SCOPE

An entity shall apply this Standard to all leases, including leases

of right-of-use assets in a sublease, except for:
a) Leases to explore for or use minerals, oil, natural gas and
similar non-regenerative resources;
b) Leases of biological assets within the scope of IAS 41
Agriculture held by a lessee;
c) Service concession arrangements within the scope of IFRIC
12 Service Concession Arrangements;
d) Licences of intellectual property granted by a lessor within
the scope of IFRS 15 Revenue from Contracts with
Customers; and
e) Rights held by a lessee under licensing agreements within
the scope of IAS 38 Intangible Assets for such items as
motion picture films, video recordings, plays, manuscripts,
patents and copyrights.
 Definitions
Lease is a contract that conveys the right to use an identified
asset for a period of time in exchange for consideration.
 Key concepts

Identified Period of
asset=underlying time=Lease Consideration=
Right to use asset period Lease payment
 Identifying a lease
➢ At inception of a contract, an entity shall assess whether the
contract is, or contains, a lease. A contract is, or contains, a
lease if the contract conveys the right to control the use of an
identified asset for a period of time in exchange for
consideration.
➢ It is very important to assess whether a contract conveys the
right to use an asset or is, instead, a contract for a service that
is provided using the asset.
➢ Leases are different from service contracts: a lease provides
a customer with the right to control the use of an asset;
whereas, in a service contract, the supplier retains control.
Example
 For example, an entity might want to transport a
specified quantity of goods, in accordance with a
stated timetable, for a period of five years from A
to B by rail. To achieve this, it could either rent a
number of rail cars or it could contract to buy the
transport service from a freight carrier. In both
cases, the goods will arrive at B – but the
accounting might be quite different!
Identifying a lease
Identifying a lease
Example 1
Case I: A trucking company enters into a contract with a
supplier of refrigerated trailers for 10 trailers for a period
of 5 yrs. The contract specifies the trailers. The trailers are
to be maintained at the customer’s premises. The
customer determines when the trailers are used and the
freight carried; or may not place them into service, but
uses them for terminal storage. The supplier cannot
retrieve the trailers until the five years are completed.
Is this a lease contract?
Identifying a lease

2. Has the right

It is a lease 3. Has a right to
to substantially
contract 1. Controls direct use of the
because the the use of all of the
trailers for
customer; specific economic
transport or
trailers; benefits of the
storage.
use of the
trailers; and
Identifying a lease
Example 2
Coffee Bean enters into a contract with an airport operator to
use some space in the airport to sell its goods from portable
kiosks for a three year period. Coffee Bean owns the portable
kiosks. The contract stipulates the amount of space and states
that the space may be located at any one of several departure
areas within the airport. The airport operator can change the
location of the space allocated to Coffee Bean at any time
during the period of use, and the costs that the airport
operator would incur to do this would be minimal. There are
many areas in the airport that are suitable for the portable
kiosks.

Required: Does the contract contain a lease?

 Identifying a lease
ANSWER
The contract does not contain a lease because there is no
identified asset.
The contract is for space in the airport, and the airport
operator has the practical right to substitute this during the
period of use because:
 There are many areas available in the airport that would
meet the contract terms, providing the operator with a
practical ability to substitute
 The airport operator would benefit economically from
substituting the space because there would be minimal cost
associated with it. This would allow the operator to make the
most effective use of its available space, thus maximising
profits.
Identifying a lease
Separating components of a contract
An entity shall account for each lease component within the
contract as a lease separately from non-lease components of the
contract, unless the entity applies the practical expedient.
Contract that contains a lease component and one or more
additional lease or non- lease components, a lessee shall
allocate the consideration in the contract to each lease
component on the basis of the relative stand-alone price of the
lease component and the aggregate stand-alone price of the
non-lease components.
The relative stand-alone price of lease and non-lease
components shall be determined on the basis of the price of the
lessor, or a similar supplier, would charge an entity for that
component, or a similar component, separately.
If an observable stand-alone price is not readily available, the
lessee shall estimate the stand-alone price, maximizing the use
of observable information.
 Identifying a lease
As a practical expedient, a lessee may elect, by class
of underlying asset, not to separate non-lease
components from lease components, instead account
for each lease component and any associated non-
lease components as a single lease component.
 Identifying a lease
Example 3.
TTCL enters a 4-year lease contract of a car. The supplier (lessor)
will provide also maintenance services for the car during the
lease. Total consideration to be paid for car lease and
maintenance services amounts to $15,000 per year. Additionally,
the lessee will be charged $500 per year as a reimbursement of
car tax paid by the lessor.
❖How to allocate the total annual consideration payable to
supplier of $15,500 into lease component and non- lease
components based on estimated stand-alone selling prices?:
Lease term – general guidance
.

