SLFRS 16

Leases

Lesson Content
1. Introduction and definitions
2. Lessee accounting
3. Lessee accounting: reassessment and modification

K
4. Lessors: Lease classification
5. Lessor accounting

.L
6. Sale and leaseback transactions

2. LESSEE ACCOUNTING

G
A single lessee accounting model is applied to all leasing arrangements with two

IN
exceptions, which can be accounted for using simplified accounting.

2.1 RECOGNITION EXEMPTION (SIMPLIFIED ACCOUNTING)

T
A company can elect not to apply the lessee accounting rules to

Short-term leases N
These are leases with a term of 12 months or less. A lease that contains a purchase option
U
cannot be a short-term lease.

Leases of low-value assets

O

These are leases for underlying assets with low values when new (such as tablet and
personal computers or small items of office furniture and telephones). Low value is not
C

defined in the standard, however the Basis for Conclusions refers to individual assets
with a value (when new) of US$5,000 or less.
C

The election must be made by class of short term leases but may be made on a lease by
A

lease basis for low value assets.

If such an election is made, the rental costs of the assets are recognised in profit or loss
E

on a straight line basis or some other systematic basis if that gives a better reflection of
the benefit arising from the asset.
N

Question 1 – Simplified accounting

LI

Casey Recruitment Co (CRC) enters into the following lease arrangements in the year
ended 31 December 2017:
N

1. An agreement to use 100 tablet computers for two years. Each tablet has a cash
O

cost when new of Rs. 84,000 each

2. An agreement to lease a module to increase the storage capacity of the mainframe
server. The server was obtained through a lease arrangement in 2014. The module
has a cash cost of Rs. 140,000.
3. An agreement to obtain use of additional office space for the duration of a
customer contract. The lease term is 3 years, with a break clause at 12 months.
 CRC expects its contracted work for the customer to be complete within 12
months and therefore expects to exercise the break clause.

Required
Explain whether simplified accounting can be applied to these lease agreements.

Question 2 – Simplified accounting

K
On 1 January 2013 Alahakoon entered into a lease contract to obtain the use of 7 tablet

.L
computers for its staff. The tablets would have cost Rs. 795,000 to buy outright. The terms
of the lease agreement require an initial non-refundable deposit of Rs. 32,000 and then
quarterly rentals of Rs. 28,000 paid in arrears for 4 years.

G
Required

IN
Record the expense recognised in Alahakoon's financial statements in the year ended 31
March 2013 assuming that it elects to apply the recognition exemption. Assume 1st
quarter payment is made.

T
2.2 INITIAL RECOGNITION

N
A lease is capitalised at the commencement of the lease term. This involves the
recognition of the asset that is subject to the lease (the underlying asset) and a liability
U
for the future lease payments.
O

The initial double entry is based on the lease liability but the asset might also contain
other components in its initial measurement.
C

Illustration: Double entry (in part) on initial recognition of a lease

C

Debit Credit
Right-of-use Asset XXX
A

Lease liability XXX

E

Initial measurement of the lease liability

N

The lease liability is measured at the commencement date as the present value of the
lease payments not yet paid at that date.
LI

The lease payments are discounted using the interest rate implicit in the lease or, if that
rate cannot be readily determined, the lessee’s incremental borrowing rate is used.
N

Definition: Lessee’s incremental borrowing rate

Lessee’s incremental borrowing rate: The rate of interest that a lessee would have to pay
O

to borrow over a similar term, and with a similar security, the funds necessary to obtain
an asset of a similar value to the right-of-use asset in a similar economic environment.

The liability is the capital amount (the principal) that the lessee will have to pay back to
the lessor over the term of the lease. It is the present value of the lessee’s lease payments.
 Initial measurement of the right-of-use asset

The right of use asset is measured at the commencement date as follows:

Rs.
Initial measurement of the lease liability xxx
Lease payments made at or before the commencement date (less lease xxx

K
incentives received)
Initial direct costs incurred (by the lessee) xxx

.L
Estimate of the costs of dismantling and removing the asset and restoring the xxx
site where it is located (when the entity has an obligation to dismantle and
remove the asset at the end of its life)

G
Right-of-use asset xxx

IN
Question 3 – Initial measurement of a lease liability & ROU asset

X plc enters into a lease. The following information is relevant:

T
X Plc must pay five annual rentals of Rs. 100,000 in arrears.

