Leases

IFRS 16

2019
Objective of the lecture
•Revision of third year work on IFRS 16
•Introduce key concepts in IFRS 16 for lessees
•Identification
•Recognition
•Measurement
•Presentation and disclosure;
•Consider the deferred tax treatment of leases.

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Economics of the transaction

What is a lease?
What is the ECONOMICS of a lease?
Definition: A contract that conveys to the customer (‘lessee’) the right to
use an asset for a period of time in exchange for a consideration

•Lessor
•Right to receive payment & obligation to deliver asset BC22,
BC25, 26
•Lessee
and BC27
•Right to use asset & obligation to make lease payments
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Economics of the transaction

Is the right of use asset the same as the

underlying asset itself?

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IFRS 16 LESSEE accounting summary

•A lessee is required to:

(a) SFP: recognise assets and liabilities for all leases; and
(b) SPL: recognise
(i) depreciation of lease assets separately from
(ii) interest on lease liabilities

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Issue 1: Do you have a lease? Para 9 to 16
& B9 to b31
At inception of a contract, an entity shall assess whether the
contract is, or contains a lease.

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Identification Para 9 to 16
& B9 to b31

(2)
(1) Customer Lease =
Identified controls “Right of
asset right of use use” of asset

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 B14 to B19 for
(1) Identified asset assessment indicators of
‘substantive’

B16 NB

The supplier would

Practical ability to
substitute
alternative assets
& benefit
economically to
substitute the asset

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Example 1
•Power Plant

•A Utility Company (Customer) enters a contract with a power

company (Supplier) to purchase all the electricity produced by
a new solar farm for 20 years. The Solar Farm is owned and
operated by the Supplier. Supplier is unable to provide power
to the customer from another plant.

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Deloitte 10
(1) Identified asset
What about portions of assets?

A portion of a bigger asset is an identified asset if it is physically distinct

E.g. a capacity portion of

E.g. A separate a fibre optic cable is
floor of a building unlikely to be an
identified asset

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Example 2

•Fiber Optic Cable

•Waldo enters into a 15 year contract with Alphapha for the

right to use a specified amount capacity within a cable
connecting Johannesburg to Gaborone. The specified
amount is equivalent the customer having the use of the full
capacity of three fiber strands within the cable (the cable
contains 15 fiber strands with similar capacities)
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Deloitte 12
(2) Control assessment

Who makes decisions

Who has the right to regarding the
obtain substantially use/operation of the
asset (i.e. who directs
all of the economic
the use of the asset)?
benefits from the
use of the asset?
B42(a) and (b)

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(2) Control assessment
1) Who has the right to obtain substantially all of the economic benefits from
the use of the asset? (assessed within the scope of the contract)
AND
2) Who makes decisions regarding the use/operation of the asset (i.e. who
directs the use of the asset)?
i. Customer can direct ‘how and for what purpose’ asset is used (see B24(a))
ii. Predetermination (See B24(b))
> Supplier cannot change the operating instructions of the asset, or
> Customer designed the asset in a way that predetermines the use of the asset
•Lessor’s protective rights?
•Doesn’t in isolation prevent lessees ability to direct the use of asset
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(2) Control assessment

Customer controls the right of use of Supplier controls the right of use of
the asset (or portion) the asset

“LEASE CONTRACT” “SERVICE CONTRACT”

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Class examples

Illustrative examples 1 to 10:

Very important examples to explain the identification principles

NB - Decision
tree in B31

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Lease and non-lease (e.g. service) component

• Must be distinct
• Separated based on relative stand alone selling prices
• Estimate based on observable prices if not readily available

E.g. – Truck rental contract with related maintenance services

See illustrative example 12

• Practical expedient
• Whole contract accounted for as a single lease component

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Exemptions Para 5

Elect not to apply IFRS 16 requirements

 Short-term leases (<12 months)
 Takes into account extension and termination options
 Not available if contract contains a purchase option
 Indicators for assessing lease term in application guidance

 Underlying asset is low-value

• Assessed when new
• Absolute amount, ignore materiality or relative value
• BC’s: < US $5,000 PER asset
• Unless highly dependent on interrelated assets?
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Lease exemption applied? Para 6 – 8