RECORDING IN THE
BOOKS OF LESSEE
Recognition and measurement in the
books of lessee
 Initial Recognition of Lease Contrant shall account for
two items:
1. Lease Liability
2. Right to Use an Assets
Measurement of Lease Liability
Initial measuring of Lease Liability
 At the commencement date, a lessee shall measure the
lease liability at the present value of the lease
payments that are not paid at that date.
 The lease payments shall be discounted using the
interest rate implicit in the lease , if that rate can be
readily determined.
 If that rate cannot be readily determined, the lessee
shall use the lessee’s incremental borrowing rate .
Recognition and measurement in the books of lessee
Initial measuring of Right of use asset
 Initial measurement of the right-of-use asset: At the
commencement date, a lessee shall measure the right-
of-use asset at cost.
 Recognition and measurement in the books of lessee
 At the commencement date , a lessee shall recognize a
right-of-use asset and a lease liability.
 Journal Entry to Pass

DR CR
Right of Use Asset xxxx
Lease Liability xxxx
Recognition of right of use assets

 A lessee may elect not to apply the requirement above to:

(a) short-term leases ( applicable by class of assets); and
(b) leases for which the underlying asset is of low value(
applicable on lease by lease basis)
Example 4
On 1 January 20X6 Taggart acquires telephones for its
sales force under a two year lease agreement. The terms
of the lease require an initial payment of $2,000,
followed by two payments of $8,000 each on 31
December 20X6 and 31 December 20X7. Interest rate =
6%
Required
a)Pass Journal Entry to record Initial Recognition of
Lease
b)Show the impact of this lease arrangement on the
financial statements of Taggart for the year ended 31
December 20X6.
 Recognition and measurement in the books of lessee
Initial measuring of Lease Liability

Lease © amounts (d)

liability (a) Fixed (b) expected to Exercise
compose payments (e)Penaltie
variable be payable price of a
the less any s for
following lease by the purchase terminatin
lease payments lessee option if
incentives (index) g
receivable under lessee is the lease
residual reasonably
value certain to
guarantees; exerciseth
e option
Recognition and measurement in the books of lessee
 Recognition and measurement in the books of lessee

Subsequent measurement of the lease liability

(a)Increasing the CL to reflect interest on the lease liability;
DR CR
Interest Expense xxx
Lease Liability xxxx
(b) Reducing the CA to reflect the lease payments made;

DR CR
Lease Liability xxx
Bank xxxx

(c) Remeasuring the CA to reflect any reassessment or lease modifications

to reflect revised in-substance fixed lease payments ( change in lease term
or future lease payment or residual value guarantee)
Recognition and measurement in the books of lessee

Initial measuring of Right of use

asset
 Recognition and measurement in the books of lessee
Subsequent Measurement of RoU

(a) any accumulated

depreciation and any
accumulated impairment
losses and
NOTE:
(b) adjusted for any
After the commencement date, a
remeasurement of the
lessee shall measure the right-of-use
lease liability
asset applying a cost model, unless it
applies Fair value model if under IP Lessee shall apply depreciation
class fair value is applied or requirements of IAS 16
revaluation model if is under PPE (UL=Ealier of lease term or
class in which revaluation model is lifetime of the ROU)
applied.
Example 5
 Lessee leases office space from lessor with original
terms as follows
 Size of office space: square meter 5000
 Lease term: 5 years from 1 January 20x1 to December
20x5 with no extension or termination options
 Lease payments $ 100,000 payable annually in arrears
 Implicit borrowing rate: 5%
 Consider the following modifications; In each of the
modifications, lessee and lessor agree to amend the
original lease on 1 January 20x3. All lease payments are
paid annually in arrears
 Modification 1: Leasee and lessor agree on 1 January
20x3 to reduce the annual lease payments to $ 97,000
for the remaining three years. The IBR on 1st January
20x3 is 6% p.a.
 Modification 2: Lease and Lessor agree on 1 January
20x3 to extend the lease upon expiry from 1 January
20x6 for two years at an annual lease payment of $
105,000. The IBR on 1 January 20x3 is 6% p.a
 Modification 3: Lessee and Lessor agree on 1 January
20x3 to lease an additional 1000 sqr meters of office
space from 1 January 20x4 for two years at an annual
lease payment of $ 21,000 which is considered to be at
market rate. The terms of the lease relating to original
5000 sqr meters remain unchanged. The IBR on 1
January 20x4 is 7% p.a
Solution
 RoU Asset
 Bal on 1/01/20x1 [PV of 5 Payments at 5% ] 432,948
 Accumulated Dep (432,948/5 *2) (173,179)
 Balance 1 Jan 20x3 259,769

 Lease Liab [PV of 3 payments at 5%] 272,325

Modification 1
 Modified Rent on $97,000
 Lease Liabilities PV of 3 payments of 97,000 at 6%
 = $259,282
 Difference between Original Lease Liab and Modified
Liability
 =259,282-272,325 = 13,043
 The difference of 13,043 is adjusted against RoU
 Dr Lease Liability 13,043
 Cr RoU 13,043
Amortization of Lease Liab
Year Beg Bal 6% Payment Capital Ending
Interest Repay Bal
2023
Pre M 272,325
Adj (13,043)
Post M 259282 15,557 (97,000) 81,443 177,839
20x4 177,839 10670 (97,000) 86,330 91,509
20x5 91,509 5491 (97,000) 91,509
RoU Asset
Year Beginning Depreciation Ending
Balance Balance
20x3
Pre-M 259,769
Adj (13,043)
Post-M 246,726 (82,242) 164,484
20x4 164,484 (82,242) 82,242
20x5 82,242 (82,242) -
Impact in The Financial Statement for the year
ended 20x3
 Statement of Profit and Loss
 Interest Expense 15,557
 Depreciation 82,242