Rs. 40,000.
X Plc incurs initial direct costs of Rs. 5,000.
N
X Plc must also guarantee the residual value of the asset at the end of the lease term to be
U
The interest rate implicit in the lease is 8%.
O

Required
C

What is the lease liability and ROU asset?

2.3 SUBSEQUENT MEASUREMENT

C

Subsequent measurement of the asset

A

After the commencement date, a right-of-use asset is measured using a cost model unless
E

it is a type of asset for which an alternative measurement model is being used.

N

 If a lessee uses the LKAS 40: Investment property fair value model for its
investment properties, that model must be used for right-of-use assets that meet
LI

the definition of investment property; and

 If a lessee applies the revaluation model in LKAS 16: Property, plant and
N

equipment to a class of property, plant and equipment it may elect to apply the
same accounting treatment to all right-of-use assets that relate to that class.
O

The rules in IAS 36: Impairment of assets apply to right-of-use assets in the usual way.

Cost model

The cost model is used in the usual way by applying the depreciation requirements in
LKAS 16: Property, plant and equipment.
 The asset is measured as follows using the cost model:

Illustration: Carrying amount of a right-of-use asset

Rs.
The amount recognised on initial recognition of the lease xxx
Less accumulated depreciation and accumulated impairment loss xxx

K
Carrying amount xxx

.L
An asset is depreciated from the commencement date to the end of its useful life when:

 the lease transfers ownership of the underlying asset to the lessee by the end of

G
the lease term; or
 if the cost of the right-of-use asset reflects that the lessee will exercise a purchase

IN
option.

In other cases the asset is depreciated from the commencement date to the earlier of:

T
 the end of its useful life; or
 the end of the lease term

Question 4 – Subsequent measurement of ROU asset

N
U
X Plc enters into a 5-year lease of a machine on 1 January Year 1.
O

The lease liability at the commencement of the lease was Rs. 426,494 and X Plc incurred
C

initial direct costs of Rs. 5,000 when arranging the lease.

X Plc has guaranteed the residual value of the asset at the end of the lease term at Rs.
40,000.
C

The estimated useful life of the asset is 5 years.

The accounting policy for similar owned machines is to depreciate them over their useful
A

life on a straight line basis.

E

Required
What is the value should be recorded in terms of ROU asset?
N

Subsequent measurement of the lease liability

LI

During each year, the lessee makes one or more lease payments. The payment is recorded
in the ledger account as follows.
N

Illustration: Lease payment

O

Debit Credit
Lease liability XXX
Cash/Bank XXX

A lease liability is measured as follows at each reporting date:

 Illustration: Subsequent measurement of lease liability

Rs.
The amount recognised on initial recognition of the lease xxx
Plus: Interest accrued xxx
Minus: Repayments (lease payments) (xxx)

K
Lease liability xxx

.L
In effect, each lease payment consists of two elements:
 a finance charge (interest charge) on the liability; and
 a partial repayment of the liability.

G
The finance charge is treated as a finance cost in profit or loss for the period. The partial

IN
repayment of the lease obligation reduces the amount of the liability that remains unpaid.

Finance charge

T
The total rental payments over the life of the lease will be more than the amount initially
recognised as a liability. The difference is finance charge.

Illustration: Total finance charge

N
U
Rs.
O

Lessee’s lease payments (total) xxx

Amount on initial recognition (xxx)
Total finance charge xxx
C

The finance charge (interest) is recognised over the life of the lease by adding a periodic
C

charge to the lease liability with the other side of the entry as an expense in profit or loss
for the year.
A

Current and non-current elements of the lease liability

E

The total liability must be divided between:

N

 the current liability (amount payable within the next 12 months), and
 the non-current liability.
LI

The easy way to do it is to use the tables to identify the current liability or the noncurrent
liability and then find the other as a balancing figure.
N

Question 5 – Subsequent measurement of lease liability (Paid in arrears)

O

X Plc enters into a 5-year lease of a machine on 1 January Year 1.

The lease liability at the commencement of the lease was Rs. 426,494 and X Plc incurred
initial direct costs of Rs. 5,000 when arranging the lease.
 X Plc has guaranteed the residual value of the asset at the end of the lease term at Rs.
40,000.

The interest rate implicit in the lease is 8%.

Required
a) What is the value should be recorded in terms of lease liability?

K
b) Classify current liability component
c) What is the entry for final payment in respect of the guaranteed residual value

.L
d) What is the entry at the end of the lease term the asset has a carrying amount of
Rs. 40,000 at the end of the lease but is only worth Rs. 35,000.