• Recognise lease payment on a straight-line basis over lease

term
• Expense to SPLOCI
• Operating cash flow in SCF

• See Module Class example 2 for the resulting journals and

deferred tax implications.
• See Illustrative Example 11

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MEASUREMENT

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BIG PICTURE: Lease contract

Commencement
date

LEASE LIABILITY RIGHT OF USE ASSET

PV lease payments Lease liability +
@ implicit rate / directly attributable costs
incremental borrowing rate

Interest
Depreciation
Expense
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 Para 26
Issue 2: Measuring LEASE LIABILITY

•Recognise and measure on commencement (lease start) date

•The date that lessee becomes entitled to exercise its right to use
the leased asset
•Not the date that you enter into agreement (inception date)

•Essentially: PV all contractual payments likely to incur which can be

measured reliably on commencement of lease
•PV = (rate, period, payment, FV)

•Re-measure ongoing basis

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Measuring lease liability: INPUTS
Lease term Non-cancellable period of a lease plus: “Reasonably certain”
(= n)  Extension periods (if likely to exercise); assessment & “facts and
 Termination periods (if likely will not exercised) circumstances” B37

Lease payments Include:

(= PMT and/or  Fixed payments (including in substance fixed payments)
FV)  Variable ONLY IF / to extent based on observable index or rate (e.g.
inflation). Use base year index/rate and reassess when actual cash flows
change due to the change in index/rate.
 Other amounts if likely to incur: purchase options + termination penalties
(similar to IFRS 15)
 End of lease payments / guaranteed residual values

Discount rate  Interest rate implicit in agreement OR if not determinable App. A

(= i)  Lessees incremental rate of borrowing (lease specific) Definitions

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Lease term Para 18 – 21

•Total period for which lease contract is enforceable

•Not enforceable if
•Can terminate without permission of other party
•Minimal penalty on cancellation

•Includes rent-free periods

•Para B37 provides guidance on how to determine of it is likely that

termination and extension options will be exercised – do they create an
‘economic incentive’ to terminate or extend?

•Use past practice and other available information

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 Para 27 – 28
Lease payments
•In substance fixed payment
•Payments that seem variable but are unavoidable
•Variable payments linked to index / rate
•E.g. inflation
•Include with PMT – use base cash flows at commencement date and
adjust when actual cash flows change
•Illustrative example 14 (Vol B2)
•Variable payments NOT linked to index / rate
•E.g. based on earnings / units sold
•Recognise expense as incurred in SPLOCI
•Payments expected to be made under residual value guarantees.
•Purchase options where it is likely to be exercised
•Penalties if lease term reflects that the lessee will terminate the lease

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Interest rate implicit in the lease (App A)
• Rate for the lessor – NB!
 = “lease pmts”

“Lease
term” N=0 N=1 N=2

PMT =  lease payments PMT =  lease payments

FV =
PV = Fair value +  Guaranteed
Initial direct costs of residual value
lessor
I/YR? +
Unguaranteed
residual value

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 Para 23 – 25
Issue 3: RIGHT TO USE ASSET

•Measure on commencement (lease start) date

•Measured at COST
= Initial measurement of liability (from above)
+ prepayments (part of cost, not part of liability as ‘paid’)
- less lease incentives (similar to IAS16)
+ initial direct costs (similar to IAS16)
+ dismantling / site restoration (similar to IAS16; link to IAS 37 + IFRIC 1)

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Subsequent measurement of assets
•Apply a cost model
•Depreciate asset
•Apply IAS 36 if asset is impaired
•Remeasurement [if liability remeasured] Para 29 – 33

•Unless
•Leasing an investment property and apply a FAIR VALUE model
to other investment properties (IAS 40) {‘shall apply’}
•Similar class of PPE asset is revalued {‘elect to apply’}
revaluation model to right to use assets Para 34 – 35

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Class example 1: background fact pattern

R
Cash cost excl VAT 100 000
VAT 15 000
Term of lease 4 years
Annual Instalment 42 999
Option to extend – not reasonably certain 2 years
Incremental borrowing rate of the lessee 12%
Rate implicit in the lease 25%