 Statement of Financial Position

 N/C Assets:
 RoU [Cost 246,726- Acc Dep 82,242] 164484
 Liability
 Non C/L : Lease Liability 91,509
 C/L: Lease Liability 86,330
Modification 2
.
• Extend Lease
IBR: 5% • IBR: 6%

1 Jan x3
1 Jan x1 Effective 31 Dec x5 31Dec x7
Date of
Modification
Extension
Original ($ 100k p.a) ($105k p.a)
Analysis
 As the modification does not add the right to use
one or more underlying assets, it is not accounted
for as a separate lease. Instead, it is accounted
for at the effective date of the lease modification,
which is 1 January 20x3. Accordingly, Lessee
remeasures the existing lease liability on 1
January 20x3 based on the modified lease
payments using the IBR on that date (IFRS
16.45). A corresponding adjustment is made to
the RoU asset (IFRS 16.46(b))
Lessee records the following journal entry on 1
January 20x3:
 Dr RoU Asset 156,608
 Cr Lease Liability 156,608

 To remeasure the lease liability to reflect the modification. This

represents the difference between the original lease liability
($272,325) and the modified lease liability ($428,933) on 1
January 20x3.
 The modified lease liability of $428,933 is calculated as the
present value of three payments of $100,000 from 20x3 to 20x5
and two lease payments of $105,000 from 20x6 to 20x7, all
discounted at 6%
Amortization of Lease Liab
Year Beg Bal 6% Payment Capital Ending
Interest Repay Bal
2023
Pre M 272,325
Adj 156,608

Post M 428933 25736 (100,000) 74264 354669

20x4 354669 21280 (100,000) 78720 275949
20x5 275949 16557 (100,000) 83443 192506
20x6 192506 11550 (105,000) 93450 99057
20x7 99057 5943 (105,000) 99057
RoU Asset
Year Beginning Depreciation Ending
Balance Balance
20x3
Pre-M 259,769
Adj 156,608
Post-M 416377 (83,275) 333,102
20x4 333102 (83,275) 249,826
20x5 249826 (83,275) 166,551
20x6 166551 (83,275) 83275
20x7 83275 (83,275)
Modification Three
 Modification: Lessee and Lessor agree on 1
January 20x3 to lease an additional 1,000m2 of
office space from 1 January 20x4 for two years at
an annual lease payment of CHF21,000, which is
considered to be at market rates. The terms of
the lease relating to the original 5,000m2 remain
unchanged.

 The original 5,000m2 and the additional 1,000m2

of space constitute separate lease components.
The IBR on 1 January 20x4 is 7% p.a.
Analysis
.

Lease additional
space at market
IBR: 5%
rates

1 Jan x3
1 Jan x1 Effective 1 Jan x4 31Dec x5
Date of
Modification

Original 5000 sqr m ($ 100k p.a)

Additional
1000sqr m
($21k p.a)
 The additional 1,000m2 is accounted for as a
separate lease because it increases the scope of
the lease by adding the right to use an underlying
asset (extra space) at market rates (IFRS 16.44).
Furthermore, because the two sets of spaces
constitute separate lease components, the lease
of the original 5,000m2 and the additional
1,000m2 are accounted for independently of each
other
 As a result, the RoU asset and lease liability relating to:
the original 5,000m2 is not affected as there has been no
change to its terms, and
the additional 1,000m2 is recognised on the new lease’s
commencement date, i.e. on 1 January 20x4.
Lessee records the following journal entry on 1
January 20x4:
 Dr RoU asset 37,968
 Cr Lease liability 37,968
To recognise the lease of the additional 1,000m2 on
commencement date of that lease component at the
present value of two payments of CHF21,000 discounted
at 7%.
Lease of existing 5,000m2
Year Beg Bal 5% Payment Capital Ending
Interest Repay Bal
20x3 272325 13616 -100,000 86,384 185,941
20x4 185941 9297 -100,000 90,703 95238
20x5 95238 4762 -100,000 95,238

The pre- and post-modification amount of the lease

liability and RoU asset on 1 January 20x3 is the same as the
modification does not affect the existing lease component
RoU Asset
Year Beginning Depreciation Ending
Balance Balance
20x3 259769 (86,590) 173179
20x4 173179 (86,590) 86590
20x5 86590 (86,590) -
Lease of additional 1,000m2
Year Beg Bal 7% Payment Capital Ending
Interest Repay Bal
20x3
20x4
Pre-IR* NA

IR* 37968
Post IR* 37968 2658 (21,000) 18342 19626
20x5 19626 1374 (21,000) 19626
RoU Asset
Year Beginning Depreciation Ending
Balance Balance
20x3 NA
20x4
Pre-IR NA
IR 37968
Post- IR 37968 (18,984) 18984
20x5 18984 (18,984)
 Recognition and measurement in the books of lessee
Example 6
On 1 January 20X1, Dynamic entered into a two year lease for a
lorry. The contract contains an option to extend the lease term for a
further year. Dynamic believes that it is reasonably certain to
exercise this option. Lorries have a useful life of ten years.
Lease payments are $10,000 per year for the initial term and $15,000
per year for the option period. All payments are due at the end of
the year. To obtain the lease, Dynamic incurs initial direct costs of
$3,000. The lessor immediately reimburses $1,000 of these costs.
The interest rate within the lease is not readily determinable.
Dynamic’s incremental rate of borrowing is 5%.

