LEASE IFRS 16 – Paragraph 63 (TOMS) “Automatic Finance Lease”

- Contract or part of a contract that conveys the right to use the 1. T — transfer of ownership
underlying asset for a period of time in exchange for consideration 2. O — option to purchase the asset
(Appendix A of IFRS 16). 3. M — material lease term
4. S — substantial PV of Lease Payments
Right to Control / Use of an Asset: --- how would we know?
1. Obtain substantially all the economic benefits from the use of the Transfer of Ownership
identified asset. - Lease transfers ownership of the underlying asset to the Lessee at the
2. Lessee has the right to direct the use of the identified asset. end of the lease term.

Type of Lease: Option to Purchase the Asset

1. Operating Lease - Lessee has the option to purchase the asset at a price sufficiently lower
2. Finance Lease than the fair value at the date the option becomes exercisable.
- Requirement: “at the inception of the lease, it must be reasonably
Operating Lease certain that the option will be exercised”
- Lease does not transfer substantially all the risk and rewards to
ownership of an underlying asset. Material Lease Term
- Lessor still the owner of the asset. - Lease term is for a major part of the economic life of the underlying
- Rent transaction. asset.
- Lease term is at least 75% of the useful life of the asset.
Finance Lease
- Lease that transfers substantially all the risks and rewards of Substantial Present Value of Lease Payments
ownership. - Present value of the lease payments amounts to substantially all the
- Lessee is the owner. fair value of the underlying asset at the inception of the lease.
- Form = Rent - Substantial = PV of Lease Payments are at least 90% of the Fair Value
- Substance = Sale; Lease Payments = Installment Payments of the asset.
- Substance over form.
T.O. = asset will be reverted to the lessee at the end of the lease term.
M.S. = asset will be reverted back to the lessor.
OPERATING LEASE → LESSOR’S POV Straight Line Basis Illustrative 1: Pepper Company owns an office building and normally charges
- Lease Payments = Recognized as Income - rent income tenants P3,000 per square meter per year for office space.
not same every period
the same Because the occupancy rate is low, Pepper Company agreed to lease 1,000
1st Yr 100,000
2nd Yr 110,000 360,000 / 3 years square meters to Ivana Company at P1,200 per square meter for the first year
rd
3 Yr 150,000 = 120,000 / year of a three-year operating lease. Rent for the remaining years will be at the
P3,000 rate.
Cash Received Rent Income Asset/Liability
st
1 Yr 100,000 120,000 20,000 Rent Receivable Pepper Company moved into the building on January 1, 2022 and paid the first
2nd Yr 250,000 240,000 10,000 Rent Payable year’s rent in advance.
3rd Yr 360,000 360,000 0
Required: What amount of rental revenue should be reported in the income
- Owner = Lessor; Depreciation Expense recorded by Lessor statement for the year ended September 30, 2022?
a) 2,400,000 c) 1,800,000
Special Concepts: b) 1,200,000 d) 900,000
1. Initial Direct Costs Paid by the Lessor
- Added to the Carrying Amount of the Asset Solution:
- Recognized as Expense over the Lease Term (amortized) 1st Year = (P1,200 * 1,000) = 1,200,000
2. Executory Costs 2nd Year = (P3,000 * 1,000) = 3,000,000 7,200,000 / 3 years
- Costs that are incurred by the lessor in maintaining the asset 3rd Year = (P3,000 * 1,000) = 3,000,000 = 2,400,000 Annual Rent
- Depreciation, maintenance & repairs, taxes, etc.
- Expensed as incurred Rent Income (9mos) = 2,400,000 * 9/12
3. Refundable Security Deposits Rent Income (9mos) = 1,800,000
- ✗ Income Refundable = returned to lessee
- ✓ Liability
4. Lease Bonus
- Suhol, additional payments made by the lessee to obtain the lease.
- Unearned Revenue = Liability
- Income over the Lease Term (amortized)
Illustrative 2: Pepper Company leased an office to Ivana Company for a five-
year term beginning January 1, 2022.
Under the terms of the operating lease, rent for the first year is P800,000 and
rent for years 2 through 5 is P1,250,000 per annum.
Illustrative 3: On January 1, 2017, Pepper Company leased a building to Ivana
Company under a four-year operating lease. The monthly rental for 2017, 2018,
2019, and 2020 is P100,000, P150,000, P200,000, and P250,000 respectively.
Rentals are payable at the end of each month. All rental payments within the
year were made when due.

