IFRS 16 - Leases

Chapter 12
Learning objectives
 Definitions
• 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.
• The lessor is the 'entity that provides
the right to use an underlying asset in
exchange for consideration.
 Definitions (cont.)
• The lessee is the 'entity that obtains
the right to use an underlying asset in
exchange for consideration.'
• A right-of-use asset 'represents the
lessee's rights to use an underlying
asset for the lease term.'
Lessee accounting
 Lessee accounting
Basic principle
• At the commencement of the lease, the
lessee should recognize a lease liability
and a right-of-use asset
Initial measurement
• The lease liability is initially measured at
the present value of the lease payments
that have not yet been paid.
 Initial measurement
Lease payments should include the following
(IFRS 16, para 27):
• Fixed payments
• Amounts expected to be payable under
residual value guarantees
• Options to purchase the asset that are
reasonably certain to be exercised
• Termination penalties, if the lease term
reflects the expectation that these will be
incurred.
 Initial measurement
(cont.)
• A residual value guarantee is when the
lessor is guaranteed that the underlying
asset at the end of the lease term will not
be worth less than a specified amount.
• The discount rate should be the rate
implicit in the lease. If this cannot be
determined, then the entity should use
its incremental borrowing rate (the rate
at which it could borrow funds to
purchase a similar asset).
 The right-of-use asset
The right-of-use asset is initially
recognized at cost.
The initial cost of the right-of-use asset
comprises (IFRS 16, para 24):
• The amount of the initial measurement of
the lease liability
• Lease payments made at or before the
commencement date
 The right-of-use asset
(cont.)
• Any initial direct costs
• The estimated costs of removing or
dismantling the underlying asset as per
the conditions of the lease.
 The lease term
To calculate the initial value of the liability and
right-of-use asset, the lessee must consider the
length of the lease term. The lease term
comprises:
• Non-cancellable periods
• Periods covered by an option to extend the
lease if reasonably certain to be exercised
• Periods covered by an option to terminate the
lease if these are reasonably certain not to be
exercised.
 Test your
understanding 1
 Subsequent
measurement
The liability
Dr Finance costs (SPL) X
Cr Lease liability (SFP) X

The carrying amount of the lease liability

is reduced by cash repayments:
Dr Lease liability X
Cr Cash X
Payments in arrears or
in advance
Payments in arrears
Year Balance b/f Interest Payment Balance c/f
1 X X (X) X
2 X X (X) X
(NCL)

Payments in advance
Year Balance b/f Payment Subtotal Interest Balance c/f
1 X (X) X X X
2 X (X) X X X
(NCL)
 The right-of-use asset
The right-of-use asset is measured using the cost
model (unless another measurement model is
chosen). This means that the asset is measured at
its initial cost less accumulated depreciation and
impairment losses.
Depreciation is calculated as follows:
• If ownership of the asset transfers to the lessee
at the end of the lease term then depreciation
should be charged over the asset's useful life,
• Otherwise, depreciation is charged over the
shorter of the useful life and the lease term
(as defined previously).
 Short-life and low
value assets
• If the lease is short-term (less than 12
months at the inception date) or of a
low value then a simplified treatment is
allowed.
• In these cases, the lessee can choose
to recognize the lease payments in
profit or loss on a straight line basis.
No lease liability or right-of-use asset
would therefore be recognized.
 Illustration 2
On 1 April 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 March 20X7 and 31 March 20X8.
Show the impact of this lease
arrangement on the financial
statements of Taggart for the year
ended 31 December 20X6.
 Mid-year entry into a
lease
• If a company enters into a lease part-
way through the year, the depreciation
and interest will need to be time-
apportioned.
• The liability table is likely to need extra
columns to split the table between pre-
and post-payment.
 Illustration 3
Shaeen Ltd entered into an agreement to lease
an item of plant on 1 October 20X8. The lease
required four annual payments of $200,000
each, commencing on 1 October 20X8. The
plant has a useful life of four years and is to be
scrapped at the end of this period. The present
value of the lease payments is $700,000. The
implicit interest rate within the lease is 10%.
Prepare extracts of the financial statements
in respect of the leased asset for the year
ended 31 March 20X9.
 Sales and leaseback
• If an entity (the seller-lessee) transfers an asset
to another entity (the buyerlessor) and then
leases it back from the buyer, the seller-lessee
must assess whether the transfer should be
accounted for as a sale.
• For this purpose, the seller must apply IFRS 15
Revenue from Contracts with Customers to
decide whether a performance obligation has
been satisfied. This normally occurs when the
buyer obtains control of the asset. Control of an
asset refers to the ability to obtain substantially
all of the remaining benefits
 Transfer is not a sale
• If the transfer is not a sale then the
seller-lessee continues to recognize the
transferred asset and will recognize a
financial liability equal to the transfer
proceeds.
• In simple terms, the transfer proceeds
are treated as a loan. The detailed
accounting treatment of financial assets
and financial liabilities is covered in
Chapter 9.
 Transfer is a sale
• If the transfer does qualify as a sale
then the seller-lessee must measure
the right-of-use asset as the
proportion of the previous carrying
amount that relates to the rights
retained.
• This means that the seller-lessee will
recognize a profit or loss based only on
the rights transferred to the buyer-
lessor.
 TUY 3.
On 1 January 20X1, Painting sells an item of machinery
to Collage for its fair value of $3 million. The asset had a
carrying amount of $1.2 million prior to the sale. This sale
represents the satisfaction of a performance obligation, in
accordance with IFRS 15 Revenue from Contracts with
Customers. Painting enters into a contract with Collage
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. The remaining useful life of the machine is much
greater than the lease term.
Required: Explain how Painting will account for the
transaction on 1 January 20X1.
 Test your
understanding 4