Required:
Calculate the initial carrying amount of the lease liability and the
right-of-use asset and provide the double entries needed to record
these amounts in Dynamic's financial records.
Recognition and measurement in the books of lessee
Example 7
On 1 January 20X1 Swish entered into a contract to lease a
crane for three years. The lessor agrees to maintain the crane
during the three year period. The total contract cost is
$180,000. Swish must pay $60,000 each year with the
payments commencing on 31 December 20X1. Swish
accounts for non-lease components separately from leases.
If contracted separately it has been determined that the
standalone price for the lease of the crane is $160,000 and the
standalone price for the maintenance services is $40,000.
Swish can borrow at a rate of 5% a year.

Required:
Explain how the above will be accounted for by Swish in the
year ended 31 December 20X1.
 Recognition and measurement in the books of lessee
Example 8
On 1 January 20X1, Kingfisher enters into a four year lease of
property with annual lease payments of $1 million, payable at the
beginning of each year. According to the contract, lease payments
will increase every year on the basis of the increase in the Consumer
Price Index for the preceding 12 months. The Consumer Price Index
at the commencement date is 125. The interest rate implicit in the
lease is not readily determinable. Kingfisher’s incremental
borrowing rate is 5 per cent per year.
At the beginning of the second year of the lease the Consumer Price
Index is 140.

Required:
Discuss how the lease will be accounted for:
 during the first year of the contract
 on the first day of the second year of the contract
 Review questions
Question one
IFRS 16 - Leases was issued in January 2016 and is effective for
accounting periods beginning on or after 1 January 2019. The
IFRS brings significant changes to those leases formerly
classified as operating leases under IAS 17 - Leases, the
previous standard.
 On 1 August 2017, Manfred Plc entered into an agreement to
lease a building for a 10-year period. The lease terms
stipulated that the annual lease rental would be TZS 100,000
per annum in arrears, with the first payment due on 31 July
2018. The interest rate implicit in the lease is 7%, and the
present value of the minimum lease payments is TZS
702,358. Manfred incurred costs of TZS 30,000 in entering
the lease. The lease terms allow for the extension of the
lease at market rental. However, it is not certain that
Manfred will take up this option.
 Review questions
 On the same date, Manfred Plc entered into an agreement to
acquire a motor vehicle. The terms of the agreement were that the
vehicle would be leased for 5 years from the date of inception,
subject to a deposit of TZS 19,972 and 5 annual payments of TZS
6,500 in advance, commencing on 1 August 2017. The fair value of
the vehicle and the present value of the lease payments were TZS
48,000 at inception. The interest rate implicit in the lease is 8%.
REQUIRED:
i. Outline the key principles behind the accounting treatment for
leases as required by IFRS 16.
ii. Show, with appropriate calculations, the accounting entries
required to record each transaction above for the year ended 31
July 2018. Present the relevant extracts from the statement of
profit or loss for the year ended 31 July 2018, and the statement
of financial position as at that date.
 Review questions
Solution (i)
 The approach to leases adopted by IFRS 16 requires the
commitment to make annual payments to be recognised as a
liability, provided the resulting benefit is an asset under the
control of the entity for the term of the lease.
 The asset is recognised at present value of the minimum required
lease payments, and is depreciated over the shorter of the lease
term or the asset’s useful economic life (unless it is highly likely
that the asset will transfer to the lessee at the end of the least
term, in which case the asset’s useful economic life should be
used).
 The liability is initially measured at the present value of
minimum required lease payments, and is subsequently
measured at amortised cost, with finance costs taken to profit or
loss as incurred, using the effective rate implicit in the lease, or
the entity’s cost of capital if the implicit rate is not available.
 Review questions
Question two
a. IFRS 16 – Leases – was issued in January 2016 and applies to accounting
periods beginning on or after 1 January 2019. However, earlier
application is permitted. IFRS 16 replaces IAS 17 – Leases. IFRS 16
makes substantial changes to the requirements for the recognition of
rights and obligations under leasing arrangements for lessees.
Required: Explain:
i. Why the International Accounting Standards Board considered it
necessary to make significant changes to the requirements for the
recognition of rights and obligations under leasing arrangements in
the financial statements of lessees.
ii. How IFRS 16 requires lessees to recognise and measure rights and
obligations under leasing arrangements.
iii. Any exceptions to the usual requirements you have outlined in (ii)
above. Your answer should briefly describe the accounting treatment
required in the case of such exceptions and, where appropriate, the
types of assets which these exceptions might apply to.
 Review questions
b. Kappa prepares financial statements to 30 September each
year. On 1 October 2016, Kappa began to lease a property
on a 10-year lease. The annual lease payments were
$500,000, payable in arrears – the first payment being
made on 30 September 2017. Kappa incurred initial direct
costs of $60,000 in arranging this lease. The annual rate of
interest implicit in the lease is 10%. When the annual
discount rate is 10%, the present value of $1 payable at the
end of years 1–10 is 6·145 dollars.
Required:
Explain and show how these transactions would be reported
in the financial statements of Kappa for the year ended 30
September 2017 under IFRS 16 – Leases.
 Review questions
Solution (a)
i. IAS 17 – the previous financial reporting standard dealing with
leasing – distinguished between two types of lease: finance and
operating. IAS 17 required lessees to recognise rights and obligations
under leasing arrangements in the case of finance leases but not in
the case of operating leases. The distinction between finance leases
and operating leases in IAS 17 was very subjective. Generally
speaking, classifying leases as operating leases led to financial
statements of lessees reporting a more favourable picture than
classifying leases as finance leases. This incentive to treat leases as
operating leases, together with the subjective nature of lease
classification, meant that the requirements in IAS 17 needed
amending.
ii. IFRS 16 requires lessees to recognise a right of use asset and an
associated liability at the inception of the lease. The initial
measurement of the right of use asset and the lease liability will be
the present value of the minimum lease payments.
 The discount rate used to measure the present value of the minimum
lease payments is the rate of interest implicit in the lease (If this rate is
not available to the lessee, then a commercial rate of interest can be
used instead).
 Review questions
 The right of use asset is subsequently depreciated in accordance
with IAS 16 – Property, Plant and Equipment (assuming it is a
tangible asset).
 The lease liability is effectively treated as a financial liability which
is measured at amortised cost, using the rate of interest implicit in
the lease as the effective interest rate.
iii. A short-term lease is a lease which, at the date of
commencement, has a term of 12 months or less. Lessees can
elect to treat short-term leases by recognising the lease rentals
as an expense over the lease term rather than recognising a
‘right of use asset’ and a lease liability. A similar election – on a
lease-by-lease basis – can be made in respect of ‘low value
assets’. Examples of low-value underlying assets can include
tablet and personal computers, small items of office furniture
and telephones. (Note: Any reasonable attempt to describe a
‘low-value’ asset would receive credit.)
 Review questions
Solution (b)
 The initial right of use asset and lease liability would be
$3,072,500 (500,000 x 6·145).
 The initial direct costs of the lessee would be added to the right
of use asset to give an initial carrying amount of $3,132,500
($3,072,500 + $60,000).
 Depreciation would be charged over a ten-year period, so the
charge for the year ended 30 September 2017 would be $313,250
($3,132,500 x 1/10). The closing carrying amount of PPE in non-
current assets would be $2,819,250 ($3,132,500 x 9/10).
 Kappa would recognise a finance cost in profit or loss of $307,250
($3,072,500 x 10%). The closing lease liability would be
$2,879,750 ($3,072,500 + $307,250 – $500,000). Next year’s
finance cost will be $287,975 ($2,879,750 x 10%), so the current
liability at 30 September 2017 will be $212,025 ($500,000 –
$287,975). The balance of the liability of $2,667,725 ($2,879,750 –
$212,025) will be non-current.
.

