R
Income tax expense (current tax) (P/L) 106 518
Recognise income tax provision for 20.11
Income tax expense (deferred tax) (P/L) 21 626
(from Rnil to liability of R21 626)
31 December 20.12
Income tax expense (current tax) (P/L) 156 302
Recognise income tax provision for 20.12
(from liability of R21 626 to asset of R18 305)
2.6.8 Operating leases in the financial statements of lessors (IFRS16.81-86)
 Ownership as well as risks and rewards of ownership are not transferred to the lessee.
 The lessor retains the asset on the statement of financial position.
 Depreciable assets are depreciated in accordance with IAS 16 and IAS 38:
 over its useful life,
 on a systematic basis consistent with the lessor's normal depreciation policy for similar
assets.
 Lease income (excluding services provided such as insurance and maintenance) should
be recognised using the straight-line method over the lease term unless another
systematic basis is more representative of the time pattern of earnings from the lease.
 Costs (including depreciation) incurred in earning lease income are recognised as an
expense in profit or loss.
 Initial direct costs incurred by lessors in negotiating and arranging an operating lease shall
be added to the carrying amount of the underlying leased asset and recognised as an
expense over the lease term on the same basis as the lease income (as part of
depreciation).
A lessor shall apply IAS 36 Impairment to determine whether an underlying asset subject to
an operating lease is impaired and to account for any impairment loss identified.
MANUFACTURER OR DEALER LESSOR
A manufacturer or dealer lessor does not recognise any selling profit on

entering into an operating lease because it is not the equivalent of a
sale.
EXAMPLE 19
Rain Ltd is a company which owns an office block. The offices are leased out to tenants and
one of the tenants is Pour Ltd. In terms of the lease agreement entered into with Pour Ltd, the
lease term is for a three year period with an option to extend the lease at the end of the
period. The lease agreement contains a lease in terms of IFRS 16, Leases.
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FAC3703/501
Commencement date: 1 January 20.17
Instalments (rental payments): R120 000 on 1 January 20.17
(annually in advance) R100 000 on 1 January 20.18
R80 000 on 1 January 20.19
Initial direct costs R1 300 (deductible for tax purposes)
REQUIRED
Prepare the journal entries for the above transaction in the accounting
records of Rain Ltd for the Financial year ended 31 December 20.17.
Journal narrations are not required.

Standards (IFRS).
SOLUTION 19
Straight-lining of lease payments:
R
Total lease payments (120 000 + 100 000 + 80 000) 300 000
Straight-lined lease payment (R300 000/3) 100 000
Journal entries
Dr Cr
1 January 20.17 R R
Bank (SFP) 120 000
Operating lease income (P/L) 100 000
Operating lease income received in advance (SFP) * 20 000
Office block (SFP) 1 300

Bank (SFP) 1 300
31 December 20.17
Depreciation (P/L) (1 300/3) ** 433
Accumulated depreciation (SFP) 433
* OPERATING LEASE INCOME RECEIVED IN ADVANCE

The straight-lined expense is recognised in profit or loss. The difference
between the straight-lined expense and lease payment for the year gives
rise to revenue received in advance.
** INITIAL DIRECT COSTS
The information relating to the cost and useful life of the office block is
not available. This journal illustrates the principle that the initial direct
costs are capitalised to the office block and depreciated over the lease
term.
113
2.6.9 Tax effect of operating lease for the lessor
The operating lease payments received for the year must be included in the lessor's taxable
income, excluding VAT. Initial indirect costs such as legal fees and commission are
deductible for tax purposes as it is incurred in the production of income. The lessor may claim
tax allowances on the asset.
Section 23A of the Income Tax Act limits the tax allowances on the assets leased out in terms
of an operating lease. Tax allowances and scrapping allowances may not exceed the taxable
rental income relating to that asset in that year. A tax loss may therefore not be created by
these tax allowances against lease income. Any surplus not claimed as a deduction in the
current tax year may be transferred to a subsequent tax year.
2.6.10 Disclosure – Lessor (IFRS 16.89-97)
The objective of the disclosures is for lessors to disclose information in the notes that,
together with the information provided in the statement of financial position, statement of profit
or loss and statement of cash flows, gives a basis for users of the financial statements to
assess the effect that leases have on the financial position, financial performance and cash
flows of the lessor.
A lessor shall disclose the following for the reporting period:
For both finance leases and operating leases

 Additional qualitative and quantitative information about its leasing activities necessary to
meet the disclosure objective above. The additional information includes, but is not limited
to, information that helps users of the financial statements to assess:
- The nature of the lessor’s leasing activities; and
- How the lessor manages the risk associated with any rights it retains in underlying
assets. A lessor shall disclose its risk management strategy for the rights it retains in
underlying assets, including any means by which the lessor reduces risk.
(Such means may include, buy back agreements, residual value guarantees or
variable lease payments for use in excess of specified limits).
Finance leases
 A lessor shall disclose the following in a tabular format unless another format is more
appropriate:
- Selling profit or loss
- Finance income on the net investment in the lease; and
- Income relating to variable lease payments not included in the measurement of the
net investment in the lease.
 A lessor is required to provide a qualitative and quantitative explanation of the significant
changes in the carrying amount of the net investment in finance leases.
 Disclose a maturity analysis of the lease payments receivable showing the undiscounted
lease payments to be received on an annual basis for:
- Minimum of each of the first five years; and
- A total of the amounts for the remaining years.
 Reconcile undiscounted lease payments to the net investment in the lease.
The reconciliation shall identify the unearned finance income to the lease payments
receivable and any discounted unguaranteed residual value.
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 Short-term and long-term portions of the net investment in the lease are shown to tie up to
the statement of financial position.
Operating leases
 A lessor shall disclose the following in a tabular format unless another format is more
appropriate:
- Lease income, disclosing income relating to variable lease payments that do not
depend on an index or rate separately.
 For items of property, plant and equipment subject to an operating lease, a lessor shall
apply the disclosure requirements of IAS 16, Property, plant and equipment.
In applying the disclosure requirements of IAS 16, a lessor shall disaggregate each class
of property, plant and equipment into assets subject to operating leases and assets not
subject to operating leases. A lessor shall provide the disclosures required by IAS 16 for
assets subject to an operating lease (by class of underlying asset) separately from owned
assets held and used by the lessor.
 A lessor shall apply the disclosure requirements in IAS 36, IAS 38, IAS 40 and IAS 41 for
assets subject to operating leases.
 A lessor shall disclose a maturity analysis of lease payments, showing the undiscounted
lease payments to be received on an annual basis for:
- Minimum of each of the first five years; and
- A total of the amounts for the remaining years.
EXAMPLE 20
On 1 January 20.16 Tide Ltd leased a machine to Sade Ltd. Tide Ltd used the machine in its
manufacturing process. The lease agreement contains a lease in terms of IFRS 16, Leases.
Sade Ltd has a high credit rating.
The terms of the lease agreement were as follows:
Open market value of the machine at commencement of lease R339 000
Instalments payable annually in arrears R110 020
Period of lease 5 years
Date of first payment 31 December 20.16
Tide Ltd incurred R15 000 in legal fees to secure the lease agreement. The legal fees are
deductible for tax purposes.
The estimated useful life of the machine is five years with a residual value of Rnil. Sade Ltd
will take ownership of the machine at the end of the lease term at no additional cost. The
machine was originally purchased on 1 November 20.15 for R350 000.
The income tax rate is 28%. A tax deduction is granted for the machine over five years on the
straight-line basis apportioned for part of a year. The deferred tax balance at 1 January 20.15
was Rnil.
Assume that the profit before tax of Tide Ltd for the reporting periods ended
31 December 20.16 and 20.17, before taking the lease agreement into account, was
R420 000 and R550 000 respectively.
115
REQUIRED
Present and disclose the lease transaction in the annual financial

statements of Tide Ltd for the reporting period ended 31 December 20.17.

Standards (IFRS).
Ignore VAT.
Round all interest rates to five decimals.
Cash flow statement and statement of changes in equity are not required.
EXAM TECHNIQUE
You are required to “present” and “disclose” the lease in the annual financial
statements:
“Present” refers to the presentation of the information on the face of the statement
of profit or loss and other comprehensive income and the statement of financial
position.
“Disclose” refers to the disclosure of the lease in the notes to the financial
statements.
As comparative figures are not specifically excluded, comparative figures are
required.
As no notes are specifically excluded, all notes that are affected by the lease
transaction need to be disclosed, including accounting policy notes and the
disclosure of categories of financial assets in terms of IFRS 7, Financial
Instruments: Disclosure.
SOLUTION 20
TIDE LTD
EXTRACT FROM THE STATEMENT OF FINANCIAL POSITION AS AT
31 DECEMBER 20.17
Notes 20.17 20.16
R R
ASSETS
Non-current assets
Net investment in finance leases 6 174 945 244 075
Current assets
Net investment in finance leases 6 69 130 59 211

Deferred tax 8 12 808 9 787
Current liabilities
Other payables: SARS 165 206 124 606
116
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TIDE LTD
EXTRACT FROM THE STATEMENT OF PROFIT OR LOSS AND OTHER
COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.17
Notes 20.17 20.16

R R
Profit before tax 3 600 809 479 973
Income tax expense 4 (168 227) (134 392)
Profit for the year 432 582 345 581
TIDE LTD
Reporting Standards issued by the International Accounting Standards Board.
The financial statements have been prepared on the historical cost basis, as adjusted with the
revaluation of land and buildings, investment property, available-for-sale financial assets and
financial assets and financial liabilities at fair value through profit or loss.
2.1 Financial assets
Financial assets are recognised in the company's statement of financial position when the
company becomes a party to the contractual provisions of an instrument. Regular way
purchases and sales of financial assets are recorded on the trade date.
Financial instruments are initially measured at fair value, plus, in the case of financial
instruments not at fair value through profit or loss, transaction costs. The fair value of a
financial instrument that is initially recognised is normally the transaction price, unless the fair
value is evident from the observable market data.
The company classifies its financial assets in the following categories:

 financial asset at fair value through profit or loss,
 financial asset at fair value through other comprehensive income, and
 financial asset at amortised cost.
2.2 Leases
Leases that transfer substantially all the risks and rewards of ownership are classified as
finance leases. All other leases are classified as operating leases.
The company as lessor
Amounts due from lessees under finance leases are recognised in the statement of financial
position and presented as a receivable at an amount equal to the net investment in the lease.
The difference between the gross receivable and the cost of the asset is recognised as
117
unearned finance income. Lease finance income is recognised based on a pattern reflecting a
constant periodic rate of return on the net investment outstanding in respect of the finance
lease.
Rental income derived from operating leases is recognised on a straight-line basis over the
term of the lease in profit or loss. Initial direct costs incurred in negotiating and arranging the
operating lease are included in the carrying amount of the leased asset and recognised in
profit or loss on a straight-line basis over the lease term.
Leases of assets by the company to other parties which are classified as finance leases are
recognised as receivable at amounts equal to the net investment in the leases. The finance
income on the finance lease agreements is recognised according to the interest rate implicit in
the lease.
Initial indirect costs incurred are included in the initial measurement of the finance lease
receivable and reduce the amount of interest income recognised over the lease term.
2.3 Taxation
Current and deferred tax are recognised as income or an expense and included in profit or
loss for the period, except when the tax relates to items that are recognised outside profit or
comprehensive income are also recognised in other comprehensive income. Tax that relates
to items that are recognised directly in equity are also recognised directly in equity.
Deferred taxation
Deferred tax is generally recognised for all temporary differences using the statement of
consequences that would follow from the manner in which the company expects to recover or
taxable profit.
— is not a business combination, and
— at the time of the transaction, affects neither accounting profit nor taxable profit (tax
loss).
asset and liability in a transaction which:
 at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).
118
FAC3703/501
A deferred tax asset is recognised for the carry forward of unused tax losses and unused tax
credits to the extent that it is probable that future taxable profit will be available against which
the unused tax losses and unused tax credits can be utilised.
Current tax
Income Tax Act. Taxable profit differs from the profit for the period as reported in the
20.17 20.16
R R
Profit before tax includes the following:
Income
Profit on sale of asset (339 000 – 338 333) - 667
Finance income [C1] 50 809 59 306
Expenses
Depreciation - -
DISCLOSURE OF FINANCE INCOME

Finance income can be disclosed as part of the profit before tax note or a
separate note.