G
Question 6 – Subsequent measurement of lease liability (Paid in advance)

IN
X plc enters into a lease. The following information is relevant:

X Plc must pay five annual rentals of Rs. 100,000 in advance.

X Plc must also guarantee the residual value of the asset at the end of the lease term to be

T
Rs.40,000.
X Plc incurs initial direct costs of Rs. 5,000.
N
The interest rate implicit in the lease is 12.37%.
U
Required
O

What is the value should be recorded in terms of ROU asset & Lease liability?

Impact of using the lessee’s incremental borrowing rate

C

The above section illustrated that the initial right of use asset and the total finance charge
C

is the same for two leases whose only difference is that payments are made in advance
for one and in arrears for the other provided the interest rate implicit in the lease is used
A

to measure the lease liability.

E

This is not the case if the lessee’s incremental borrowing rate is used (because the interest
rate implicit in the lease is not readily determinable). This is because the same discount
N

rate would be used for payments in advance and for payments in arrears.

2.4 PRESENTATION
LI

Statement of financial position

Right of use assets must either be presented separately in the statement of financial
N

position or disclosed in the notes. If not presented separately, right of use assets are
included in the same line item as the corresponding underlying assets would be if they
O

were owned and this must be disclosed. This does not apply to right-of-use assets that
meet the definition of investment property, which must be presented in the statement of
financial position as investment property.
 Lease liabilities must either be presented separately in the statement of financial position
or disclosed in the notes. If not presented separately, the line item in which they are
included must be disclosed.

Statement of profit or loss

Interest expense on the lease liability must be presented separately (as a component of
finance costs) from the depreciation charge for the right-of-use asset.

K
Statement of cash flows

.L
Cash payments for the principal portion of the lease liability must be classified within
financing activities.

G
Cash payments for the interest portion of the lease liability are classified by applying the
requirements in LKAS 7: Statement of Cash Flows for interest paid.

IN
Short-term lease payments, payments for leases of low-value assets and variable lease
payments not included in the measurement of the lease liability are classified within
operating activities.

T
2.5 DISCLOSURE
N
Information is provided that, together with the information provided in the primary
U
financial statements gives users a basis to assess the effect that leases have on the
financial position, financial performance and cash flows of the lessee.
O

Information is disclosed in a single note (or separate section of the financial statements).
However, information already presented elsewhere in the financial statements, does not
C

need to be duplicated as long as the information is incorporated by cross-reference in the

single note or separate section about leases.
C

The following must be disclosed:

A

 depreciation charge for right-of-use assets by class of underlying asset;

 interest expense on lease liabilities;
E

 expense relating to:

o short-term leases accounted for by applying the recognition exemption
N

(but not that relating to leases with a lease term of one month or less);
o leases of low-value assets accounted for by applying the recognition
exemption (but not that relating to short-term leases of low-value assets
LI

included above);
o variable lease payments not included in the measurement of lease
liabilities;
N

 income from subleasing right-of-use assets;

 total cash outflow for leases;
O

 additions to right-of-use assets;

 gains or losses arising from sale and leaseback transactions; and
 the carrying amount of right-of-use assets at the end of the reporting period
byclass of underlying asset.
 These disclosures should be given in a tabular format, unless another format is more
appropriate. Amounts disclosed must include costs that are included in the carrying
amount of another asset during the reporting period.

The LKAS 40: Investment property disclosures apply to right-of-use assets that meet the
definition of investment property.

K
Disclosure requirements of LKAS 16: Property, plant and equipment apply to right-of-use
assets revalued in accordance with that standard.

.L
SLFRS 7; Financial Instruments: Disclosures requires a maturity analysis for non-
derivative financial liabilities. The requirement is to provide information on the

G
contracted undiscounted future cash. A similar disclosure must be provided for lease
liabilities separately from the maturity analyses of other financial liabilities. As this is a

IN
disclosure of undiscounted cash flows it will not agree with the balance of the liabilities
in the statement of financial position which represent discounted amounts. However, the
two can be reconciled be deducting future finance charges from the undiscounted
amount.

T
Example: Lease liability maturity analysis

Lease payments
N Gross
U
Rs.
No later than 1 year 100,000
Later than 1 year and no later than 5 year 340,000
O

(3 * 100,000 + 40,000)
Later than 5 years nil
C

440,000
Less finance charge that relates to future periods (73,119)
C

(113,506 - 40,387)
A

Present value of lease liabilities (the total lease liability) 367,881

E
N
LI
N
O