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Journals – Year 1
Dr/Cr Description Dr Cr
Initial recognition
Dr Right to use asset 86 546

Dr VAT – input 15 000

Cr Lease liability 101 546

Subsequent measurement - Liability

Dr Lease liability 17 612

Dr Interest expense [CA x discount rate] 25 387

Cr Bank 42 999

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Journals

Dr/Cr Description Dr Cr
Subsequent measurement – Asset
Dr Depreciation* 21 637

Cr Acc Depr: Right to use asset * 21 637

Reassessment (if applicable – per slide 26)

Dr/Cr Lease liability
Cr/Dr Right to use asset

* Or Impairment + Acc. Impairment

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Reassessments – i.e. Change in ESTIMATES Para 39 – 43
•Adjust both liability and right to use asset
•Guaranteed residual
values ,
•Lease term, purchase and
•Variable payments
extension option (par 40 &
because the oberservable
41)
index changed
(par 42 & 43)

Use original
Calculate new
rate discount
discount rate
rate

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Class example 2 (ignore VAT in this example):

Lease term 10 years

Payments for 10 years (in advance) R50 000
Option to extend (not reasonably certain to extend at 5 years
commencement)
Payments during extension period (in advance) R55 000
Incremental borrowing rate of the lessee 5%
Interest rate implicit not determinable -

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Journals – Initial recognition

Dr/Cr Description Dr Cr
Dr Right to use asset 405 391

Cr Lease liability 355 391

Cr Bank 50 000

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End of year 6, it is determined that is likely that the lessee will
exercise the extension option. The lessees incremental borrowing
rate is now 6%.

Carrying
Amount before
Reassessed liability R192 011
the
= R378 174
reassessment =
R186 162

Dr/Cr Description Dr Cr
Dr Right to use asset 192 011

Cr Lease liability 192 011

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 Para 47 – 60
PRESENTATION + DISCLOSURE

PURPOSE
Provide sufficient information to enable users to assess the effect
that leases have on the financial position, financial performance and
cash flows of the lessee

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DEFERRED TAX

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 IAS 12
Issue 5: DEFERRED TAX principles
•Accounting consequences
•Interest expense
•Depreciation
•Variable lease payments NOT incl. in measurement of lease liability

•Tax consequence
•Deduction for actual lease PAYMENT(s) made
•VAT on payment is not deductible

•TEMPORARY differences = deferred tax

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DEFERRED TAX: Lease liability
•Carrying amount as calculated
•PV of outstanding lease payments

•Tax base = CA of liability less amounts deductible in future for tax purposes
•Lease payments are deductible
•VAT is NOT deductible
•I.e. tax base = VAT portion of future lease payment

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DEFERRED TAX: Right to use asset
•Carrying amount as calculated
•Cost less acc. depreciation & acc. impairment

•Tax base = amounts deductible in future for tax purposes

•SARS does not allow the lessee any tax deductions for the leased asset
•I.e. TB = ZERO

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Class example 3: s23C implications (continued fact pattern from
example 1 from earlier slides)
Yr 1
Claim for tax purposes

Lease payments made 42 999

Less: 42 999 x R15 000 3 750

171 996

Lease payments claimable for tax 39 249

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Class example 3: Income Statement Method
Yr 1
Claim for tax purposes
Add back:
Interest 25 387
Depreciation 21 637

Deductions:
Lease payments (less s23C VAT) (39 249)
Temporary Differences: 7 775
X 28% = Defferred Tax Movement
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Class example 3: Balance Sheet Method
CA TB Temp Diff
RIGHT TO USE ASSET
64 909 0 64 909 Liability
86 457/ 4 years x 3 years remaining

LEASE LIABILITY

83 934 11 250 72 684 Asset

PV VAT on future lease
payments *

Temporary Difference 7 775

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How to approach IFRS 16
• Horizontally
•“Need to know” vs. “Be able to identify , and know where to find it”?
•Excluded: “modifications”
> Illustrative examples 15 – 18
> IFRS 16 par 44 - 46
• Lessors, sale and leasebacks and subleases will be addressed in lecture 2

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