SA normal tax
Current tax [C2]
— Current year 165 206 124 606
Deferred tax [C3]
— Movement in temporary differences 3 021 9 787
168 227 134 392
Tax reconciliation
Accounting profit [C2] 600 809 479 973
Tax at 28% 168 227 134 392
5. Property, plant and equipment

Machine
Carrying amount beginning of the year - 338 333
Cost - 350 000
Accumulated depreciation (350 000/5 x 2/12) - (11 667)
Disposal (338 333)
119
20.17 20.16
R R
Carrying amount end of the year - -
Cost - -
Accumulated depreciation - -
DISPOSAL OF MACHINE
The asset is leased in terms of a finance lease from 1 January 20.16 which
gives rise to a disposal on 1 January 20.16 for accounting purposes.
For tax purposes the asset lease has not been disposed.
6. Net investment in finance leases

6.1 Reconciliation of net investment in finance leases:
20.17 20.16
R R
Opening balance [C1] 303 286 -
New leases entered into [C1] - 354 000
Repayments of capital [C1] (59 211) (50 714)
Effect of lease modification - -
244 075 303 286
6.2 Maturity analysis of future finance lease instalments receivable at reporting date:
Later
than
20.18 20.19 20.20 20.21 20.22 20.22
20.17 R R R R R
Undiscounted lease payments 110 020 110 020 110 020 - - -
Unearned finance income [C1] (40 890) (29 309) (15 787) - - -
Net investment in the lease 69 130 80 711 94 233 - - -
Later
than
20.17 20.18 20.19 20.20 20.21 20.21
20.16 R R R R R
Undiscounted lease payments 110 020 110 020 110 020 110 020 - -
Unearned finance income [C1] (50 809) (40 890) (29 309) (15 787) - -
Net investment in the lease 59 211 69 130 80 711 94 233 - -
7. Categories of financial assets IFRS 7 disclosure
Non-current financial assets 20.17 20.16

Financial assets at amortised cost R R
Net investment in finance leases (refer to note 6.2) 174 945 244 075

Net investment in finance leases (refer to note 6.2) 69 130 59 211
120
FAC3703/501
The company manages its credit risk by entering into lease transactions with clients with
high credit ratings. As the lease transaction was entered into with a client with a high credit
rating, no allowance was made for credit losses.
Interest rate risk and market risk in financial assets
The present value on inception of the lease was calculated using the market interest rate.
The present value will be amortised over the lease term.
As the interest rate on the lease transaction is a fixed rate, no sensitivity analysis was
performed for changes in the interest rate.
20.17 20.16
R R
Net investment in finance leases (current + non-current) 244 075 303 286
Net investment in finance leases - High credit rating 244 075 303 286
8. Deferred tax
Net investment in finance leases (12 808) (9 787)

Net deferred tax liability (12 808) (9 787)
CALCULATIONS

PV = (339 000 + 15 000) (fair value + initial direct costs of lessor)
PMT = 110 020
I = ? 16.75298% per annum

R
Net investment in finance leases (present value in step 1) 354 000
121
Interest at Closing
Date Instalment 16,75298% Capital balance
R R R R
1 January 20.16 354 000
31 December 20.16 110 020 59 306 50 714 303 286
31 December 20.17 110 020 50 809 59 211 244 075
31 December 20.18 110 020 40 890 69 130 174 945
31 December 20.19 110 020 29 309 80 711 94 233
31 December 20.20 110 020 15 787 94 233 1
550 100 196 101 353 999
EXAM TECHNIQUE
There is a rounding difference of R1. In the exam you will not be penalised
for a small rounding difference as above. The amortisation table is only a
calculation. Remember to use the amortisation table in your answer and
refer to it. For example, if the amounts calculated in the amortisation table
are not disclosed in the notes (except if only calculations have been
required) it will not be marked.
C2. Current tax

20.17 20.16
R R
Profit before interest (before lease) (given) 550 000 420 000
Finance income 50 809 59 306
Profit on sale of asset - 667
Accounting profit 600 809 479 973
Movement in temporary differences [C3] (10 789) (34 953)
Taxable profit 590 020 445 020
Current tax at 28% 165 206 124 606
Proof of temporary differences: (10 789) (34 953)

Reverse accounting profit on sale of asset - (667)
Deduct legal fees - (15 000)
Add capital portion of finance lease instalments paid 59 211 50 714
Deduct tax allowance on machine [C4] (70 000) (70 000)
DEFERRED TAX ON THE MACHINE

The depreciation and tax deductions are the same, as a result the temporary
difference is Rnil on 31 December 20.15 in C3 below. For accounting purposes,
the machine was sold on 1 January 20.16, as a result the carrying amount for the
machine on 31 December 20.16 is Rnil.
For tax purposes, the machine was not sold on 1 January 20.16. Therefore the
machine continues to have a tax base.
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C3. Deferred tax
Deferred
tax at
28%
Carrying Tax Temporary asset/
R R R R
31 December 20.15 (given) [C4] 338 333 338 333 — —
31 December 20.16
Machine [C4] — 268 333 (268 333) 75 133
Movement in temporary differences (34 953 – 0) 34 953 (9 787)
31 December 20.17
Machine [C4] — 198 333 (198 333) 55 533

C4. Tax base of machine
R
Cost (excluding legal fees) (See comment below) 350 000
Tax deduction (350 000/5 x 2/12) (11 667)
Tax deduction (350 000/5) (70 000)
Tax deduction (350 000/5) (70 000)
LEGAL FEES INCURRED BY TIDE LTD
For tax purposes, SARS allows a section 11(c) deduction for the legal fees. As a
result, the legal fees do not form part of the cost of the asset for tax purposes
and is excluded from the tax base of the machine.
EXAMPLE 21
East Ltd acquired equipment on 1 July 20.16 for R900 000. West Ltd started leasing
equipment from East Ltd on 1 July 20.16 in terms of an operating lease agreement. The
period of the lease is three years, after which West Ltd has the option to extend the lease for
a further 12 months.
The lease payments are payable as follows:

R
1 July 20.16 43 000
30 June 20.17 265 000
30 June 20.18 265 000
30 June 20.19 252 000
825 000
123
The equipment has an estimated useful life of six years and a residual value of Rnil.
East Ltd paid commission amounting to R30 000 to enter into the lease agreement.
West Ltd and East Ltd depreciate equipment according to the straight-line method over the
useful life of the asset. Both companies have a 30 June year-end.
SARS grants a tax allowance on equipment over five years according to the straight-line
basis. The income tax rate is 28% for the year and the opening balance of deferred tax was
Rnil on 1 July 20.16. Profit before tax was R100 000 before taking the above transactions into
account.
REQUIRED
(a) Prepare the journal entries of East Ltd for the reporting period ended
30 June 20.17. Journal narrations are required.
(b) Present the above transaction in the statement of financial position at
30 June 20.17 and disclose the above lease transaction in the notes to
the annual financial statements of East Ltd for the year ended
30 June 20.17.
Standards (IFRS).
Ignore VAT.
Disclosure of categories of financial assets in terms of IFRS 7, Financial
Instruments: Disclosure is not required.
SOLUTION 21
(a) Journal entries

Dr Cr
Year ended 30 June 20.17 R R
Equipment: Cost price (SFP) (900 000 + 30 000) 930 000
Bank (SFP) 930 000
Equipment purchased 1 July 20.16 and capitalise commission
Bank (SFP) (43 000 + 265 000) 308 000
Operating lease income: Equipment (P/L) [C1] 275 000
Lease income received in advance (SFP) [C2] 33 000
Lease income received for the year
Depreciation (P/L) (900 000/6) + (30 000/3) 160 000
Accumulated depreciation: Equipment (SFP) 160 000
Income tax expense (current tax) (P/L) [C3] 55 440
Current tax provision for the year
Deferred tax (SFP) [C4] 4 760
Deferred tax movement for the year
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(b) Disclosure
EAST LTD
EXTRACT FROM THE STATEMENT OF FINANCIAL POSITION AS AT 30 JUNE 20.17
Notes 20.17
R
ASSETS
Non-current assets
Property, plant and equipment 4 770 000

Total liabilities
Deferred tax 7 4 760
Operating lease income received in advance [C2] 23 000
Current liabilities
Other payables 55 440
EAST LTD
Reporting Standards as issued by the International Accounting Standards Board.
The financial statements have been prepared on the historical cost basis, as adjusted with the
revaluation of land and buildings, investment property, available-for-sale financial assets and
financial assets and financial liabilities at fair value through profit or loss.
2.1 Property, plant and equipment
Owned equipment and equipment that are leased out are initially recognised at cost price and
subsequently measured at historical cost less accumulated depreciation and accumulated
impairment losses.
The equipment is depreciated on a straight-line basis over its estimated useful life of six
years.
Initial direct costs to secure an operating lease agreement are capitalised against the leased
asset and are depreciated over the lease term of three years.
The residual values and useful life of equipment are reviewed, and adjusted if necessary, at
each reporting date.
Depreciation is charged to profit or loss. Gains or losses on disposal are determined by

comparing the proceeds with the carrying amount of the asset. The net amount is included in
profit or loss for the period.
125
2.2 Leases
Leases that transfer substantially all the risks and rewards of ownership are classified as
finance leases. All other leases are classified as operating leases.
The company as lessor
Amounts due from lessees under finance leases are recognised in the statement of financial
position and presented as a receivable at an amount equal to the net investment in the lease.
The difference between the gross receivable and the cost of the asset is recognised as
unearned finance income. Finance income is recognised based on a pattern reflecting a
constant periodic rate of return on the net investment outstanding in respect of the finance
lease.
Rental income derived from operating leases is recognised on a straight-line basis over the
term of the lease in profit or loss. Initial direct costs incurred in negotiating and arranging the
operating lease are included in the carrying amount of the leased asset and recognised in
profit or loss on a straight-line basis over the lease term.
2.3 Taxation
Current and deferred tax are recognised as income or an expense and included in profit or
loss for the period, except when the tax relate to items that are recognised outside profit or
comprehensive income is also recognised in other comprehensive income. Tax that relates to
items that are recognised directly in equity is also recognised directly in equity.
Deferred taxation
Deferred tax is generally recognised for all temporary differences, using the statement of
consequences that will follow from the manner in which the company expects to recover or
taxable profit.
 is not a business combination, and
 at the time of the transaction, affects neither accounting profit nor taxable profit (tax
loss).
asset and liability in a transaction which:
 at the time of the transaction, affects neither accounting profit nor taxable profit (tax loss).
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A deferred tax asset is recognised for the carrying forward of unused tax losses and unused
tax credits to the extent that it is probable that future taxable profit will be available, against
which the unused tax losses and unused tax credits can be utilised.
Current tax
Income Tax Act. Taxable profits differs from the profit for the period as reported in the
Profit before tax is shown after taking into account the following items:
20.17
R
Income
Straight-line operating lease income
- Equipment [C1] 275 000
Expenses
Depreciation (refer to note 4) 160 000
Equipment
Carrying amount at 1 July 20.16 -
Cost -
Accumulated depreciation -
Additions 900 000
Commission capitalised 30 000
Depreciation [(900 000/6) + (30 000/3)] (160 000)
Carrying amount at 30 June 20.17 770 000
Cost 930 000
Accumulated depreciation (160 000)
The equipment is leased out in terms of an operating lease (refer to note 6).
COMMISSION CAPITALISED TO EQUIPMENT
Commission paid to enter into the operating lease are capitalised to the
equipment. The commission are then depreciated over the lease term.
The cost of the equipment of R900 000 will be depreciated over the useful life of
the asset.
SA normal tax
Current tax
- Current year [C3] 55 440
Deferred tax
- Movement in temporary differences [C4] (17 000 x 28%) 4 760
60 200
127
20.17
R
Tax reconciliation
Tax at 28% (215 000 x 28%) 60 200
6. Operating lease agreement
The undiscounted lease payments expected to be received under operating lease

agreements at the reporting date is as follows:
30 June 20.18 265 000

30 June 20.19 252 000
517 000
7. Deferred tax

Property, plant and equipment
- Accelerated deductions for tax purposes [C4] (14 000)
CALCULATIONS
C1. Straight-lining of operating lease payments

R
Total lease payments (given) 825 000
Equalised lease payment per annum (825 000/3) 275 000
C2. Operating lease income received in advance

* Lease
Equalised
Instalments income
instalments
received in received in
recognised
cash advance
R
R R
For year-end 30 June 20.17 308 000 275 000 33 000
For year-end 30 June 20.18 265 000 275 000 (10 000)
Total 573 000 550 000 23 000
For year-end 30 June 20.19 252 000 275 000 (23 000)
Total 825 000 825 000 -
*The lease income received in advance is recognised as a credit balance in the
Statement of Financial Position.
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FAC3703/501
C3. Current tax
R
Profit before tax 100 000
Equalised operating lease income 275 000
Depreciation (160 000)
Movement in temporary differences (taxable) (see C4 below) (17 000)
Current tax at 28% (198 000 x 28%) 55 440
Proof of movement in temporary differences:
Movement in temporary differences (17 000)
Reverse equalised operating lease income (275 000)
Add operating lease income received in cash 308 000
Add back depreciation 160 000
Deduct tax allowance (900 000/5) (180 000)
Deduct full commission (30 000)
CURRENT TAX CALCULATION

The accounting profit is calculated in order to complete the tax reconciliation in
the income tax expense note.
Please note that the movement in temporary differences of R17 000 calculated
in C3 above is equal to the movement in temporary differences in C4 below.
In C4 below, the taxable temporary differences give rise to a deferred tax
liability. Therefore the R17 000 is deducted from the taxable profit as it is only
taxable in future and not in the current year.
APPLICATION OF SECTION 23A OF THE INCOME TAX ACT

The tax allowance on the equipment must not exceed the lease income received
for the equipment. The tax allowance on the equipment of R180 000 is less than
the lease income of R308 000, therefore no limit is applicable.
C4. Deferred tax Deferred tax

@ 28%
Carrying Temporary asset/
amount Tax base differences (liability)
R R R R
30 June 20.16 - -
30 June 20.17
Equipment 770 000 a720 000 50 000 b (14 000)
Lease income received in advance (33 000) c- (33 000) d 9 240
Deferred tax liability at 30 June 20.17 17 000 (4 760)
Movement in temporary differences (taxable) (17 000 – 0) 17 000 (4 760)

a 900 000 – (900 000/5) = 720 000 Commission is not capitalised for tax purposes.
b Carrying amount of asset > tax base of asset ∴ deferred tax liability
c Carrying amount (33 000) minus amounts not taxable in future (33 000 already taxed) = 0
d Carrying amount of liability > tax base of liability ∴ deferred tax asset
129
EXAMPLE 22
Laser Ltd manufactures machinery and sells or leases it to customers. Laser Ltd leased
machinery to Jet Ltd on 1 January 20.17. The lease agreement is a lease in terms of IFRS 16,
Leases.
The following information regarding the finance lease is applicable:
Cost of leased machinery R80 000

Selling price of leased machinery R110 000
Lease period 4 years
Lease instalments (payable annually in arrears) R36 216
Interest rate implicit in the lease 12% p.a.
The market-related interest rate implicit in the lease for such a transaction is 18% per annum.
Laser Ltd incurred R5 000 legal fees to secure the lease agreement. At the end of the lease
period the machinery will be transferred to Jet Ltd at no additional cost.
The income tax rate is 28%. The accounting profit for the year ended 31 December 20.17,
before the above lease agreement was taken into account, amounted to R500 000. SARS
allows a tax deduction on the fair value of the machine of 40% in the first and 20% for the
remaining three years, not apportioned for part of a year. The deferred tax balance as at
31 December 20.16 amounted to Rnil. The company had no other income apart from those
indicated in the above information.
REQUIRED
Present the lease on the statement of financial position and the statement of
profit or loss and other comprehensive income for the year ended
31 December 20.17 and disclose the lease in the notes to the annual
financial statements of Laser Ltd for the year ended 31 December 20.17.