However, as an inducement to enter the lease, Pepper Company granted Ivana Required: What amount should be reported as rent receivable from Ivana
Company the first six months of the lease rent-free. Company on December 31, 2018?
a) 1,000,000 c) 1,200,000
Required: What amount should be reported as rental income for 2022? b) 600,000 d) 900,000
a) 1,200,000 c) 1,080,000
b) 1,160,000 d) 800,000 Solution:
Annual Rentals Rent
Mo. Rental Income
Solution: Rentals Received Receivable
1st Year = 800,000 * 6/12 = 400,000 2017 100,000 1,200,000
2nd Year = 1,250,000 2018 150,000 1,800,000 3,000,000 4,200,000 1,200,000
3rd Year = 1,250,000 5,400,000 / 5 years 2019 200,000 2,400,000
4th Year = 1,250,000 = 1,080,000 Annual Rent 2020 250,000 3,000,000
5th Year = 1,250,000 8,400,000
/ 4
Annual Rent Income = 1,080,000 Annual Rent 2,100,000
Income

2,100,000 * 2
1,200,000 + 1,800,000
Illustrative 4: On January 1, 2022, Pepper Company leased a building to Ivana Illustrative 5: Pepper Company leased a new machine to Ivana Company on
Company under an operating lease for ten years at P500,000 per year, payable January 1, 2022. The lease expires on January 1, 2027. The annual rental is
the first day of each lease year. Pepper Company paid P150,000 to a real estate P900,000. Additionally, on January 1, 2022, Ivana Company paid P500,000 to
broker as initial direct costs. The building is depreciated P120,000 per year. Pepper as a lease bonus and P250,000 as a security to be refunded upon
Pepper Company insurance and property tax expense totaling P90,000 for expiration of the lease.
2022.
Required: What amount should be reported as rent revenue for the current
Required: What is the net rent income for 2022? year?
a) 275,000 c) 350,000 a) 1,400,000 c) 1,000,000
b) 290,000 d) 365,000 b) 1,250,000 d) 900,000

Solution: Solution:
Initial Direct Cost = 150,000 / 10 years Lease Bonus = 500,000 / 5 years
Initial Direct Cost = 15,000 Lease Bonus = 100,000
Executory Costs = 120,000 + 90,000
Executory Costs = 210,000 Annual Rental 900,000
Lease Bonus 100,000
Rent Income 500,000 Rent Revenue 1,000,000
IDC Per Year (15,000)
Exec. Costs (210,000)
Net Rent Income 275,000
FINANCE LEASE → LESSOR’S POV
- Direct Finance Lease
- Sales Type Lease

Direct Finance Lease

- Lessor is engage in the financing business
- Papautangin yung customer, para magkaron ng property. Bibilhin yung property, then papaupa sakaniya.
- An arrangement between a financing entity and a lessee.
- Income = Interest Income (a.k.a. Financing Income)
- NO GROSS PROFIT TO BE RECOGNIZED because the Fair Value and the Cost of the asset are EQUAL.

Sales Type Lease

- Manufacturer or Dealer of properties.
- Income = Gross Profit (Sales – COGS)
= Interest Income

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ACTUAL SALE
- Hindi na tinapos ni lessee yung lease term, binili agad.

Selling Price vs. Carrying Amount of the Lease Receivable

• SP > CA = Gain
• SP < CA = Loss
 Direct Finance Lease Sales Type Lease

Gross Investment Gross Rentals (annual rental x lease term) ** xx Gross Rentals xx
ADD: Residual Value * xx ADD: Residual Value * xx
Gross Investment xx Gross Investment xx

* whether GUARANTEED or UNGUARANTEED.

* Residual Value is only considered if there is NO TRANSFER OF OWNERSHIP & BARGAIN PURCHASE OPTION.
T = nothing is added to the gross rentals
O = option price will be added to the gross rentals
MS = residual value will be added to the gross rentals

** Gross Rentals NOT GIVEN

Costs of the Asset xx
LESS: PV of Residual Value (xx) Rate: (Priority)
PV of Rentals xx 1. Implicit Rate
2. Incremental Borrowing Rate
÷ PV Factor (OA or AD) xx
Annual Rentals xx

Net Investment Costs of the Asset xx PV of Rentals xx

ADD: Initial Direct Costs Paid by Lessor xx ADD: PV of Residual Value or Option xx
Net Investment xx Net Investment xx

Unearned Interest Income Gross Investment xx Gross Investment xx

- total financing income LESS: Net Investment *** (xx) LESS: Net Investment (xx)
that will be recognized Unearned Interest Income xx Unearned Interest Income xx
over the lease term
*** Paragraph 67 (IFRS 16)
- Lessors shall recognize assets (Lease Receivable) equal to the net investment in the lease. (INITIAL MEASUREMENT)

Amortized using the effective interest

method
 Sales Net Investment
Ø Or Whichever is lower
Fair Value

Cost of Goods Sold Cost of the Asset xx

Ø ADD: Initial Direct Cost xx
COGS xx

Gross Profit Sales xx

Ø LESS: COGS (xx)
Gross Profit xx

COGS
Residual Value is Guaranteed Residual Value is Unguaranteed
Cost of the Asset xx Cost of the Asset xx
ADD: Initial Direct Cost paid by the Lessor xx ADD: Initial Direct Costs xx
COGS xx LESS: PV of Unguaranteed Residual Value (xx)
COGS xx