RECORDING IN THE
BOOKS OF LESSOR
 Accounting for lease in the books of Lessor
 A lessor shall classify each of its leases as either an operating
lease or a finance lease.
 A lease is classified as a finance lease if it transfers substantially
all the risks and rewards incidental to ownership of an
underlying asset.
 A lease is classified as an operating lease if it does not transfer
substantially all the risks and rewards incidental to ownership of
an underlying asset.
 Accounting for lease in the books of Lessor
 Examples of situations that individually or in combination would
normally lead to a lease being classified as a finance lease are:
a) the lease transfers ownership of the underlying asset to the lessee
by the end of the lease term;
b) 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;
c) the lease term is for the major part of the economic life of the
underlying asset even if title is not transferred;
d) at the inception date, the present value of the lease payments
amounts to at least substantially all of the fair value of the
underlying asset; and
e) the underlying asset is of such a specialised nature that only the
lessee can use it without major modifications.
 Accounting for lease in the books of Lessor
Example 6
DanBob is a lessor and is drawing up a lease agreement for a
building.
The building has a remaining useful life of 50 years. The lease term,
which would commence on 1 January 20X0, is for 30 years.
DanBob would receive 40% of the asset’s value upfront from the
lessee. At the end of each of the 30 years, DanBob will receive 6% of
the asset’s fair value as at 1 January 20X0.
Legal title at the end of the lease remains with DanBob, but the
lessee can continue to lease the asset indefinitely at a rental that is
substantially below its market value. If the lessee cancels the lease,
it must make a payment to DanBob to recover its remaining
investment.
Required:
Per IFRS 16 Leases, should the lease be classified as an operating
lease or a finance lease?
Finance
 Accounting for lease in the books of Lessor
Solution
A finance lease is defined by IFRS 16 as a lease where substantially
all of the risks and rewards of ownership transfer from the lessor to
the lessee.
Key indications, according to IFRS 16, that a lease is a finance lease
are as follows:
 The lease transfers ownership of the asset to the lessee by the end
of the lease term.
 The lease term is for the major part of the asset’s economic life.
 At the inception of the lease, the present value of the lease
payments amounts to at least substantially all of the fair value of
the leased asset.
 If the lessee can cancel the lease, the lessor’s losses are borne by
the lessee.
 The lessee can continue the lease for a secondary period in
exchange for substantially lower than market rent payments.
 Accounting for lease in the books of Lessor
The lease term is only for 60% (30 years/50 years) of the asset’s useful
life. Legal title also does not pass at the end of the lease. These factors
suggest that the lease is an operating lease.
However, the lessee can continue to lease the asset at the end of the
lease term for a value that is substantially below market value. This
suggests that the lessee will benefit from the building over its useful life
and is therefore an indication of a finance lease.
The lessee is also unable to cancel the lease without paying DanBob.
This is an indication that DanBob is guaranteed to recoup its
investment and therefore that they have relinquished the risks of
ownership.
It also seems likely that the present value of the minimum lease
payments will be substantially all of the asset’s fair value. The minimum
lease payments (ignoring discounting) equate to 40% of the fair value,
payable upfront, and then another 180% (30 years × 6%) of the fair value
over the lease term. Therefore this again suggests that the lease is a
finance lease.
All things considered, it would appear that the lease is a finance lease.
.