Standards (IFRS).
Accounting Policies are not required.
Ignore VAT.
130
FAC3703/501
SOLUTION 22
LASER LTD
EXTRACT FROM THE STATEMENT OF FINANCIAL POSITION AS AT
31 DECEMBER 20.17
Notes 20.17
R
ASSETS
Non-current assets
Net investment in finance leases 5 56 701
Current assets
Net investment in finance leases 5 22 042
Deferred tax 8 225
Current liabilities
Other payables: SARS 148 163

COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 20.17
Notes 20.17
R
Gross profit (500 000 + 17 423 profit) 517 423
Finance income [C2] 3 17 536
Other expenses — legal expenses (5 000)
Profit before tax 2 529 959
Income tax expense 4 (148 388)
Profit for the year 381 571

20.17
Profit before tax includes the following R
Income
Gross profit on inventory sold in terms of a lease agreement 17 423
(97 423 [C1] – 80 000)
3. Finance income
Finance income on net investment in finance leases [C2] 17 536

Major components of tax expense:
SA normal taxation
Current taxation
— Current year [C3] 142 707
Deferred taxation
— Movement in temporary differences [C4] (20 289 x 28%) 5 681
148 388
131
20.17
R
Tax reconciliation
Tax at 28% (529 959 x 28%) 148 388
5. Net investment in finance leases

5.1 Reconciliation of net investment in finance leases:
Opening balance -
New leases entered into [C2] 97 423
Repayments of capital [C2] (18 680)
Effect of lease modification -
78 743
5.2 Maturity analysis of the finance lease instalments receivable at reporting date:
20.18 20.19 20.20 20.21

20.17 R R R R
Undiscounted lease payments 36 216 36 216 36 216 -
Unearned finance income [C1] (14 174) (10 206) (5 525) -
Net investment in the lease 22 042 26 010 30 691 -
6. Categories of financial instruments IFRS 7 disclosure

20.17
Non-current financial assets R
Net investment in finance leases (refer to note 5) 56 701

Net investment in finance leases (refer to note 5) 22 042

liabilities are matched according to cash flow needs and that the company has adequate
access to credit. Expected cash flow requirements are monitored with rolling cash flow
budgets.

Net investment in finance leases (current + non-current) (note 5) 78 743
Net investment in finance leases - High credit rating (note 5) 78 743
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FAC3703/501
8. Deferred tax
20.17
R
Net investment in finance leases [C4] (5 681)
CALCULATIONS
C1. Present value of the finance lease
At inception of the lease it is necessary to calculate what the selling price would be if a normal
market-related interest rate had been charged.
Present value of lease at 18% per annum:
N = 4 (4 years x 1 payment per year)
I = 18% per annum (market-related)
PMT = 36 216
PV = ? R97 423 (fair value excluding initial direct costs)
The sale price should have been R97 423 (fair value) and not R110 000. The amortisation
table must be prepared for R97 423 with an interest rate of 18% per annum.
C2. Amortisation table at R97 423
Closing
Instalment Interest at18% Capital
balance
Date R R R
R
1 January 20.17 97 423
31 December 20.17 36 216 17 536 18 680 78 743
31 December 20.18 36 216 14 174 22 042 56 701
31 December 20.19 36 216 10 206 26 010 30 691
31 December 20.20 36 216 5 525 30 691 —
144 864 47 441 97 423
C3. Current tax

20.17
R
Accounting profit (given) 500 000
Revenue (recoupment as inventory now becomes capital asset for tax) 97 423
Cost of sales (80 000)
Finance income 17 536
Legal fees (5 000)
Movement in temporary differences (taxable) [C4] (20 289)
Taxable profit 509 670
Tax at 28% (509 670 x 28%) 142 708
Proof of movement in temporary differences:

Movement in temporary differences (20 289)
Include capital portion of finance lease instalment paid 18 680
Tax deduction on machinery (97 423 x 40%) (38 969)
133
MACHINERY
The machinery is inventory of Laser Ltd. From 1 January 20.17, the machinery is
leased out in terms of a finance lease, and for tax purposes, the machinery is now
transferred from inventory to “leased assets”. As a result SARS will allow a tax
deduction on the machinery even though it is not recognised as an asset for
accounting purposes. The tax deduction for the machine is based on the
recoupment amount of R97 423.
C4. Deferred tax

Deferred tax
Carrying Tax Temporary at 28% asset/
R R R R
31 December 20.16 - -
31 December 20.17
Net investment in finance leases 78 743 - 78 743 (22 048)
Machinery - a58 454 (58 454) 16 367
Movement in temporary differences (taxable) (20 289 – 0) 20 289 (5 681)
a 97 423 – (97 423 x 40%) = 58 454
134
FAC3703/501
2.7 Annexure A: Basic examples on how to prepare an amortisation
table
An amortisation table is prepared to calculate the split between capital and interest of the
lease instalments. It is very important that you are able to calculate the interest rate implicit in
the lease on your financial calculator. You must also be able to calculate the amortisation
table manually and to extract the numbers of the amortisation table from your financial
calculator.
The four examples below will be used to illustrate important principles when preparing
an amortisation table.
EXAMPLE A
Payments in arrears
Beetle Ltd entered into a finance lease agreement with Apple Ltd on 1 January 2017 whereby
Apple Ltd will lease a machine from Beetle Ltd for a period of two years. The cash selling
price and fair value of the machine amounted to R40 000 on 1 January 2017. The instalments
amount to R13 200 each and are payable half yearly in arrears. Beetle Ltd didn’t incur any
initial direct costs. Ownership of the machine will transfer to Apple Ltd at the end of the lease
term at no additional cost.
The financial year end of Beetle Ltd is 31 December.
REQUIRED
Prepare the amortisation table that Beetle Ltd will use to account for the
lease of the machine.
SOLUTION A
In this example 1, Beetle Ltd is the lessor and Apple Ltd is the lessee.

Set HP and Sharp EL-738 calculators on 2P/YR (as there is two instalments payable per
year)
N = 4 (2 payments per year x 2 years)
PV = (40 000 + 0) (fair value + initial direct costs of the lessor)
PMT = 13 200*
FV = 0* + 0* (guaranteed and unguaranteed residual values)
I = ? 24,22% per annum
(Sharp EL-733A will calculate 12,11% per six months
12,11% x 2 = 24,22% for 12 months)
* IMPORTANT
The amounts for "PMT" and "FV" entered into your financial calculator represent
cash inflows for Beetle Ltd and must have the same signs, for example, they must
both be positive or negative. The “PV” represents the outflow of the finance
provided for the machine to Beetle Ltd from Apple Ltd and must have the opposite
sign of the “PMT” and “FV”.
135
Step 2: Determine the initial recognition amount.
Recognise the asset and liability at the lower of the:
- present value of the minimum lease payments discounted at the interest rate implicit in
the lease (R40 000), or
I = 24,22% per annum (calculated in step 1)
PMT = 13 200
FV = 0 (guaranteed residual value only)
PV = ? (40 000)
- fair value of the leased property (R40 000).
COMMENT
The present value of the minimum lease payments is equal to the fair value of
R40 000. As a result the machine and the finance lease liability will both be
recognised at R40 000. As a result, the amortisation table is prepared at
R40 000.
Step 3: Prepare the amortisation table for R40 000.
Interest at Outstanding
Payment date Instalment 24,22% p.a. Capital balance
R R R R
1 January 20.17 40 000
30 June 20.17 13 200 a 4 844 b 8 356 c 31 644
31 December 20.17 13 200 3 832 9 368 22 276

30 June 20.18 13 200 2 698 10 502 11 774
31 December 20.18 13 200 1 426 11 774 -
52 800 12 800 40 000
a 40 000 x 24,22% x 6/12 = 4 844 or 40 000 x 12,11% = 4 844

b 13 200 – 4 844 = 8 356
c 40 000 – 8 356 = 31 644
EXAMPLE B
Payments in advance
The same information applies as in example A except that the instalments are payable half
yearly in advance.
REQUIRED
136
FAC3703/501
SOLUTION B

IIMPORTANT: Set your calculator on BEGIN mode as instalments are payable at the
beginning of every six months.
Set HP and Sharp EL-738 calculators on 2P/YR (as there is two instalments payable per
year)
PV = (40 000 + 0) (fair value + initial costs of the lessor)
PMT = 13 200
I = ? 44,77% per annum
(Sharp EL-733A will calculate 22,38% per six months
22,38% x 2 = 44,77% for 12 months)
Step 2: Determine the initial recognition amount.
Recognise the asset and liability at the lower of the:
- present value of the minimum lease payments discounted at the interest rate implicit in
the lease (R40 000), or

I = 44,77% per annum (calculated in step 1)
PMT = 13 200
FV = 0 (guaranteed residual value only)
PV = ? (40 000)
- fair value of the leased property (R40 000).
R R R R
1 January 20.17 40 000
1 January 20.17 13 200 - 13 200 a 26 800
1 July 20.17 13 200 b 5 999 c 7 201 19 599
1 January 20.18 13 200 4 387 8 813 10 786
1 July 20.18 13 200 2 414 10 786 -
52 800 12 800 40 000
a 40 000 – 13 200 = 26 800

b 26 800 x 44,77% x 6/12 = 5 999 or 26 800 x 22,38% = 5 999
c 13 200 – 5 999 = 7 201
COMMENTS ON EXAMPLE A AND EXAMPLE B

Compare the amortisation tables of example A and example B. Note the
differences between the interest rates and payment dates as a result of the
instalments being payable in arrears or in advance.
The payment dates are different for example B as the instalments are payable at
the beginning of the six-month period. The lease was entered into on
137
1 January 20.17 and in example B, the first payment was made on the same
date. As a result the first instalment paid on 1 January 20.14 comprises only of
capital because no time has passed for interest to accrue.
The interest rates in both example A and example B were rounded off to two
decimals. In a question you will normally be instructed to round off the interest
rate to a specific number of decimals, for example, round off the interest rate to
two decimals.
EXAMPLE C
Payments in arrears
Example C contains the same information as example A except that the financial year end of
Beetle Ltd is 30 April and not 31 December.
REQUIRED
SOLUTION C
Step 1 and Step 2 are the same as for example A.
PAYMENTS DO NOT COINCIDE WITH YEAR END
The payments are made on 30 June and 31 December and the financial year end
is 30 April. No instalments are made at year-end but interest is accrued at year-
end.
R R R R
1 January 20.17 40 000
30 April 20.17 - a 3 229 - b 43 229
30 June 20.17 13 200 c 1 615 d 8 356 e 31 644
31 December 20.17 13 200 f 3 832 g 9 368 h 22 276

i 1 799 j 24 075
30 April 20.18 - -
30 June 20.18 13 200 k 899 l 10 502 m 11 774
31 December 20.18 13 200 1 426 11 774 -

52 800 12 800 40 000
a 40 000 x 24,22% x 4/12 = 3 229 or 40 000 x 12,11% x 4/6 = 3 229

b 40 000 + 3 229 = 43 229. R43 229 is the capital outstanding and the interest accrued as at
year end combined. This amount is only calculated for disclosure in the financial
statements and must not be used to calculate interest in the amortisation table.
c 40 000 x 24,22% x 2/12 = 1 615 or 40 000 x 12,11% x 2/6 = 1 615
Please note that the interest from 1 January 20.17 until 30 June 20.17 totals R4 844 and is
split into R3 229 (for four months) and R1 615 (for two months).
138
FAC3703/501
d 13 200 – (3 229 + 1 615) = 8 356
e 40 000 – 8 356 = 31 644
f 31 644 x 24,22% x 6/12 = 3 832 or 31 644 x 12,11% x 6/6 = 3 832
g 13 200 – 3 832 = 9 368
h 31 644 – 9 368 = 22 276
i 22 276 x 24,22% x 4/12 = 1 799 or 22 276 x 12,11% x 4/6 = 1 799
j 22 276 + 1 799 = 24 075. R24 075 is the capital outstanding and the interest accrued as at
year end. This amount is only calculated for disclosure in the financial statements and
must not be used to calculate interest in the amortisation table.
k 22 276 x 24,22% x 2/12 = 899 or 22 276 x 12,11% x 4/6 = 899
l 13 200 – (1 799 + 899) = 10 502
m 22 276 – 10 502 = 11 774
EXAMPLE D
Payments in advance
Example D contains the same information as example B except that the financial year end of
Beetle Ltd is 30 April and not 31 December.
REQUIRED
SOLUTION D
Step 1 and Step 2 are the same as for example B.
COMMENT
The payments are made on 30 June and 31 December and the year end is
30 April. No instalment is paid at year end and only interest has accrued at year
end.
R R R R
1 January 20.17 40 000
1 January 20.17 13 200 - a 13 200 b 26 800
c 3 999 d 30 799
30 April 20.17 - -
1 July 20.17 13 200 e 2 000 f 7 201 g 19 599
1 January 20.18 13 200 h 4 387 i 8 813 j 10 786

k 1 609 l 12 395
30 April 20.18 - -
1 July 20.18 13 200 m 805 n 10 786 o -
52 800 12 800 40 000
139
a The full instalment of R13 200 is capital.
b 40 000 – 13 200 = 26 800
c 26 800 x 44,77% x 4/12 = 3 999 OR 26 800 x 22,38% x 4/6 = 3 999
d 26 800 + 3 999 = 30 799. R30 799 is the capital outstanding and the interest accrued as at
e 26 800 x 44,77% x 2/12 = 2 000 or 26 800 x 22,38% x 2/6 = 2 000
Please note that the interest from 1 January 20.17 until 30 June 20.17 totals R5 999 and is
split into R3 999 (for 4 months) and R2 000 (for 2 months).
f 13 200 – (3 999 + 2 000) = 7 201
g 26 800 – 7 201 = 19 599
h 19 599 x 44,77% x 6/12 = 4 387 or 19 599 x 22,38% x 6/6 = 4 387
i 13 200 – 4 387 = 8 813
j 19 599 – 8 813 = 10 786
k 10 786 x 44,77% x 4/12 = 1 609 or 10 786 x 22,38% x 4/6 = 1 609
l 10 786 + 1 609 = 12 395. R12 395 is the capital outstanding and the interest accrued as at
m 10 786 x 44,77% x 2/12 = 805 or 10 786 x 22,38% x 2/6 = 805
n 13 200 – (1 609 + 805) = 10 786
o 10 786 – 10 786 = 0
ASSESSMENT CRITERIA
Are you now able to
 distinguish between a finance lease and an operating lease by applying

the criteria for the recognition of a finance lease and operating lease?
 for a lessee, record and disclose a lease, taking the tax effect into
account in the financial statements of the lessee and the lessor according
to the requirements of the International Financial Reporting Standards?
 for a lessor, record and disclose a finance lease and operating lease
properly, taking the tax effect into account, in the financial statements of
the lessee and the lessor according to the requirements of the
International Financial Reporting Standards?
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FAC3703/501
FAC3703
LEARNING UNIT 3
EMPLOYEE BENEFITS
141
LEARNING OUTCOMES (IAS 19)
Learners should be able to account for and disclose employee benefits (refer to comments
on defined-benefit plans and other long-term employee benefits) and the tax implications
thereof in the financial statements of companies in terms of the Companies Act and the
International Financial Reporting Standards (IFRS).
TABLE OF CONTENTS
The learning unit is divided into the following:
4.1 Short-term employee benefits (IAS 19.9-10) ...................................................... 143