SALES
Residual Value is Guaranteed Residual Value is Unguaranteed
Net Investment Net Investment
Or Whichever is lower Or Whichever is lower LESS PV of Unguaranteed RV
Fair Value Fair Value
LEASE ACCOUNTING → LESSEE’s POV - Not Part of Costs:
- Under Paragraph 22 (IFRS 16), all leases should be accounted by lessee 1. Leasehold Improvement
as Finance Lease except: 2. Executory Costs
1. Short-Term Lease 3. Refundable Security Deposits
- Lease 12 months or less.
2. Low Value Asset Subsequent Measurement of ROUA
- Fair Value of Asset ≤ $5,000 Costs xx
- Wherein, lessee is permitted (not required) to use operating lease LESS:
accounting. Accumulated Depreciation (xx)
Accumulated Impairment Loss (xx)
OPERATING LEASE → LESSEE’s POV Carrying Amount xx
- Lessee shall recognize Lease Payments as an EXPENSE in either: * Carrying Amount is adjusted for any Remeasurement of the
1. Straight Line Basis over the Lease Term Lease Liability
2. Another Systematic Basis (Paragraph 6, IFRS 16)
Other Subsequent Measurements of ROUA
FINANCE LEASE → LESSEE’s POV 1. FV Model
- In the inception date, Lessee shall recognize: - Lessee should only apply this model if:
1. Right of Use Asset (ROUA) i. ROUA meets the definition of Investment
2. Lease Liability Property.
ii. Lessee applies the FV model in measuring
RIGHT OF USE ASSET (ROUA) Investment Property and ROUA (lease asset)
- Paragraph 23 (IFRS 16), at commencement date lessee should measure is actually an Investment Property.
ROUA at Cost. (Initial measurement) 2. Revaluation Model
Initial Measurement of ROUA (Part of Cost): - Lessee should only apply this model if:
i. ROUA relates to a class of PPE to which the
Initial Measurement of Lease Liability xx
lessee applies the revaluation model.
Initial Direct Cost Paid by Lessee xx
(Par. 34 & 35)
Lease Bonus xx
Lease Incentives (xx) Paragraph 29 (IFRS 16)
Estimated Cost of Dismantling, Restoration/Removing Cost xx - If the problem is silent of the method or model to use, use cost model.

Cost xx
Paragraph 47 (IFRS 16) LEASE LIABILITY
- Lessee should present the ROUA as a separate line item in the
statement of financial position. Initial Measurement: (Paragraph 26, IFRS 16)
- Alternatively, lessee may include the ROUA in the appropriate line item - PV of Lease Payments
within which the corresponding underlying asset would be presented
if owned. Part of Lease Payments:
Fixed Lease Payments xx
Depreciation of ROUA: Variable Lease Payments xx
Costs – Residual Value *Option Price xx
Annual Depreciation =
Useful Life **Residual Value Guaranteed xx
Termination Penalties xx
Residual Value: Lease Payment xx
1. Guaranteed * reasonably certain to exercise the option
- At the end of lease term. ** hindi pwede magsabay option price & residual value
2. Unguaranteed (ignore LESSEE’s POV)
- At the end of lease term. Subsequent Measurement:
3. At the End of Life of the Asset CA. Beginning xx Lease Payment xx
Principal Payment (xx) Interest Expense (xx)
If there is Transfer of Ownership / Option to Purchase (T.O.): Amortized Cost xx Principal Payment xx
- Residual Value at the end of the life of the asset will be used.
- Useful Life of the asset will be used. CA. Beginning xx
x Rate xx
If there is NO Transfer of Ownership / Option to Purchase (T.O.): Interest Expense xx
- Residual Value Guaranteed will be used. -------------------------------------------------------------------------------------------------------
- Useful Life or Lease Term, whichever is shorter will be used. ACTUAL PRUCHASE
- At the middle of the lease term, lessee purchased the asset.
CA of ROUA xx
Cash Payment xx
CA of Lease Liability (xx)
Cost of Asset xx
SALE & LEASEBACK TRANSACTIONS - Total Gain (Operating Lease)
- Arrangement where one party sells an asset to another party then • Recognized in Full
immediately leases back from the new owner. Fair Value xx
- Seller sells asset to Buyer (Sale). LESS: Carrying Amount (xx)
- Buyer leases the asset to Seller (Lease). Total Gain xx
- Seller = Lessee; Buyer = Lessor
- Reasons for Sale & Leaseback: - Total Gain (Finance Lease)
• Seller-Lessee is experiencing cashflow or financial problems. • Gain to be recognized
• There are tax advantages in such arrangement in the lessee’s Right Transferred
Total Gain x
jurisdictions. Fair Value
• The seller-lessee would like to avoid the burden of paying the
executory costs attendant to the asset. Fair Value xx
LESS: Right Retained (xx)
Seller-Lessee (items to be recognized at the commencement date): Right Transferred xx
- Right of Use Asset
Right Retained • Gain not to be recognized
Costs = Carrying Amount of Asset x
Fair Value Right Retained
Total Gain x
Fair Value
PV of the Lease Payments xx OR
LESS: Additional Financing (SP > FV) (xx) Total Gain xx
ADD: Prepayments (SP < FV) xx LESS: Gain to be Recognized (xx)
Right Retained xx Gain Not to be Recognized xx

- Lease Liability
• PV of the Lease Payments