ACCOUNTING FOR
FINANCE LEASE
Accounting for Finance leases
 At the commencement date, a lessor shall 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 .
Non-Manufacturacture/dealer
 The Lease should recognize a lease receivable in the
statement of financial position
 The amount of receivable should be equal to the net
investment in the lease
 Measure the net investment in the lease by using the
interest rate implicit in the lease
 Include initial direct costs incurred by the lessor,
unless the lessor is a manufacturer/ dealer lessor
DR CR
Lease Receivable xxx
PPE xxx
Subsequent Measurement
 A finance income on the lease receivable and the
reduction of the lease receivable should be recognize
by the lessor
 The lessor allocates 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
DR CR
Lease Receivable (SFP) xxx
Finance Income (P/L) xxx

DR CR
Bank (SFP) xxx
Lease Receivable (SFP) xxx
Accounting for Finance leases.
 Accounting for Finance leases

Lease © amounts (d)

Receivabl (a) Fixed (b) expected to Exercise
e payments (e)Penaltie
variable be payable price of a
compose less any s for
the lease by the purchase terminatin
lease payments lessee option if
following
incentives (index) g
receivable under lessee is the lease
residual reasonably
value certain to
guarantees; exerciseth
e option
Accounting for Finance leases
Example 7
 Wheels Ltd enters into a five-year, non-cancellable lease for a car
that commences on January 1, 2008. The total cost of the car is
Tshs160 million and the fair value of the car is Tshs120 million.
Wheels has estimated the economic life of the car to be 5 years
and the car would have no residual value at the end of 5 years.
The lessee must make annual payments of Tshs57.556 million at
the beginning of each year. The present value of the minimum
lease payment is Tshs240 million, based on a market rate of
interest of 10%.
 Wheels Ltd has effectively sold the asset to the lessee and
therefore this would be classified as a finance lease.
Required:
provide the necessary journal entries to record the above
transaction for the year ended 31 December 2008.
Solution
 Lease Receivable = 240M- 57.556= 182.444
 Initial Recognition
 Dr Bank 57.556M
 Dr Lease Receivable 182.444M
 Cr PPE 240M
Journal Entries at 31/12/2008
 Recording of Lease finance Income
 Dr Lease Receivable 18.2444
 Cr Finance Income 18.2444

 Recording of Lease Receipt

 Dr Bank 57.556
 Lease Receivable 57.556
Impact in Financial Statement at 31/12/2008
 Statement of Profit/Loss
 Other Income
 Finance Income 18.444

 Statement of Financial Position

 Assets
 Lease Receivable 143.1324
 Bank 115.112
 Manufacturer or dealer lessors
 At the commencement date, a manufacturer or dealer
lessor shall recognise the following for each of its finance
leases:
a) 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;
b) 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
c) 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 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.
Manufacturer or dealer lessors
d) If artificially low rates of interest are quoted, a
manufacturer or dealer lessor shall restrict selling profit
to that which would apply if a market rate of interest were
charged.
e) A manufacturer or dealer lessor shall recognise as an
expense costs incurred in connection with obtaining a
finance lease at the commencement date because they
are mainly related to earning the manufacturer or
dealer’s selling profit.
f) Costs incurred by manufacturer or dealer lessors in
connection with obtaining a finance lease are excluded
from the definition of initial direct costs and, thus, are
excluded from the net investment in the lease.
Journal Entries
DR CR
Lease Receivable (SFP) XXX
Cost of Goods Sold XXX
Revenue XXX
Inventory XXX

DR CR
Initial direct costs (P/L) XXX
Bank (SFP) XXX
.