4.1.1 All short-term employee benefits ........................................................................ 144
4.1.2 Short-term compensated absences (IAS 19.13-18) ........................................... 145
4.1.3 Accounting treatment of accumulating compensated absences ......................... 148
4.1.4 Profit sharing and bonus plans (IAS19.19-24) .................................................... 150
4.2 Post-employment benefits .................................................................................. 153
4.2.1 Defined-contribution plans .................................................................................. 153
4.2.2 Defined-benefit plans (IAS 19.55-125) .............................................................. 155
4.3 Other long-term employee benefits (IAS 19.153-158) ........................................ 155
4.4 Termination benefits (IAS 19.159-171) ............................................................... 155
4.5 Tax implications .................................................................................................. 157
4.6 Comprehensive example .................................................................................... 157
STUDY
Refer to the chapter on employee benefits (IAS 19) in the prescribed textbook of this
module.
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OVERVIEW
In terms of IAS 19, employee benefits can be classified into the following main categories:
 short-term employee benefits such as wages, salaries and social security

contributions, paid annual leave and paid sick leave, profit-sharing and bonuses (if
payable within 12 months of the end of the period), and non-monetary benefits (such
as medical care, housing, cars and free or subsidised goods or services) for current
employees.
 post-employment benefits such as pensions, other retirement benefits, post-
employment life insurance and post-employment medical care.
 other long-term employee benefits, including long-service leave or sabbatical leave,
jubilee or other long-service benefits, long-term disability benefits and, if they are not
payable wholly within 12 months after the end of the period, profit sharing, bonuses
and deferred compensation.
 termination benefits are typically lump sum payments, but sometimes also include:
(a) enhancement of post-employment benefits, either indirectly through an employee
benefit plan or directly, and
(b) salaries until the end of a specified notice period if the employees render no
further service that provides economic benefits to the entity.
Note that equity compensation benefits are dealt with in IFRS 2, Share-based payment
and reporting employee benefit plans are dealt with in IAS 26, Accounting and reporting by
retirement benefit plans and do not form part of this module.
The chapter in your prescribed textbook on employee benefits, with the exception of the
accounting treatment and disclosure of defined benefit plans, should be studied
thoroughly.
This guide only contains examples to illustrate the accounting treatment and disclosure of
the different categories of employee benefits in terms of the International Financial
Reporting Standards (IFRS).
4.1 Short-term employee benefits (IAS 19.9-10)
Short-term employee benefits are employee benefits (other than termination benefits) that
are expected to be settled wholly before 12 months after the end of the annual reporting
period in which the employees render the related service.
Short-term employee benefits include items such as the following, if expected to be settled
wholly before 12 months after the end of the annual reporting period in which the
employees render the related services:
(a) wages, salaries and social security contributions
(b) paid annual leave and paid sick leave
(c) profit-sharing and bonuses
(d) non-monetary benefits (such as medical care, housing, cars and free or subsidised
goods or services) for current employees
143
4.1.1 All short-term employee benefits
When an employee has rendered service to an entity during an accounting period, the
entity shall recognise the undiscounted amount of short-term employee benefits expected
to be paid in exchange for that service.
EXAMPLE 1
Beckett Ltd is a manufacturing company specialising in the manufacturing of medical

equipment. The company's year-end is 31 March.
Salaries
It is the policy of the company to pay the salaries to employees on the last Friday of each
calendar month. Due to cash flow problems the company will not be able to pay the
salaries until one of the debtors pays its account on 2 April 20.18. The total salary bill for
March 20.18 amounts to R1 500 000 and this amount will be paid to employees on
3 April 20.18.
Wages
It is the policy of the company to pay weekly wages (Monday to Friday) to employees on
every Friday. The total wages for 30 March 20.18 to 3 April 20.18, the 3rd being a Friday,
is R50 000.
REQUIRED
Prepare the journal entries in the accounting records of Beckett Ltd for the
year ended 31 March 20.18.
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SOLUTION 1
Dr Cr
R R
31 March 20.18
Short-term employee benefits (P/L) 1 500 000

Accrued expenses: Salaries (SFP) 1 500 000
Salaries for March to be paid on 3 April 20.18
Short-term employee benefits (P/L) (50 000/5 x 2) 20 000

Accrued expenses: Wages (SFP) 20 000
Recognise wages for 30-31 March to be paid on 3 April 20.18
(Wages for 1,2 and 3 April 20.18 will only be recognised in the following financial year)
4.1.2 Short-term compensated absences (IAS 19.13-18)

Short-term compensated absences consist of:
 accumulating compensated absences, and
 non-accumulating compensated absences.
Accumulating compensated absences
Compensated absences can be carried forward to future periods if the number of days
entitled to in the current period is not used in full. These accumulated compensated
absences can either be vesting or non-vesting:
 Vesting benefits are not conditional on future employment by the company and a
cash payment to the employee is made on termination of employment.
 Non-vesting benefits are conditional on future employment and a cash payment will
not be made on termination of employment.
Non-accumulating compensated absences
Leave unutilised in the current leave cycle cannot be carried forward to the following
period and therefore lapses at the end of the current cycle. No accrued expense for leave
should be recognised in the accounting records.
145
EXAMPLE 2
Accumulating vesting short-term compensated absences

Weir Ltd, a retail company, opened its doors for business on 1 January 20.18. The year-
end of Weir Ltd is 31 December. On 1 January 20.18 the company hired 20 employees.
Each of the 20 employees is each entitled to 20 working days leave per calendar year.
Leave not taken by the end of the calendar year, is carried forward to the next calendar
year and is only paid in cash to the employees when their services are terminated. All
employees are obliged to take 15 days leave over December.
At 31 December 20.18, four employees have taken all their leave. 14 employees took only
17 days leave and the remaining employees only took the compulsory 15 days over
December. The daily rate for all employees is R200 and no employees resigned during the
year.
REQUIRED
Prepare the journal entries in the accounting records of Weir Ltd in respect
of the untaken/unused leave days for the year ended 31 December 20.18.
SOLUTION 2
Dr Cr
R R
31 December 20.18
Short-term employee benefits (P/L) [C1] 10 400
Accrued expense: Unused leave days (SFP) 10 400
Recognise unused leave pay accrual for the year ended 31 December 20.18
CALCULATIONS
C1 Accrued expense: Unused leave days R

4 employees took all their leave days, no accrued expense -
14 employees x 3 days (20 – 17 days) x R200 per day 8 400
10 400
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EXAMPLE 3
Accumulating non-vesting short-term compensated absences

Weir Ltd, a retail company opened its doors for business on 1 January 20.15. On
1 January 20.18 the company had 20 employees, who were each entitled to 20 working
days leave per calendar year.
A maximum of seven unused leave days may be carried forward to the next calendar year,
after which it lapses without payment, if not taken. All employees must take ten days leave
during December.
Four employees took all their leave during the 20.18 financial year. Thirteen employees
took only 17 days leave and the remaining employees only took the compulsory ten days
during December. The daily rate for all employees is R200 and no employees resigned
during the year.
Past experience has shown that on average only five unused leave days that were carried
forward were indeed taken during the next year. The accrued leave for the year ended
31 December 20.17 amounted to R9 200.
REQUIRED
Prepare the journal entries in the accounting records of Weir Ltd in respect
of the untaken/unused leave days for the year ended 31 December 20.18.
SOLUTION 3
Dr Cr
R R
1 January 20.17
Accrued expense: Unused leave days (SFP) (amount given) 9 200
Short-term employee benefits (P/L) 9 200
Accrued leave pay for the year ended 31 December 20.17 reversed
31 December 20.10
Recognise unused leave pay accrual for the year ended 31 December 20.18
CALCULATIONS
C1 Accrued expense: Unused leave days R

4 employees took all their leave days, no accrued expense -
3 employees x 5 days x R200 per day 3 000
10 800
Three employees had 10 days unused leave (20 – 10 days). As past experience
have shown that on average, only five days will be used, the accrued expense is
raised only for the days that are expected to be used, i.e. five days.
147
EXAMPLE 4
Non-accumulating compensated absences
Weir Ltd, a retailer, opened its doors for business for the first time on 1 January 20.15. On
days leave per calendar year.
Unutilised leave cannot be carried forward to the next year and lapses at the end of 20.18.
All employees must take ten days leave over December.
Sixteen employees took all their leave during 20.18. The remaining employees took only
17 days leave.
REQUIRED
Prepare the journal entries in the accounting records of Weir Ltd in

respect of the untaken/unused leave days for the year ended
31 December 20.18.
SOLUTION 4
There will be no accrued leave pay and therefore no journal entries at 31 December 20.18
as unutilised leave cannot be carried forward.
4.1.3 Accounting treatment of accumulating compensated absences
When accounting for accumulating compensated absences (leave), the expected cost of
the benefit should be recognised when the employees render services that increase their
entitlement to future compensated absences. The amount is measured as the additional
amount an entity expects to pay as a result of the unused entitlement that has
accumulated at the reporting date. The basic formula to calculate this would be:
Expected number of days' leave to be taken or paid out x tariff per day
If the employer expects employees to have all accumulated leave paid out in cash, the
employer will use a tariff based on the gross basic salary of these employees to measure
the leave pay accrual (unless in rare circumstances the leave conditions specify something
else).
If it is expected that the employees will take the leave days (be absent from work) in
future, the tariff used to measure the leave pay accrual will be based on the cost to
company amount for employees. This would be the basic gross salary plus the
additional contributions paid by the employer. This is the case because the employer
will still be required to make contributions to the pension fund, medical aid fund, etc. during
the absence of the employees.
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EXAMPLE 5
Accumulated short-term compensated absences with the financial year-end and the
leave cycle on different dates
Weir Ltd, a retailer opened its doors for business for the first time on 1 January 20.15. On
days leave per calendar year. There are 252 working days per calendar year.
Employees are obliged to take ten working days during December. No leave is carried
forward to the following leave cycle and a maximum of five unused leave days is paid out
to employees on 31 December each year. 60% of all employees only took 15 working days
leave per cycle in order to receive the cash payment. The remaining 40% of the
employees took all their leave up to 31 December 20.18. Assume the daily tariff of all
employees is R200 per employee and that no employees resigned during the year. No
leave was taken during January 20.19 and February 20.19.
Assume that the accrued leave pay for the year ended 28 February 20.18 amounted to
R5 850. The year-end of Weir Ltd is 28 February of each year.
REQUIRED
Prepare the journal entries in the accounting records of Weir Ltd in

respect of the leave paid, as well as the untaken leave for the year ended
28 February 20.19.
SOLUTION 5
Dr Cr
R R
1 March 20.18
Accrued expense: Unused leave days (SFP) (amount given) 5 850
Accrued leave pay for the year ended 28 February 20.18 reversed
31 December 20.18
Bank (SFP) 12 000
Unused leave days paid out on 31 December 20.18
28 February 20.19
Recognise unused leave pay accrual for the year ended 28 February 20.19
149
CALCULATIONS
R
C1 Unused leave paid out on 31 December 20.18
(60% x 20 employees) x 5 days (20 – 15 days) x R200 per day 12 000
C2 Accrued expense: Unused leave days

Days accrued per month: 20 days / 12 months = 1,67 days per month
Days accrued from 1 January 20.19 until 28 February 20.19:
1,67 days per month x 2 months = 3,33 days
20 employees x 3,33 days x R200 per day 13 333
YEAR-END AND LEAVE CYCLE

The new leave cycle started on 1 January 20.19 and will end on
31 December 20.19.
The financial year started on 1 March 20.18 and ended on 28 February 20.19.
At year-end, 28 February 20.19, two months of the leave cycle has already
gone past and as a result, leave days for January 20.19 and February 20.19
has already vested and must be accrued for.
4.1.4 Profit sharing and bonus plans (IAS19.19-24)

An entity shall recognise the expected cost of profit-sharing and bonus payments when
(a) the entity has a present legal or constructive obligation to make such payments as a
result of past events, and
(b) a reliable estimate of the obligation can be made
A present obligation exists only when the entity has no realistic alternative but to make the
payments.
EXAMPLE 6
Carter Ltd is a restaurant situated outside Cape Town that specialises in seafood.
Currently, the restaurant has 50 employees of which 25 are waiters, ten fishermen, ten
kitchen personnel, two chefs and three managers.
The basic salaries (excluding bonuses) of the employees are as follows:

Basic salary per employee per year
Job description R
Waiters 60 000
Fishermen 70 000
Kitchen personnel 120 000
Chefs 220 000
Managers 300 000
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All the workers, except for the managers, are entitled to 30 work days paid vacation leave
per year. Managers are entitled to 35 workdays paid vacation leave per year. The leave
cycle for Carter Ltd runs from 1 March–28 February of each year. There are 266 workdays
during the leave cycle.
The employees are not allowed to take more than five workdays vacation leave during
April, September, October and December. 25% of the employees must take ten days of
leave during May, another 25% of the employees must take ten days during November
and the remaining 50% of the employees must take ten days during January.
All employees (excluding managers) may transfer ten days of paid vacation leave to the
next year. The leave carried forward is not paid out if the employee leaves the employment
of the company or retires. Managers may transfer 20 days of paid vacation leave per year
and it will be paid out in full when they leave the employment of the company or retire.
Experience has indicated that the waiters and fishermen take all their leave per annum,
the kitchen personnel and chefs take 25 days each and managers take only 20 days. It is
expected that only 50% of the leave carried forward will be utilised.
Bonuses are paid at the end of February each year. All employees are entitled to a 13th
cheque. Furthermore employees will receive a bonus based on their years of service at
Carter Ltdlong service. The long service bonuses are calculated as follows:
Service years Benefit
7–9 years 50% of monthly basic salary
10–15 years 75% of monthly basic salary
15 and more years 100% of monthly basic salary
The service years of the employees are as follows:

Kitchen
Service years Waiters Fishermen Personnel Chefs Managers
7–9 years – 3 5 – –
10–15 years – 5 – 2 –
15 and more years – – – – 2
REQUIRED
(a) Calculate the short-term employee benefits for Carter Ltd for the
year ended 28 February 20.10.
(b) Prepare the journal entries in the accounting records of Carter Ltd
for the year ended 28 February 20.10 to account for the unused
leave days.
151
SOLUTION 6
(a) Calculations
Basic salaries
R
Waiters (25 waiters x R60 000 per waiter) 1 500 000
Fishermen (10 fishermen x R70 000 per fisherman) 700 000
Kitchen personnel (10 kitchen workers x R120 000 per worker) 1 200 000
Chefs (2 chefs x R220 000 per chef) 440 000
Managers (3 managers x R300 000 per manager) 900 000
Total 4 740 000
Bonuses R
Waiters (R60 000/12 months = R5000 per month)

(25 waiters x R5 000) 125 000
Fishermen (R70 000/12 = R5 833 per month) 88 958

(13th cheque: 10 fishermen x R5 833) 58 333
(10-15 yrs: 5 fishermen x R5 833 x 75%) 21 875
(7-9 yrs: 3 fishermen x R5 833 x 50%) 8 750
Kitchen personnel (R120 000/12 = R10 000 per month) 125 000
(13th cheque: 10 workers x R10 000) 100 000
(7-9 yrs: 5 workers x R10 000 x 50%) 25 000
Chefs (R220 000/12 = R18 333 per month) 64 167

(13th cheque: 2 chefs x R18 333) 36 667
(10-15 yrs: 2 chefs x R18 333 x 75%) 27 500
Managers (R300 000/12 = R25 000 per month) 125 000

(13th cheque: 3 managers x R25 000) 75 000
(15+ yrs: 2 managers x R25 000 x 100%) 50 000
528 125
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Unused leave days

Waiters (Took all their leave, no accured expense)
Fishermen (Took all their leave, no accured expense)
Kitchen personnel (R120 000/ 266 days = R451.13 per day)

(30 days – 25 days = 5 days unused)
(Expected that only 50% will be used)
(10 workers x 5 days x R451.13 per day x 50%) 11 278
Chefs (R220 000/ 266 days = R827.01 per day)

(Expected that only 50% will be used)
(2 chefs x 5 days x R827.13 per day x 50%) 4 135
Managers (R300 000/ 266 days = R1 127.82 per day)

(Unused days paid out in full when resign or retire)
(3 managers x 15 days x R1 127.82 per day x 100%) 50 752
66 165
(b) Journals
Dr Cr
R R
28 February 20.19
Recognise unused leave pay accrual for the year ended 28 February 20.19
4.2 Post-employment benefits

Post-employment benefits are employee benefits (other than termination benefits and
short-term employee benefits) that are payable upon the completion of employment.
4.2.1 Defined-contribution plans
Accounting for defined contribution plans is straightforward because the reporting entity's
obligation for each period is determined by the amounts to be contributed for that period.
Consequently, no actuarial assumptions are required to measure the obligation or the
expense and there is no possibility of any actuarial gain or loss. Moreover, the obligations
are measured on an undiscounted basis, except where they are not expected to be settled
wholly before 12 months after the end of the annual reporting period in which the
employees render the related service.
153
EXAMPLE 7
Emmagan Ltd paid the following in respect of staff costs during the year ended
28 February 20.19:
R
Salaries (gross) 50 000 000
Wages (gross) 20 000 000
Emmagan Ltd also paid 7,5% of the gross remuneration towards the Teyla Fund. The
Teyla Fund is a defined contribution plan. Furthermore the employees paid 10% of their
gross remuneration towards the fund.
REQUIRED
Prepare the notes to the annual financial statements of Emmagan Ltd in
respect of the employee benefits for the year ended 28 February 20.19.
Your answer must comply with the requirements of the Companies Act
and the International Financial Reporting Standards (IFRS). Ignore all tax
implications.
SOLUTION 7
EMMAGAN LTD
NOTES FOR THE YEAR ENDED 28 FEBRUARY 20.19
1. Accounting policy
1.1 Post-employment benefits
The company makes provision for post-employment benefits to employees, which

represent pensions. Contributions to a defined-contribution plan are recognised when the
services are provided by the employees.
Included in profit before tax are the following:

R
Employee benefit expense 75 250 000
Short-term employee benefits (50 000 000 + 20 000 000) 70 000 000
Defined-contribution plan expense (70 000 000 x 7,5%) 5 250 000
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4.2.2 Defined-benefit plans (IAS 19.55-125)
The accounting treatment and disclosure of defined-benefit plans do not form part of the
scope of this module. Students should, however, be able to answer basic theory and
discussion type of questions on this topic.
4.3 Other long-term employee benefits (IAS 19.153-158)
The accounting treatment and disclosure of other long-term employee benefits do not form
part of the scope of this module.
4.4 Termination benefits (IAS 19.159-171)
Termination benefits are employee benefits provided in exchange for the termination of an
employee's employment as a result of either:
(a) an entity's decision to terminate an employee's employment before the normal

retirement date, or
(b) an employee's decision to accept an offer of benefits in exchange for the termination
of employment.
EXAMPLE 8
Due to the current economic situation in the country, Saskia Ltd is experiencing financial
difficulties. The directors of the company have therefore decided on 30 June 20.18 to close
down one of the divisions of the company. As a result the following restructuring offers
were made:
 Employees of 60 years and older at the date of restructuring were forced to retire
immediately. These employees were paid out an amount equal to six months' salary as
a lump sum.
 All other employees had a choice to either:
o immediately leave the employment of the company after receiving a lump sum
equal to three months' salary, or
o stay in the employment of the company after receiving a lump sum equal to 10%
of their annual salaries (including 13th cheques) before restructuring and
reducing their future monthly salaries to 80% of their former salaries.
The year-end of the company was 30 June 20.18 and the lump sums were paid out on
7 July 20.18.
On 7 July 20.18, a directive on the restructuring allowing the payments as tax deductible
when paid was obtained from the South African Revenue Service.
155
The results of the restructuring were as follows:
 Three employees with an average monthly salary of R15 000 were 60 years and older
and were forced to retire.
 The total annual salaries, including 13th cheques, for all other employees in the
division amounted to R2 437 500. Of the 15 remaining employees, ten employees
(earning 60% of the total annual salaries) chose to leave the employment of the
company. The remaining five employees chose to stay in the employment of
Saskia Ltd.
The SA normal tax rate is 28%. The company provides for deferred taxation on all
temporary differences, using the statement of financial position approach. The deferred tax
balance as at 30 June 20.17 amounted to Rnil.
REQUIRED
Prepare the journal entries to account for the termination benefits of

Saskia Ltd for the year ended 30 June 20.18. The journal to recognise
deferred tax for the termination benefits is also required.
SOLUTION 8
Journal entries
Dr Cr
R R
30 June 20.18
Termination benefits (P/L) (270 000 [C1] + 337 500 [C2]) 607 500
Accrued employee benefits (SFP) 705 000
Accrual of termination benefits payable to employees on restructuring
30 June 20.18
Deferred tax (SFP) [C3] 197 400
Income tax expense (Deferred tax) (P/L) 197 400
Provision for deferred tax @ 28%
CALCULATIONS
R
C1. Employees older than 60 years
3 employees x R15 000 per month x 6 months 270 000
C2. Remaining 15 employees

- 10 employees terminating employment
R2 437 500/13 months = R187 500 per month
60% x R187 500 x 3 months lump sum 337 500
- 5 employees staying on at Saskia Ltd
40% of employees x 10% slump sump x R2 437 500 97 500
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C3. Deferred tax

Carrying Tax base Temporary Deferred tax
amount differences at 28%
30 June 20.18 - -
30 June 20.18
Accrued employee benefits 705 000 a- 705 000 197 400
a Accrued employee benefits is a liability. The tax base of a liability is the carrying amount
(R705 000) minus amounts deductible in future (R705 000 will be deductible when
paid). Therefore R705 000 – R705 000 = Rnil.
4.5 Tax implications
Current taxation
All amounts paid by a company to the employees in respect of services rendered to the
company are deductible in calculating the company's taxable income, provided that the
requirements of the Income Tax Act are met. The requirements are that the expenses
must be actually incurred and in the production of income but not of a capital nature.
Actually incurred does not necessarily always mean "paid" but rather "due and payable".
Only annual bonuses that, for example, are paid at the end of December of each year will
be deductible in the current tax calculation of the company with a February year-end. The
pro-rata bonus for January and February are provided for, for accounting purposes but not
for tax purposes, as the amount has not yet become "due and payable". It will only be
payable at the end of the next December. Furthermore, in terms of the Income Tax Act,
employers are deemed not to have incurred expenditure on leave pay until it is actually
paid or becomes due and payable by the company. Only employee benefits actually paid
or due and payable are thus taken into account when calculating current taxation.
Deferred taxation
Any accruals in respect of salaries, bonus provisions and leave provisions accounted for in
the annual financial statements as liabilities, give rise to temporary differences as it will
only be brought into account for current taxation once it is paid or becomes due and
payable. The tax base of the accruals will be Rnil, leading to a deferred tax asset.
4.6 Comprehensive example

The following is an extract from the salary and wage records of Dynamic Ltd for the year
ended 31 December 20.18.
R
Gross salaries and wages for 20.18 7 500 000
Employees contributions paid:
– provident fund (562 500)
– medical aid fund (120 000)
– unemployment insurance fund (75 000)
Employee's tax (PAYE) (1 135 000)
Net salaries and wages paid to employees 5 607 500
157
Employers contributions paid in respect of the current year’s salaries and
wages:
– provident fund 562 500
– medical aid fund 240 000
– unemployment insurance fund 75 000
– skills development levy 75 000
– workmen's compensation 10 000
962 500
Unused vacation leave as at 31 December 20.17, paid to employees on

31 January 20.18 (not included in the above) 67 850
Unused vacation leave as at 31 December 20.17, transferred to the 20.18
financial year 74 950
Additional information
1. Employees are each entitled to 24 working days paid vacation leave per financial year.
Ten days may be carried forward to the following year, after which it lapses without
payment. 14 days may not be carried forward and unused days will be paid out on
31 January 20.19.
The following vacation leave were carried forward to 20.19:

 five days by employees earning 50% of the total salaries and wages of the
company,
 eight days by employees earning 20% of the total salaries and wages of the
company, and
 ten days by employees earning 10% of the total salaries and wages of the
company.
It is expected that the vacation leave carried forward will be taken as follows during
20.19:
 three days by employees earning 50% of the total salaries and wages of the
company,
company, and
 eight days by employees earning 10% of the total salaries and wages of the
company.
Unused vacation leave transferred from 20.17 and taken as leave during 20.18
amounted to R74 950.
The following unused vacation leave days will be paid out on 31 January 20.19:
company,
 four days by employees earning 20% of the total salaries and wages of the
company, and
 two days by employees earning 10% of the total salaries and wages of the
company.
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There were 252 working days during 20.18.

2. The provident fund of the company is classified as a defined contribution plan. The
fund is not governed by the Pension Funds Act, No 24 of 1956 (as amended).
3. Due to the economic recession the company had to close down its Port Elizabeth
branch on 31 December 20.18 and all the employees were retrenched. No further
services will be rendered by the employees to the company after 31 December
20.18. Termination benefits as required by law and per agreement with the workers
union will be paid as follows:
31 January 20.19 – R625 000 (discounted value – R617 285)
31 January 20.20 – R625 000 (discounted value – R531 800)
A tax directive on the termination benefits was obtained from the South African
Revenue Service (SARS) indicating that it will be tax deductible.
4. The profit before tax for 20.18 before any employee benefits were taken into account,
was R15 000 000.
5. The SA normal tax rate for 20.18 was 28%.
6. Deferred tax is provided for on all temporary differences, using the statement of
financial position approach. The only temporary differences are those in respect of
the above employee benefits.
REQUIRED
(a) Calculate the taxable income of Dynamic Ltd for the year ended
31 December 20.18.
(b) Calculate the deferred tax balance on 31 December 20.18 in the
accounting records of Dynamic Ltd, indicating if it is a deferred tax
asset or liability, using the statement of financial position approach.
(c) Disclose the employee benefits in the financial statements of
Dynamic Ltd for the year ended 31 December 20.18. Assume that
all employee benefits are material.
Your answer must comply with the requirements of the International
Financial Reporting Standards (IFRS).
Accounting policy notes are not required.
All calculations should be done to the nearest rand.
159
Solution
(a) Calculation of taxable income of Dynamic Ltd
R
Profit before tax before employee benefits 15 000 000
Less – Gross salaries and wages for 20.18 (7 500 000)
Less – Employer's contribution in respect of current year's salaries (962 500)
Less – Unused leave for 20.17 paid on 31 January 20.18 (67 850)
Taxable income 6 469 650
(b) Calculation of deferred tax balance on 31 December 20.18
Carrying Tax Temporary

amount base differences
R R R
Accrued expense: Vacation leave unused
in 20.18 expected to be taken in 20.19 (110 818) [C1] – (110 818)
Accrued expense: Vacation leave unused
in 20.18 expected to be paid in 20.19 (104 167) [C1] – (104 167)
Accrued expense: Termination benefits to
be paid to employees during 20.19 and
(1 156 800) [C2] – (1 156 800)
20.20
1 371 785) – (1 371 785)
Deferred tax asset @ 28% 384 100)
(c) Disclosure
DYNAMIC LTD
Profit before tax is stated after taking the following into account:
20.18
R
Employee benefit costs 9 759 335
 Short-term employee benefits [C1] 8 602 535
 Termination benefits [C2] 1 156 800

SA normal taxation 1 467 386
Current tax – current year (6 469 650 (refer to part (a)) x 28%) 1 811 502
Deferred tax – origination and reversal of temporary differences [C3] (344 116)
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20.18
Tax reconciliation
R
Accounting profit (R15 000 000 – R9 759 335) 5 240 665
Tax at 28% (5 240 665 x 28%) 1 467 386
3. Deferred taxation
Analysis of temporary differences:
Short-term employee benefits accrued ((110 818 + 104 167) x 28%) 60 196
Termination employee benefits accrued (1 156 800 x 28%) 323 904
Net deferred tax asset (refer to part (b)) 384 100
CALCULATIONS
C1. Short-term employee benefits
Gross salaries and wages for 20.18 7 500 000