ACCOUNTING FOR
OPERATING LEASE
 Operating leases
 A lessor shall recognise lease payments from operating
leases as income on either a straight-line basis or another
systematic basis.
 The lessor shall apply another systematic basis if that basis
is more representative of the pattern in which benefit from
the use of the underlying asset is diminished.
 A lessor shall add initial direct costs incurred in obtaining
an operating lease to the carrying amount of the underlying
asset and recognise those costs as an expense over the lease
term on the same basis as the lease income.
 The depreciation policy for depreciable underlying assets
subject to operating leases shall be consistent with the
lessor’s normal depreciation policy for similar assets.
Journal Entries
DR CR
Bank (SFP) XXX
Lease Rental Income (P/L) XXX

DR CR
Depreciation (P/L) XXX
Accumulated Dep (SFP) XXX

The lessor does not recognize selling profit on

the operating lease as it is not equivalent to a
sale
Example 9
Oroc hires out industrial plant on long-term operating leases.
On 1 January 20X1, it entered into a seven-year lease on a
mobile crane. The terms of the lease are $175,000 payable on 1
January 20X1, followed by six rentals of $70,000 payable on 1
January 20X2 – 20X7. The crane will be returned to Oroc on 31
December 20X7. The crane originally cost $880,000 and has a
25-year useful life with no residual value.
Required:
Discuss the accounting treatment of the above in the year
ended 31 December 20X1.
Operating leases

Solution
Oroc holds the crane in its statement of financial
position and depreciates it over its useful life. The
annual depreciation charge is $35,200 ($880,000/25
years).
Rental income must be recognised in profit or loss on a
straight line basis. Total lease receipts are $595,000
($175,000 + ($70,000 × 6 years)). Annual rental income is
therefore $85,000 ($595,000/7 years). The statement of
financial position includes a liability for deferred income
of $90,000 ($175,000 – $85,000).
Review Question
 During the year ended June 30 2019, BMH leased
several computer equipment for 2years at TZS 20,000
per months from Computer center. The Fair value and
estimated life of the computer equipment were TZS 2
million and 4 years respectively.
 Required
 Prepare the journal entries in Lessor’s books for the
year ended 30 June 2019
 Prepare the Statement of profit and loss (extract) in
Lessor’s books for the year ended 30 June 2019
 Prepare the Statement of Financial Position (extract)
in Lessor’s books for the year ended 30 June 2019
Sale and leaseback transactions
Assessing whether the transfer of the asset is a sale
 An entity shall apply the requirements for determining when a
performance obligation is satisfied in IFRS 15 to determine whether
the transfer of an asset is accounted for as a sale of that asset.
 If the transfer of an asset by the seller-lessee satisfies the
requirements of IFRS 15 to be accounted for as a sale of the asset:
 the seller-lessee shall measure the right-of-use asset arising from
the leaseback at the proportion of the previous carrying amount
of the asset that relates to the right of use retained by the seller-
lessee. Accordingly, the seller-lessee shall recognise only the
amount of any gain or loss that relates to the rights transferred to
the buyer-lessor.
 the buyer-lessor shall account for the purchase of the asset
applying applicable Standards, and for the lease applying the
lessor accounting requirements in this Standard.
Sale and leaseback transactions
 If the fair value of the consideration for the sale of an asset
does not equal the fair value of the asset, or if the payments
for the lease are not at market rates, an entity shall make the
following adjustments to measure the sale proceeds at fair
value:
i. any below-market terms shall be accounted for as a
prepayment of lease payments; and
ii. any above-market terms shall be accounted for as additional
financing provided by the buyer-lessor to the seller-lessee.
Sale and leaseback transactions
 If the transfer of an asset by the seller-lessee does not
satisfy the requirements of IFRS 15 to be accounted for as
a sale of the asset:
 the seller-lessee shall continue to recognise the
transferred asset and shall recognise a financial
liability equal to the transfer proceeds. It shall account
for the financial liability applying IFRS 9.
 the buyer-lessor shall not recognise the transferred
asset and shall recognise a financial asset equal to the
transfer proceeds. It shall account for the financial
asset applying IFRS 9.
 Sale and leaseback transactions
Example 10
On 1 January 20X1, Mosaic sells an item of machinery to Ceramic
for $3 million. Its fair value was $2.8 million. The asset had a
carrying amount of $1.2 million prior to the sale. This sale
represents the satisfaction of performance obligation, in
accordance with IFRS 15 Revenue from Contracts with Customers.
Mosaic enters into a contract with Ceramic for the right to use the
asset for the next five years. Annual payments of $500,000 are due
at the end of each year. The interest rate implicit in the lease is 10%.
The present value of the annual lease payments is $1.9 million.
Required:
Explain how the transaction will be accounted for on 1 January 20X1
by both Mosaic and Ceramic.
Solution
 Cash (FV of asset) = 2.8M
 Carrying Amount= 1.2M
 Lease Liab= PV of Payment – Additional Cash
Consideration = 1.9 -0.2 = 1.7M

 RoU= [Lease Liab/FV * Carrying Amt]

 1.7/2.8 * 1.2= 0.729
 Gain= [FV-Lease Liab]/FV * [FV-Carrying Amt]
 = [2.8 -1.7]/2.8 * [2.8-1.2] = 0.629
Journal Entry
Journal Entries Debit Credit
Cash 2.8

RoU Assets 0.729

Property 1.2
Lease Liabilities 1.7

Gain 0.629
 Sale and leaseback transactions
Example 11
On 1 April 2006, Gamma sold a property to entity A for its fair value
of TZS 1,500,000. The terms and conditions of the sale satisfy the
sale and leaseback requirements of IFRS 15 – Revenue from
Contracts with Customers. The carrying amount of the property in
the financial statements of Gamma at 1 April 2006 was TZS
1,000,000.
The estimated future useful life of the property on 1 April 2006 was
20 years. On 1 April 2006, Gamma entered into an agreement with
entity A under which Gamma leased the property back. The lease
term was for five years, with annual rentals of TZS 100,000 payable
in arrears. The annual rate of interest implicit in the lease was 10%
and the present value of the minimum lease payments on 1 April
2006 was TZS 379,100.
Sale and leaseback transactions
Required
What are the amount to be recognised in the financial
statements at 31 March 2007 in respect of the above
transactions?
IFRS 16

THE END!!!!
Question One
a) A customer enters into a contract with a telecommunications company for network services.
To supply the services, it is necessary to install a server at the customer’s premises. The
supplier can reconfigure or replace the server, when needed, to continuously provide the
network services; the server also has to be operated by the telecommunication company,
but the customer has the right to decide on the speed and the quality of data transportation
in the network using the servers.