Employer's contribution paid in respect of current year's salaries and 962 500
wages
Vacation leave unused and expected to be taken during 20.19: 110 818
– employees earning 50% of the total salaries and wages 50 372
((7 500 000 + 962 500) x 50% x 3/252)
((7 500 000 + 962 500) x 20% x 5/252)
((7 500 000 + 962 500) x 10% x 8/252)
Vacation leave not taken, to be paid out on 31 January 20.19 104 167
(7 500 000 x 50% x 5/252)
(7 500 000 x 20% x 4/252)
(7 500 000 x 10% x 2/252)
Vacation leave unused during 20.17 and expected to be taken during

20.18 – now reversed (74 950)
Short-term employee benefits 8 602 535
161
C2. Termination benefits
R
Payable on 31 January 20.19 a 625 000
Payable on 31 January 20.20 b 531 800
1 156 800
a As the payment will be made one month after year end no discounting is required.
b For payments more than 12 months after year end, discounting is required.
C3. Deferred tax on 31 December 20.17
Carrying Tax base Temporary

amount differences
R R R
Accrued expense: Vacation leave unused in

20.17 expected to be taken in 20.18 (74 950) – (74 950)
Accrued expense: Vacation leave unused in
20.17 expected to be paid in 20.18 (67 850) – (67 850)
(142 800) – (142 800)
Deferred tax asset on 31 December 20.17 (142 800 x 28%) 39 984
Deferred tax asset on 31 December 20.18 (refer to part (b)) 384 100
Increase in deferred tax asset (credit to P/L) 344 116
DEFERRED TAX BALANCE AT 31 DECEMBER 20.17

In order to calculate the movement in the deferred tax balance as at
31 December 20.18, the deferred tax balance as at 31 December 20.17 must
also be calculated.
ASSESSMENT CRITERIA
Are you now able to
 record short-term employee benefits, taking the tax implications into
account?
 record defined-contribution plans, taking the tax implications into
account?
 classify post-employment benefit plans?
 record termination benefits, taking the tax implications into account?
 discuss defined-benefit plans and other long-term employee benefits?
 disclose employee benefits?
162
FAC3703
LEARNING UNIT 4
BORROWING COSTS
163
Learners must be able to calculate, account for and disclose the capitalisation of borrowing
cost and the tax implications thereof in the financial statements of companies in terms of
the requirements of the Companies Act and the International Financial Reporting
Standards (IFRS).
TABLE OF CONTENTS
4.1 Definitions (IAS 23.5-7) ..................................................................................... 165

4.2 Accounting treatment ........................................................................................ 166
4.2.1 Recognition of borrowing costs (IAS 23.8-11) ................................................... 166
4.2.1.1 Specific loans (IAS 23.12-13)............................................................................ 167
4.2.1.2 General loans (IAS 23.14-15) ........................................................................... 168
4.2.2 Period upon which capitalisation should take place (IAS 23.17-25) .................. 168
4.3 Tax implications ................................................................................................ 169
4.4 Disclosure (IAS 23.26) ...................................................................................... 169
4.5 Decision tree: Capitalisation of borrowing costs ................................................ 170
4.6 Comprehensive example .................................................................................. 171
STUDY
Refer to the chapter on borrowing costs (IAS 23) in the prescribed textbook of this module.
164
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OVERVIEW
Where borrowing cost are incurred in order to finance the acquisition, construction or
production of qualifying assets, a part or all of the borrowing cost will be capitalised (added
to the cost price of the asset) towards the cost price of the asset. The amount of borrowing
cost that will be capitalised depends on certain criteria, which will be discussed in detail in
this learning unit.
4.1 Definitions (IAS 23.5-7)

Borrowing costs are interest and other costs incurred by an enterprise in connection with
the borrowing of funds.
IAS 23 states that borrowing costs may, among other things, include the following:
 Interest expense (also referred to as finance costs) calculated using the effective
interest method as described in IFRS 9, Financial Instruments.
 Interest in respect of lease liabilities recognised in accordance with IFRS 16, Leases.
 Exchange differences arising from foreign currency borrowings to the extent that they
are regarded as an adjustment to interest costs.
A qualifying asset is an asset that necessarily takes a substantial period of time to get
ready for its intended use or sale.
According to IAS 23 any of the following, depending on the circumstances, may be
qualifying assets:
 Inventories (Inventories that are manufactured over a short period of time are not
qualifying assets),
 manufacturing plants,
 power generation facilities,
 intangible assets,
 investment properties, and
 bearer plants.
4.2 Accounting treatment
4.2.1 Recognition of borrowing costs (IAS 23.8-11)
Borrowing costs that are directly attributable to the acquisition, construction or production
of a qualifying asset must be capitalised as part of the cost of that asset.
The portion of borrowing costs that is not capitalised should be recognised as an expense
in the statement of profit or loss and other comprehensive income in the period in which
they are incurred.
The borrowing costs that are directly attributable to the acquisition, construction or
production of a qualifying asset are those borrowing costs that would have been avoided if
the expenditure on the qualifying asset had not been made. Such borrowing costs are
capitalised as part of the cost of the asset when it is probable that they will result in future
economic benefits to the entity and the cost can be measured reliably.
165
EXAMPLE 1
Wacko Ltd obtained a loan of R1 000 000 to construct a new factory which is a qualifying
asset in terms of IAS 23, Borrowing costs. Wacko Ltd paid finance costs amounting to
R150 000 for this loan. R100 000 of the finance costs of R150 000 has been incurred
within the capitalisation period and must be capitalised as borrowing costs.
The journals to account for the finance costs are as follows:
Dr Cr
R R
Bank (SFP) 150 000
Payment of finance costs for loan
New factory: Cost (SFP) 100 000

Capitalising borrowing costs by reallocating finance costs to the cost of the new factory
Before the capitalisation of borrowing costs of R100 000, the finance costs recognised in
P/L amounted to R150 000. After the capitalisation of borrowing costs, only R50 000 of the
finance costs remain in P/L (R150 000 – R100 000).
As a result, the finance costs recognised in P/L for the year is reduced from R150 000 to
R50 000 due to the capitalisation of borrowing costs. On the other hand, the cost of the
new factory was increased with R100 000 due to the capitalisation of borrowing
costs. When the factory plant is ready for use, the total cost of the new factory (which will
include the R100 000 borrowing costs), will be depreciated in P/L over the useful life of the
plant.
4.2.1.1 Specific loans (IAS 23.12-13)
When funds are borrowed specifically for the purpose of obtaining a qualifying asset (for
example a mortgage bond), the funds can either be received as a lump sum when the
project has commenced (or the loan has been approved) or be advanced as a facility
whereby the funds are received as needed (as progress payments).
When all the funds are received as a lump sum on the date the project has commenced or
the loan has been approved, the amount of borrowing costs relating to that asset that may
be capitalised must be determined as follows:
The actual borrowing costs incurred on that borrowing during the period (based on the
full amount of the loan), less any investment income on the temporary investment of
those borrowings.
When the funds are received in the form of a specific facility (as progress payments), the
amount of borrowing costs relating to that asset that may be capitalised must be
determined by applying the interest rate to the part of the specific facility that has been
utilised during the period.
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EXAMPLE 2
Wacko Ltd obtained a specific loan of R1 000 000 on 1 January 20.18 to construct a new
factory which is a qualifying asset in terms of IAS 23, Borrowing costs. The loan carries
interest at 15% per annum payable annually on 31 December. R400 000 of the loan
amount was spent immediately and R600 000 was only spent on 1 October 20.18. The
new factory was completed on 31 December 20.18.
Wacko Ltd paid finance costs amounting to R150 000 on this loan for the year ended
31 December 20.18 (R1 000 000 x 15% x 12/12). Wacko Ltd also earned interest income
amounting to R20 000 on the R600 000 that was not used immediately. The borrowing
costs that must be capitalised will be R130 000 (being the total finance costs of R150 000
minus the interest income of R20 000). The reasoning is that the loan obtained and
interest income earned would have been avoided had the factory not been constructed.
SPECIFIC FACILITY
If the loan in Example 2 was a specific facility, the bank would only have given
the funds to Wacko Ltd as it was needed. As a result, Wacko Ltd would not
have earned interest income on the R600 000 as the R600 000 would only
have been received by Wacko Ltd on 1 Oct 20.18.
The borrowing costs that must be capitalised will then be calculated as follows:
From 1 Jan 20.18 – 31 Dec 20.18: R400 000 x 15% x 12/12 = R60 000
From 1 Oct 20.18 – 31 Dec 20.18: R600 000 x 15% x 3/12 = R22 500
Total = R82 500
The total finance costs payable for the specific facility will also be R82 500.
4.2.1.2 General loans (IAS 23.14-15)
To the extent that funds are borrowed generally (for example a bank overdraft) and used
for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for
capitalisation should be determined by applying a capitalisation rate to the expenditures
on that asset.
The capitalisation rate should be the weighted average of the borrowing costs applicable
to the borrowings of the enterprise that are outstanding during the period, other than
borrowings made specifically for the purpose of obtaining a qualifying asset.
When there is only one general loan, the interest rate of that loan will be the capitalisation
rate. Where there is more than one general loan, the rates of all general loans will be used
to calculate the capitalisation rate (weight average rate).
The amount of borrowing costs capitalised during a period should not exceed the amount
of borrowing costs incurred during that period.
167
EXAMPLE 3
Wacko Ltd obtained funding on 1 January 20.18 to construct a new factory which is a
qualifying asset in terms of IAS 23, Borrowing costs. The construction was financed with
general borrowings which were made up of a general loan and bank overdraft facility. The
weighted average interest rate for this pool of funds is 18% per annum, payable annually
on 31 December. R400 000 was spent immediately and R600 000 was spent on
1 October 20.18. The new factory was completed on 31 December 20.18.
The borrowing costs that must be capitalised is R99 000 which is based on the actual
expenses incurred at the weighted average interest rate (capitalisation rate):
From 1 Jan 20.18 – 31 Dec 20.18: R400 000 x 18% x 12/12 = R72 000
From 1 Oct 20.18 – 31 Dec 20.18: R600 000 x 18% x 3/12 = R27 000
Total = R99 000
4.2.2 Period upon which capitalisation should take place (IAS 23.17-25)
 Commencement of capitalisation (IAS 23.17-19)
The capitalisation of borrowing costs as part of the cost of a qualifying asset should
commence when:
 expenditure for the asset is being incurred, and
 borrowing costs are being incurred, and
 activities that are necessary to prepare the asset for its intended use or sale are in
progress (even technical and administrative work prior to actual construction, such as
obtaining council approval).
EXAMPLE 4
Company X received a loan on 1 February for the construction of a manufacturing plant.

However, the work required to construct the plant began on 15 February. The borrowing
costs can then only be capitalised from 15 February, and not 1 February.
 Suspension of capitalisation (IAS 23.20-21)
Capitalisation of borrowing costs should be suspended during extended periods in which

active development is interrupted. This does not apply during periods when substantial
technical and administrative work is being carried out, or when a temporary delay is a
necessary part of the process of getting an asset ready for its intended use or sale. A
general rule of thumb would be to test whether the events can be controlled by
management or are beyond the control of management.
 Cessation of capitalisation (IAS 23.22-25)
Capitalisation of borrowing costs should cease when substantially all the activities
necessary to prepare the qualifying asset for its intended use or sale have been
completed. In other words: when the asset is ready for its intended use or sale.
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When the construction of an asset is completed in parts and each part is capable of being
used while construction continues on other parts, capitalisation of borrowing costs on that
part should cease when substantially all the activities necessary to prepare that part for its
intended use or sale are completed. If all parts are needed before the asset can be used
or sold, capitalisation takes place until the asset as a whole is completed.
EXAMPLE 5
A business park comprising of several buildings, each of which can be used individually, is
an example of a qualifying asset of which each building is capable of being used while
construction on other buildings continue.
EXAMPLE 6
An industrial plant such as a steel mill involves several process which are carried out in
sequence at different parts of the plant. This is an example of a qualifying asset that must
be complete before any part can be used.
4.3 Tax implications
For accounting purposes, the cost of the asset (including borrowing cost capitalised) is
depreciable over the useful life of the asset from the date when the asset is ready for use,
which is in contrast with the tax treatment.
For tax purposes, the tax deductibility of the total interest expense (finance costs) depends
on whether or not the entity is trading:
 If the entity is a trading company, the total interest expense can be deducted in terms
of the general deduction formula in section 11(a) of the Income Tax Act.
 If the company has not yet started to trade and awaits the completion of the
qualifying asset in order to trade, the interest expense is referred to as pre-trade
expenses in terms of section 11A of the income Tax Act. This pre-trade interest will
only be allowed as a tax deduction when the asset is brought into use. The
difference between the accounting treatment and the tax treatment will then give rise
to a temporary difference and deferred tax.
4.4 Disclosure (IAS 23.26)
The following must be disclosed in the financial statements:
 the amount of borrowing costs capitalised for the period, distinguishing between
amounts capitalised required by IAS 23 and expensed required by IAS 1, and
 the capitalisation rate used to determine the amount of borrowing costs eligible for
capitalisation.
169
4.5 Decision tree: Capitalisation of borrowing costs
Qualifying asset No Recognise all interest

incurred as interest
expense in P/L
Yes
Borrowing costs incurred? No Do nothing
Yes
Expenditure on assets? No
Yes
Activities undertaken in No
process?
Yes
Capitalise relevant borrowing Recognise all borrowing
costs to the qualifying asset. costs as interest expense
Any remaining portion must in P/L
be recognised as interest
expense in P/L
Disclose borrowing
costs incurred, portion
capitalised and
capitalisation rate
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PART 1
Potter Ltd is a company with a 31 December year-end and has been trading in the pottery
industry for many years. Potter Ltd obtained a loan of R1 000 000 from Bee Bank on
1 January 20.18 in order to construct a new plant. The plant will take a substantial period
to be constructed and is a qualifying asset in terms of IAS 23, Borrowing costs.
The loan amount of R1 000 000 was received by Potter Ltd on 1 January 2.18. The loan
bears interest at a fixed interest rate of 12% per annum and interest is payable annually in
arrears on 31 December. The loan capital is repayable as one payment on
31 December 20.23. Lotter Ltd has in investment of R1 100 000 which will mature on
31 December 20.23 and will be used to repay the loan.
The cost of the construction of the new plant is estimated at R1 000 000. The construction
of the new plant commenced on 1 April 20.18 and will continue until 31 December 20.19.
Potter Ltd paid R200 000 on 1 April 20.18 and R250 000 on 1 November 20.18 for the
ongoing construction of the new plant. The remaining construction costs will be incurred in
the financial year starting on 1 January 20.19.
Journals to account for the loan, finance costs and construction costs for the year ended
31 December 20.18 are as follows:
Dr Cr
R R
1 January 20.18
Bank (SFP) 1 000 000
Loan liability: Bee Bank (SFP) 1 000 000
Recognise loan obtained from Bee Bank
1 April 20.18
New Plant: Cost (SFP) 200 000
Bank (SFP) 200 000
Payment of construction costs for new plant
1 November 20.18
New Plant: Cost (SFP) 250 000
Bank (SFP) 250 000
Payment of construction costs for new plant
31 December 20.18
Finance costs (P/L) (1 000 000 x 12% x 12/12) 120 000
Bank (SFP) 120 000
Payment of interest expense to Bee Bank on 31 December 20.18 for the 12-month period
As the new plant is a qualifying asset and the loan was obtained specifically to construct
the new plant, finance costs incurred within the capitalisation period must be capitalised
as borrowing costs.
171
The capitalisation period commenced on 1 April 20.18 as the construction only started on
1 April 20.18. The new plant is still under construction at year-end, 31 December 20.18:
Year-end
1 Jan 20.18 1 Apr 20.18 31 Dec 20.18
Interest expense incurred on the loan

Capitalisation period
As can be seen on the above timeline, the finance costs were incurred from
1 January 20.18 but only from 1 April 20.18 will interest be capitalised as borrowing costs.
The finance costs that qualify to be capitalised as borrowing costs is calculated as follows:
Interest expense incurred from 1 April 20.18 – 31 December 20.18 (9 months):
R1 000 000 x 12% x 9/12 = R90 000
The journal to capitalise borrowing costs for the financial year ended 31 December 20.18
is as follows:
Dr Cr
R R
31 December 20.18
New plant: Cost (SFP) 90 000
Capitalising borrowing costs by reallocating finance costs to the cost of the new plant
After the capitalisation of borrowing costs of R90 000, only R30 000 of the finance costs
remain in P/L (R120 000 – R90 000).
As a result, the finance costs expensed for the year is reduced from R120 000 to R30 000
due to the capitalisation of borrowing costs. On the other hand, the cost of the new plant
was increased with R90 000 due to the capitalisation of borrowing costs. When the
new plant is ready for use, the total cost of the new plant (which will include the R90 000
borrowing costs), will be depreciated over the useful life of the plant.
INTEREST INCOME
If interest income was earned on the loan amount that has not yet been
utilised by Potter Ltd, the interest income received during the capitalisation
period must be deducted from the borrowing costs of R90 000. For
example, if interest income of R10 000 was earned during the capitalisation
period, the borrowing costs capitalised must be reduced to R80 000
(R90 000 – R10 000).
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PART 2
Part 2 of Example 1 builds on Part 1 and addresses the following:

 The current tax and deferred tax implications of Part 1.
 The presentation and disclosure of the example in Part 1.
The accounting profit of Potter Ltd for the financial year ended 31 December 20.18
amounted to R500 000 before the above transactions were taken into account. The
accounting profit is adjusted as follows:
Accounting profit calculation
R
Accounting profit before the above transactions 500 000
Finance costs recognised in P/L (30 000)
Adjusted accounting profit 470 000
For the financial year ended 31 December 20.17, Potter Ltd had a deferred tax balance
amounting to Rnil. The deferred tax calculation for the year ended 31 December 20.18 will
be as follows:
Deferred tax calculation

Carrying Temporary Deferred tax
amount Tax base difference at 28%
R R R asset/(liability)
31 December 20.17 (given) - - - -
31 December 20.18
New plant: Cost a540 000 b450 000 90 000 (25 200)
Pre-trade interest - c- - -
Loan liability: Bee Bank (1 000 000) d(1 000 000) - -
Movement in temporary differences (90 000–0) (taxable) 90 000 (25 200)

a At year-end, the cost of the new plant amounted to R540 000 (R200 000 on
1 April 20.18, plus R250 000 on 1 November 20.18, plus R90 000 borrowing costs
capitalised).
b The tax base of an asset is amounts deductible in future. The cost to date of R450 000
(excluding the borrowing costs) will be deductible in future for tax purposes when the
asset is brought into use. As a result, the full R450 000 is still deductible in future.
c For tax purposes, the total finance costs of R120 000 is deductible under the general
deduction formula (section 11(a) of the Income Tax Act). If Potter Ltd was not trading
and would only commence trading as a business once the new plant is brought into
use, the finance costs incurred that relates to the construction of the new plant would
only be allowed as a tax deduction when the new plant is brought into use. When
this is the case, the total interest of R120 000 will be the tax base, being amounts
deductible in future.
d The repayment of the loan will have no tax consequences. The tax base of a liability is
the carrying amount (R1 000 000) minus amounts deductible in future (Rnil) =
R1 000 000.
173
The current tax calculation of Potter Ltd for the financial year ended 31 December 20.18
will be as follows:
Current tax calculation
R
Adjusted accounting profit (as calculated above) 470 000
Movement in temporary differences (taxable) (see deferred tax calculation) (90 000)
Current tax @ 28% (380 000 x 28%) 106 400
Proof of movement in temporary differences (90 000)
Deduct borrowing costs capitalised of R90 000 (see comment below*) (90 000)
*BORROWING COSTS CAPITALISED OF R90 000

For tax purposes, the full R120 000 is deductible. Finance costs of R30 000
have already been deducted in calculating the adjusted accounting profit. As
the full R120 000 is deductible for tax purposes, the R90 000 finance costs
that was capitalised as borrowing costs, must also be deducted.
The presentation and disclosure of the above transactions and calculations in the notes to
the financial statements of Potter Ltd will be as follows:
POTTER LTD

COMPREHENSIVE INCOME FOR THE FINANCIAL YEAR ENDED
31 DECEMBER 20.18
20.18
R
Revenue Xx
Cost of sales Xx
Gross profit Xx
Other income Xx
Distribution costs Xx
Administrative expenses Xx
Other expenses Xx
Finance costs note 5 (30 000)
Profit before tax Xx
Income tax expense note 6 (131 600)
Profit after tax Xx
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EXTRACT FROM THE STATEMENT OF FINANCIAL POSTITION FOR THE FINANCIAL

YEAR ENDED 31 DECEMBER 20.18
20.18
R
Non-current assets
Property, Plant and equipment note 7 540 000
Current assets
Bank Xx
Deferred tax note 8 25 200
Loan liability: Bee Bank note 9&10 1 000 000
Current liabilities
Income tax payable (see current tax calculation) 106 400
2. Accounting policy
2.1 Borrowing costs
Borrowing costs directly attributable to the acquisition, construction or production of

qualifying assets (assets that take a substantial period of time to get ready for their
intended use or sale) are capitalised to the cost of the assets. Capitalisation of borrowing
costs ceases when the qualifying assets are substantially ready for their intended use or
sale. All other borrowing costs are recognised in profit or loss as incurred.
ACCOUNTING POLICIES
For purposes of this example, the accounting policy is disclosed for

borrowing costs only.
5. Finance costs 20.18

R
Net finance costs 30 000
Total finance costs 120 000)
Borrowing costs capitalised (90 000)
Interest is capitalised to qualifying assets at a rate of 12% per annum.
FINANCE COSTS
Finance costs can be disclosed as a separate note or it can be disclosed as

part f the profit before tax note.
175
6. Income tax expense 20.18
R
Major components of tax expense:
SA normal tax 131 600)
Current tax – current year 106 400)
Deferred tax – movement in temporary differences 25 200
Tax reconciliation
Tax at 28% (470 000 x 28%) 131 600
Plant
Carrying amount at the beginning of year –
Cost –
Accumulated depreciation –
Acquisitions (200 000 + 250 000) 450 000
Borrowing costs capitalised 90 000
Carrying amount at the end of the year 540 000
Cost 540 000
Accumulated depreciation –
8. Deferred tax
Property, Plant and equipment 25 200

Net deferred tax liability 25 200
9. Loan liability from Bee Bank

A loan of R1 000 000 was obtained from Bee Bank on 1 January 20.18 for the
construction of the new factory building. The loan bears interest at 12% per annum,
annually in arrears and is repayable as one payment on 31 December 20.23.
10. Categories of financial liabilities
Non-current financial liabilities

- Loan liability: Bee Bank (note 9) 1 000 000

Financial liabilities measured at amortised cost –
Concentration of interest rate risk on financial liabilities measured at amortised

cost
The company has no exposure to interest rate changes and repricing dates as the
interest rate and redemptions price of the bond are fixed.
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20.18
R
Concentration of liquidity risk on all financial liabilities
The exposure of the company's financial liabilities to liquidity risk and the contractual
repayment dates are as follows:
Between 4 and 5 years 1 000 000
The company manages the liquidity risk inherent in the above maturity analysis of
financial liabilities by ensuring that the company has financial assets available that will
mature at approximately the same time as the financial liabilities. The table below
represents management's estimation of the expected maturity of all financial assets.
The estimates are based on management's best estimate on when they intend to
realise the financial asset if it does not have a fixed maturity date. Where instruments
do have a fixed maturity date they are included in the relevant time band based on
their contractual maturity date.
Between 4 and 5 years 1 100 000
ASSESSMENT CRITERIA
Are you now able to
 define borrowing costs and qualifying assets and identify them in
practical situations?
 determine and do basic calculations of the amount of borrowing costs
that should be capitalised?
 determine when capitalisation of borrowing costs should commence or
cease?
 apply the taxation implications with regard to capitalised borrowing
costs?
 apply the disclosure requirements in accordance with IAS 23?
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LEARNING UNIT 5
RELATED PARTIES
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Learners should be able to identify and disclose related parties and transactions between
related parties in the financial statements of companies in terms of the International
Financial Reporting Standards (IFRS).
TABLE OF CONTENTS
5.1 Introduction......................................................................................................... 179

5.2 Definitions (IAS 24.9).......................................................................................... 179
5.3 Disclosure (IAS 24.13-24) .................................................................................. 181
5.4 Identifying related parties ................................................................................... 183
5.5 Comprehensive example .................................................................................... 189
STUDY
Refer to the chapter on Related Parties (IAS 24) in the prescribed textbook for this module.
RELATED PARTIES
5.1 Introduction
A related-party relationship could have an effect on profit or loss and the financial
position of an entity. Related parties may enter into transactions that unrelated parties
would not. For example, an entity that sells goods to its parent at cost might not sell on the
same terms to another customer.
In order for financial statements to meet fair presentation, the reporting entity needs to
disclose the transactions involving the related parties in order for the users to be aware of
the interrelationships between related parties, including the level of support provided by
related parties to assist users of the financial statements in making their economic
decisions.
5.2 Definitions (IAS 24.9)

A related-party transaction is a transfer of resources, services or obligations between a
reporting entity and a related party, regardless of whether a price is charged.
A related party is a person or an entity that is related to the entity that is preparing its
financial statements. In considering each possible related-party relationship, attention is
directed to the substance of the relationship, not merely the legal form.
(a) A person or a close member of that person's family is related to a reporting entity if
that person:
(i) has control or joint control over the reporting entity,
(ii) has significant influence over the reporting entity, or
(iii) is a member of key management personnel of the reporting entity or a parent of
the reporting entity.
179
(b) An entity is related to a reporting entity if any of the following conditions apply:
(i) The entity and the reporting entity are members of the same group (which
means that each parent, subsidiary and fellow subsidiary is related to each
other).
(ii) One entity is an associate or joint venture of the other entity (or an associate or
joint venture of a member of a group of which the other entity is a member).
(iii) Both entities are joint ventures of the same third party.
(iv) One entity is a joint venture of a third party and the other is an associate of the
third entity.
(v) The entity is a post-employment benefit plan for the benefit of the employees of
either the reporting entity or an entity related to the reporting entity. If the
reporting entity is itself a plan, the sponsoring employers are also related to the
entity.
(vi) The entity is controlled or jointly controlled by a person identified in (a).
(vii) A person identified in (a)(i) has significant influence over the entity or is a
member of the key management personnel of the entity or of a parent of the
entity.
Close members of the family of a person are those family members who may be
expected to influence or be influenced by that person in their dealings with the entity and
include:
(a) that person's children and spouse or domestic partner,
(b) children of that person's spouse or domestic partner, and
(c) dependents of that person or that person's spouse or domestic partner.
Compensation includes all employee benefits in all forms of consideration paid, payable
or provided by the entity, or on behalf of the entity, in exchange for services rendered to
the entity. It also includes such consideration paid on behalf of a parent of the entity in
respect of the entity. Compensation includes the following:
(a) Short-term employee benefits such as wages, salaries, social security contributions,
paid annual leave, paid sick leave, profit-sharing and bonuses (if payable within 12
months of the end of the period), medical care, housing, cars and free or subsidised
goods or services.
(b) Post-employment benefits (pensions, other retirement benefits, life insurance and
medical care).
(c) Other long-term employee benefits (long-service leave, sabbatical leave, jubilee
benefits or other long-service benefits, long-term disability benefits and profit sharing
bonuses and deferred compensation payable after 12 months of the end of the
reporting period).
(d) Termination benefits.
(e) Share-based payments.
Key management personnel are those persons having authority and responsibility for
planning, directing and controlling the activities of the entity, directly or indirectly, including
any director, executive or otherwise, of that entity.
Significant influence is the power to participate in the financial and operating policy
decisions of an entity, but is not control over those policies. Significant influence may be
gained by share ownership, statute or agreement.
180
FAC3703/501
Government refers to government, government agencies and similar bodies whether

local, national or international.
A government-related entity is an entity that is controlled, jointly controlled or

significantly influenced by a government.
The following are not related parties:
(a) Two entities simply because they have a director or other member of key
management personnel in common or because a member of key management
personnel of one entity has significant influence over the entity.
(b) Two ventures simply because they share joint control over a joint venture.
(c) (i) Providers of finance,
(ii) Trade unions,
(iii) Public utilities, or
(iv) Departments and agencies of a government that does not control, jointly control
or significantly influence the reporting entity,
simply by virtue of their normal dealings with an entity (even though they may affect
freedom of action of an entity or participate in its decision-making process), and
(d) A customer, supplier, franchisor, distributor or general agent with whom an entity
transacts a significant volume of business, simply by virtue of the resulting economic
dependence.
In the definition of a related party, an associate includes subsidiaries of the associate and
a joint venture includes subsidiaries of the joint venture. Therefore, for example, an
associate's subsidiary and the investor that has influence over the associate are related to
each other.
5.3 Disclosure (IAS 24.13-24)