 Required:

 Explain if there is lease contract in this arrangement? (10 Marks)

a) Diego prepares financial statements to 30 September each year. On 1 October 2016, Diego
began to lease a property on a 6-year lease. The annual lease payments were $600,000,
payable in arrears – the first payment being made on 30 September 2017. Kappa incurred
initial direct costs of $60,000 in arranging this lease. The annual rate of interest implicit in the
lease is 10%. The lessee and Lessor agreed on guaranteed residual on property of $
5,000,000

 According to the contract, lease payments will increase every year on the basis of the
increase in the Consumer Price Index for the preceding 12 months. The Consumer Price
Index at the commencement date is 125. The interest rate implicit in the lease is not readily
determinable. At the beginning of the second year of the lease the Consumer Price Index is
145.

 Lease and Lessor agree on 1 October 2018 to extend the lease upon expiry 0 for three years
at an annual lease payment of $ 110,000. The IBR on 1 October 2018 is 8% p.a
 Required:

(i) Pass journal entry to record this lease arrangement for the year ended sept 30,
2017 and sept 30, 2019 in the books of Diego. (20 Marks)

(ii) Show how these transactions would be reported in the financial statements of
Diego for the year ended 30 September 2019 (10 Marks)

(iii) Pass journal entry to record this lease arrangement for the year ended sept 30,
2017 in the books of lessor (10 Marks)
a) A seller-lessee sells a building to an unrelated buyer-lessor for cash of $2,000,000.
The fair value of the building at that time is $1,800,000; the carrying amount
immediately before the transaction is $1,000,000. At the same time, the seller-
lessee enters into a contract with the buyer-lessor for the right to use the building
for 18 years, with annual payments of $120,000 payable at the end of each year.
The interest rate implicit in the lease is 4.5%, which results in a present value of the
annual payments of $1,459,200. The transfer of the asset to the buyer-lessor has
been assessed as meeting the definition of a sale under IFRS 15.

 Required: Pass journal entry to record the above arrangement in the books of A
seller-lessee (10 Marks)
 Question 2
 Lessee leases office space from lessor with original terms as
follows
 Size of office space: square meter 5000
 Lease term: 9 years from 1 January 20x1 to December 20x9 with
no extension or termination options
 Lease payments $ 100,000 payable at the beginning of each
year. To obtain the lease, Lease incurs initial direct costs of
$30,000. The lessor immediately reimburses $10,000 of these
costs.
 According to the contract, lease payments will increase every
year on the basis of the increase in the Consumer Price Index
for the preceding 12 months. The Consumer Price Index at the
commencement date is 125. The interest rate implicit in the
lease is not readily determinable. At the beginning of the
second year of the lease the Consumer Price Index is 140.
 Incremental borrowing rate: 5%
 Consider the following modifications; In each of
the modifications, lessee and lessor agree to
amend the original lease on 1 January 20x3. All
lease payments are paid annually in arrears
 Modification 1: Leasee and lessor agree on 1
January 20x3 to reduce the annual lease payments
to $ 97,000 for the remaining three years. The IBR
on 1st January 20x3 is 6% p.a. Also Lessee and
Lessor agreed on guaranteed residual value of asset
of $ 250,000
 Modification 2: Lease and Lessor agree on 1 January
20x3 to extend the lease upon expiry from 1 January
20x10 for three years at an annual lease payment of $
110,000. The IBR on 1 January 20x3 is 8% p.a. The lease
terms give the lessee an option to purchase the
building floor at purchases price of $2500,000 at the
end of extension period. The Lease is certainly that
will take up this option

 Modification 3: Lessee and Lessor agree on 1 January

20x4 to lease an additional 1000 sqr meters of office
space from 1 January 20x5 for three years at an annual
lease payment of $ 25,000 which is considered to be at
market rate. The terms of the lease relating to original
5000 sqr meters remain unchanged. The IBR on 1
January 20x4 is 8% p.a
REQUIRED
 Pass journal entries and show the impact the lease
arrangement in books of lessee for the year ended 20x3 and
20x4 (Consider each modification as separate case)
 Assume the assets has a total cost of $ 600,000 and the fair
value of $680,000 on first January 20x1. Pass journal entry
to record the lease arrangement in the books of lessor.
(Assume the lessor is non-manufacturer/dealer, Also pass
the journal entry by assuming the lessor is
manufacturer/dealer) for the year ended December 20x1
 Assume the asset as per the original lease was sold and
lease back on January 20x5 for $600,000. By that time the
fair value of the asset was $550,000. Show how this
transaction will be accounted.