Disclosure of related-party relationships
The standard requires that all relationships between a parent and subsidiary must be
disclosed irrespective of whether a transaction had occurred or not. An entity must for
parents and subsidiaries, disclose the name of the entity's parent and, if different, the
ultimate controlling company. If neither the parent nor the ultimate controlling company
produce consolidated financial statements for public use, the name of the next most senior
parent who does so, should also be disclosed. The disclosure requirement is in addition to
the requirements of IAS 27; IAS 28 and IAS 31.
Disclosure of key management personnel compensation

Key management compensation in total and for each of the following categories must be
disclosed:
 Short-term employee benefits,

 Post-employment benefits,
 Other long-term benefits,
 Termination benefits, and
 Share-based payments.
181
Disclosure of related-party transactions
Any information with regard to the related-party transaction as well as any outstanding
balances for an understanding of the potential effect of the relationship must be disclosed.
At a minimum, the disclosures must include:

 the nature of the relationships between the related parties,
 the amount of the transactions,
 the amount of any outstanding balances (payables and receivables must be clearly
distinguished):
(i) the terms and conditions, any security provided and method of settlement, and
(ii) details of guarantees given or received,
 provision for doubtful debts relating to the outstanding balances,

 the expense recognised in respect of bad or doubtful debts due during the period.
The disclosure of related party transactions shall be made for the following categories:
 parent,
 entities that are jointly controlled or exercise significant influence,
 subsidiaries,
 associates,
 joint ventures in which the entity is a venture,
 key management personnel of the entity or its parent, and
 other related parties.
Possible examples of the different types of disclosure of related-party transactions are:

 purchases or sales of property,
 leases, and
 rendering or receiving of services.
Participation by a parent or subsidiary in a defined benefit plan that shares risks between
the group entities is a transaction between related parties.
Items of a similar nature must be disclosed in total except when separate disclosure is
necessary for an understanding of the related-party transaction that has occurred.
Government-related entities
A reporting entity is exempt from the disclosure requirements of IAS 24 if:

 a government has control, joint control or significant influence over the reporting entity,
or
 transactions with another entity that is a related party due to a common government
having control, joint control or significant influence over both the other entity and
reporting entity.
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FAC3703/501
If the exemption stated above is applied, the entity must, however, disclose the following:
 the name of the government as well as the nature of the relationship of the reporting
entity with the government, and
 the following information detailed enough to enable users of the entity's financial
statements to understand the effect of related-party transactions on the entity:
 the nature and amount of each individually significant transaction, and
 for all transactions that are collectively, but not individually significant, a quantitative
or qualitative indication of their extent. (Refer to IAS 24 for a list of such
transactions.)
5.4 Identifying related parties
IAS 24 contains a detailed definition of a related party. In considering each possible

related-party relationship, attention is directed to the substance of the relationship and not
merely its legal form. Each element of the definition of a related party will now be
considered in more detail.
5.4.1 The entity and the reporting entity are members of the same group
(IAS 24.9(b)(i))
EXAMPLE 1
X Limited
100% 70%
Y Limited Z Limited
In the separate financial statements of holding company X Limited, both subsidiaries, Y

Limited and Z Limited will be disclosed as related parties as they are controlled by X
Limited.
In the separate financial statements of Y Limited, holding company X Limited will be a

related party as X Limited controls Y Limited. Subsidiary Z Limited will also be disclosed as
a related party in the separate financial statements of Y Limited as it is under common
control, namely X Limited. On similar grounds X Limited and Y Limited will be related
parties in the separate financial statements of Z Limited.
183
5.4.2 The reporting entity is an associate of the other entity (IAS 24.9(b)(ii))
EXAMPLE 2
X Limited
30%
Y Limited
The 30% interest of X Limited in Y Limited, constitutes significant influence. In Y Limited's

financial statements, X Limited will be a related party.
5.4.3 The reporting entity is a joint venture of the other entity (IAS 24.9(b)(ii))
EXAMPLE 3
X Limited
45%
Y Limited
(joint venture)
X Limited has a 45% interest in Y Limited and exercises joint control over Y Limited in
terms of a contractual arrangement with another party. In Y Limited's financial statements
X Limited will be a related party.
184
FAC3703/501
5.4.4 One entity is an associate of the reporting entity (IAS 24.9(b)(ii))
EXAMPLE 4
X Limited
30%
Y Limited
(associate)
The 30% interest of X Limited in Y Limited, constitutes significant influence. In X Limited's

financial statements, Y Limited will be a related party.
It might appear that this part of the definition is the same as the part of the definition in
5.4.2. It should, however, be noted that it does not always lead to reciprocal disclosures in
the financial statements of the relevant reporting entities.
EXAMPLE 5
X Limited
80% 35%
Y Limited Z Limited
(subsidiary) (associate)
The following related parties will have to be disclosed in the financial statements of
X Limited:
 Y Limited is a related party as it is controlled by X Limited.
 Z Limited is a related party as it is an associate of X Limited.
X Limited must therefore disclose all the transactions between X Limited and Y Limited
and between X Limited and Z Limited in the financial statements.
The following related parties' transactions will have to be disclosed in the financial
statements of Z Limited:
 X Limited is a related party as it exercises significant influence over Z Limited.
Z Limited must therefore disclose all the transactions between X Limited and Z Limited.
 Y Limited is a related party of Z Limited, as Y Limited is a member of the group of
which Z Limited is also a member.
185
5.4.5 One entity is a joint venture of the reporting entity (IAS 24.9(b)(ii))
EXAMPLE 6
X Limited
45%
Y Limited
X Limited has a 45% interest in Y Limited and exercises joint control over Y Limited in
terms of a contractual arrangement with another party. In Y Limited's financial statements
X Limited will be a related party.
In X Limited's financial statements Y Limited will be a related party.
5.4.6 Both entities are joint ventures of the same third party (IAS 24.9(b)(iii))
EXAMPLE 7
X Limited
45% 35%
Y Limited Z Limited
 Y Limited is a related party of Z Limited.

 Z Limited is a related party of Y Limited.
186
FAC3703/501
5.4.7 A person or a close member of that person's family is a member of the key
management personnel of the reporting entity (IAS 24.9(a)(iii))
EXAMPLE 8
Mr A
(Executive
Director)
X Limited
Mr C Mr B
(Planning and (Non-executive
Controlling the director)
Daily activities)
Mr A and Mr B are related parties of X Limited as they are executive and non-executive
directors of X Limited.
Mr C is a related party of X Limited as he is responsible for the planning and controlling of
the daily activities of X Limited.
5.4.8 A person or a close member of that person's family having significant

influence over a reporting entity (IAS 24.9(a)(ii))
EXAMPLE 9
Mr Jones Mrs Jones
25% 80%
Reporting entity X Limited

controlled by
Mrs Jones
Mrs Jones is a related party of the reporting entity as she is a close family member of Mr
Jones, who has significant influence over the reporting entity.
187
5.4.9 Entities controlled, jointly controlled or significantly influenced by certain
related parties (IAS 24.9(b)(vi); (vii))
EXAMPLE 10
Mr Jones Mrs Jones
25% 80%
Reporting entity X Limited

controlled by
Mrs Jones
X Limited is a related party of the reporting entity as it is an entity that is controlled by a

close family member (Mrs Jones) of Mr Jones, an individual who has significant influence
over the reporting entity.
Mrs Jones is a related party of the reporting entity as she is a close family member of Mr
Jones, who has significant influence over the reporting entity.
5.4.10 The entity is a post-employment benefit plan for the benefit of employees
of either the reporting entity or an entity related to the reporting entity
(IAS 24.9(b)(v))
EXAMPLE 11
X Limited 80% Y Limited

(Subsidiary of
X Limited)
Fund X Fund Y
(For the benefit of (For the benefit of
Employees of employees of
X Limited) Y Limited)
Both Fund X and Fund Y are related parties of X Limited and both Fund X and Fund Y are
related parties of Y Limited.
188
FAC3703/501

Asgard Limited as a diversified mining group. The group structure is as follows:
Asgard Limited
60% 30% 100%
Wraith Limited Genii Limited Nox Limited
10% 30% 45%
Ori Limited Athosian Limited
(1) Mr Deadalus is the chief financial officer of Asgard Limited. Mrs Deadalus, the wife of
Mr Deadalus is a partner in Orion Inc. Orion Inc is the accounting firm responsible for
the compiling of the financial records of the Asgard group. The accounting fees for
the reporting period ended 31 December 20.18 was R500 000.
(2) Nox Limited is responsible for the transport of the inventory of Asgard Limited. Nox
Limited charged Asgard Limited R2 500 000 for the safe transport of all the gold and
gemstones that were mined. At 31 December 20.18, R1 200 000 was still
outstanding.
(3) Wraith Limited is an engineering company. They are responsible for all the
maintenance on the mining equipment. Wraith Limited invoiced Asgard Limited for all
the maintenance amounting to R10 000 000 for the reporting period ended
31 December 20.18. Asgard Limited invoiced Athosian Limited for their portion of the
maintenance provided by Wraith Limited to the amount of R2 500 000. The accounts
receivable of Wraith Limited were R1 300 000, of which R350 000 was owed by
Asgard Limited on behalf of Athosian Limited.
(4) Genni Limited prepared a contract for a lease agreement for Athosian Limited at no
cost.
REQUIRED
Disclose all relevant information required by IAS 24, – Related-party
disclosure, in the notes to Asgard Limited's own financial statements for
the year ended 31 December 20.18.
189
SOLUTION
ASGARD LIMITED
2. Related-party transactions
2.1 Related parties
Asgard Limited is related to Wraith Limited, Nox Limited and Athosian Limited because
they are subsidiaries of Asgard Limited.
Asgard Limited is related to Genii Limited because Genii Limited is an associate of Asgard
Limited.
Mr Deadalus is a related party of Asgard Limited as he is part of the key management
personnel of Asgard Limited.
Orion lnc is a related party of Asgard Limited as Mrs Deadalus (the wife of Mr Deadalus, a
key management personnel member of Asgard Limited) has significant influence over
Orion Inc.
2.2 Transactions
The following transactions occurred between related parties of the company during the
past financial year:
20.18
R
Accounting fees paid to Orion Inc 500 000
Transport paid to Nox Limited. 2 500 000
Maintenance cost incurred: Wraith Limited 10 000 000
Maintenance cost recovered from Athosian Limited 2 500 000
Genii Limited prepared a contract for a lease agreement for Athosian Limited at no cost.
2.3 Outstanding balances

 Included in accounts payable in R1 200 000, owed to Nox Limited.
 Included in accounts receivable is R350 000, receivable from Athosian Limited.
ASSESSMENT CRITERIA
Are you now able to
 identify related parties?
 disclose related parties and related-party transactions and balances in
the Financial Statements of the reporting entity in terms of IAS 24?
Ref:/ FAC3703_2019_TL_501_E_pdf
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UNISA 2019
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FAC3703/501/3/2019

Tutorial Letter 501/3/2019

Department of Financial Accounting

This tutorial letter is your study guide for FAC3703.

All rights reserved

Printed and published by the

1 INTRODUCTION AND OVERVIEW ................................................................................. iv

2 LECTURERS AND CONTACT DETAILS ....................................................................... vii

3 LEARNING UNIT 1 – FINANCIAL INSTRUMENTS .......................................................... 1

4 LEARNING UNIT 2 – LEASES ....................................................................................... 32

5 LEARNING UNIT 3 – EMPLOYEE BENEFITS ............................................................. 141

6 LEARNING UNIT 4 – BORROWING COSTS ............................................................... 163

7 LEARNING UNIT 5 – RELATED PARTIES .................................................................. 178

1.1 PURPOSE OF YOUR STUDIES

FAC3701 – General Financial Reporting

1.2 PURPOSE OF THIS MODULE

 Financial instruments (IAS 32, IFRS 9 AND IFRS 7)

1.3 CRITICAL CROSS-FIELD OUTCOMES

These are the critical cross-field outcomes:

Students should be able to:

1.4 MEANING OF WORDS

An analysis of the action verbs contained in a question will enable you to

1.5 MASTERING OF STUDY MATERIAL

1.6 PRESCRIBED BOOKS

The study material is based on the following prescribed book:

Koppeschaar, ZR et al. Descriptive Accounting IFRS Focus. Latest edition. LexisNexis.

1.8 ABBREVIATIONS THAT ARE USED IN THIS GUIDE

 SFP Statement of Financial Position

2 LECTURERS AND CONTACT DETAILS

Lecturers Office number

Specific Financial Reporting

This learning unit is divided into the following:

1.1 Background and objectives ........................................................................................ 2

1.1 Background and objectives

The objective of IAS 32 Financial Instruments: Presentation is to establish principles for

1.2 Definitions (IAS 32.11–14 and IFRS 9 Appendix A)

A financial liability is any liability that is:

(a) a contractual obligation:

DEFINITIONS IN IFRS 9 Appendix A

THE DIFFERENCE BETWEEN A BOND AND A DEBENTURE

 Currency (cash) is a financial asset It represents the medium of exchange and is

R100 lent to borrower

 Bonds traded in the secondary market fluctuate in price in response to

 A bond's maturity refers to the specific future date on which the

 Bonds pay interest that can be fixed, floating or payable at maturity.

 Physical assets Control of such physical and intangible assets

 Prepaid expenses The future economic benefit is the receipt of

Definitions relating to hedge accounting (refer to FAC3702)

FINANCIAL LIABILITIES (IFRS 9.4.2)

A financial liability is classified as held for trading if it is:

More relevant information will arise when:

Complexity will be reduced or measurement reliability will be increased in instances:

1.4 Recognition and derecognition

B. Assets to be acquired and liabilities to be incurred as a result of a firm

D. Planned future transactions

1.4.2 Derecognition of a financial asset

An entity shall derecognise a financial asset when, and only when:

A financial liability (or a part of it) is extinguished when the debtor:

1.5.2 Subsequent measurement of financial assets (IFRS 9.5.2)

After initial recognition, an entity shall measure a financial asset at:

The accounting treatment of financial assets can be summarised as follows:

Financial asset Initial measurement Subsequent Gains and losses on

EXPLANATION OF TERMINOLOGY USED IN THIS EXAMPLE