Lecture

 1  Accounting  for  Leases  

What  is  a  lease?  

•   Lease  does  not  require  disclosure  on  the  balance  sheet  

•   Lease  payments  are  typically  treated  as  rental  expenses  (appear  only  in  Income  
Statement)  
•   Only  applies  to  short  term  or  low  value  assets  
 
Finance  leases  (on-­‐balance  sheet)  
•   Lease  liability  and  asset  recognized  at  inception  of  lease  
•   Lease  payments  allocated  between  interest  component  (expense)  and  reduction  in  lease  
principal  (lease  liability)  
•   Increased  debt  ratio  and  lower  return  on  assets  may  impact  on  perceptions  of  operating  
performance  
 
Current  regulatory  framework  
•   AASB  117:  a  lot  of  effort  went  into  distinguishing  a  lessee’s  operating  leases  (off-­‐balance  
sheet)  and  finance  leases  (on-­‐balance  sheet)  
•   AASB  16:  effectively  requires  that  ALL  leases  are  on  the  lessee’s  balance  sheet  
•   AASB  16  has  two  key  requirements  for  lessees  accounting  for  leases:  
(1)   Identify  whether  a  contract  contains  a  lease  
a.   Is  there  an  Identified  Asset?  
v   AASB  16  (para.  B13)  states  that  ‘an  asset  is  typically  identified  as  being  
explicitly  specified  in  a  contract.’  
b.   Is  there  a  Right  to  control  the  use  of  an  identified  asset?  
v   This  exists  when  the  customer  has  a  right:  
§   To  obtain  economic  benefits  from  use  of  the  identified  asset  (benefit)  
§   To  direct  the  use  of  that  asset  (power)  
(2)   Separating  the  components  of  a  contract  

 
Accounting  by  the  Lessee  
•   AASB  16  para.22:  ‘At  the  commencement  date,  a  lessee  shall  recognize  a  right-­‐of-­‐use  
asset  and  a  lease  liability’  
•   Exception:  if  the  lease  is:  
-­‐   Short  term  (<12  months  duration)  
-­‐   The  underlying  asset  of  low  value  (<$5,000)  
 ◊   NPV  of  the  lease  liability:  
-­‐   𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡  𝑟𝑎𝑡𝑒 = 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡  𝑟𝑎𝑡𝑒  𝑖𝑚𝑝𝑙𝑖𝑐𝑖𝑡  𝑖𝑛  𝑡ℎ𝑒  𝑙𝑒𝑎𝑠𝑒  
-­‐   𝑝𝑟𝑒𝑠𝑒𝑛𝑡  𝑣𝑎𝑙𝑢𝑒  𝑜𝑓  𝑡ℎ𝑒  𝑙𝑒𝑎𝑠𝑒  𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠  𝑎𝑛𝑑  𝑡ℎ𝑒  𝑢𝑛𝑔𝑢𝑎𝑟𝑎𝑛𝑡𝑒𝑒𝑑  𝑟𝑒𝑠𝑖𝑑𝑢𝑎𝑙  𝑣𝑎𝑙𝑢𝑒 =
𝑡ℎ𝑒  𝑠𝑢𝑚𝑒  𝑜𝑓  𝑡ℎ𝑒  𝑓𝑎𝑖𝑟  𝑣𝑎𝑙𝑢𝑒  𝑜𝑓  𝑡ℎ𝑒  𝑢𝑛𝑑𝑒𝑟𝑙𝑦𝑖𝑛𝑔  𝑎𝑠𝑠𝑒𝑡  𝑎𝑛𝑑  𝑎𝑛𝑦  𝑖𝑛𝑖𝑡𝑖𝑎𝑙  𝑑𝑖𝑟𝑒𝑐𝑡  𝑐𝑜𝑠𝑡𝑠  𝑜𝑓  𝑡ℎ𝑒  𝑙𝑒𝑠𝑠𝑜𝑟  
o   initial  direct  costs:  costs  directly  attributable  to  negotiating  and  arranging  
the  lease  (e.g.  commissions,  legal  fees,  costs  of  preparing  and  processing  
documents)  
 
Example  1:  

(1)   Determine  the  interest  rate  implicit  in  lease  

Beginning  of  the  lease  term  1/07/18   Present  Value  
Payment  on  1/07/18   $20,000  
+Annuity  of  4  payments  at  year  end   PV  Annuity  
Equals  Fair  Value  at  1/07/18   $80,747  
 
(2)   Determine  the  amount  of  the  lease  liability  
𝑁𝑃𝑉 = 𝑖𝑛𝑖𝑡𝑖𝑎𝑙  𝑝𝑎𝑦𝑚𝑒𝑛𝑡 + 𝑃𝑉  𝑎𝑛𝑛𝑢𝑖𝑡𝑦  𝑓𝑜𝑟  𝑟𝑒𝑚𝑎𝑖𝑛𝑖𝑛𝑔  4  𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠  
                   = $20,000 + $60,747  
                   = $80,747  
 
20,000 1
𝑁𝑃𝑉 = 1− = $60,474  
𝑟 (1 + 𝑟)F
20,000 1
                   = 1−  
0.12 (1 + 0.12)F
 
(3)   Determine  the  amount  of  the  right-­‐of-­‐use  asset  
Lease  liability   $60,474  
+  Lessee’s  initial  direct  costs   -­‐  
+  Payments  at/before  commencement  date   20,000  
-­‐  Less  incentives  received   -­‐  
+  Estimated  cost  of  dismantling/restoring  asset   $80,474  
 
 
 
 ◊   Schedule  of  lease  liability  payments  and  interest  
Period   Lease   Lease   Reduction   Interest   Lease  
liability   payment   in  lease   expense   liability  
(opening   (cash)   liability   (@12%)   (close  
bal.)   balance)  
1/07/2018   $80,474   $20,000   $20,000   -­‐   $60,474  
30/06/2019   60,474   20,000   12,710   $7,290   48,037  
30/06/2020   48,037   20,000   14,236   5,764   33,801  
30/06/2021   33,801   20,000   15,944   4,056   17,857  
30/06/2022   17,857   20,000   17,857   2,143   -­‐  
 
(4)   Initial  recognition  of  lease  liability  and  right-­‐of-­‐use  asset  by  Mercy  Ltd  
Dr  Right-­‐of-­‐use  asset:  Equipment   80,474    
           Cr  Lease  liability     80,474  
     
Dr  Lease  liability   20,000    
         Cr  Cash     20,000  
 
(5)   Subsequent  measurement  of  lease  liability  
30  June  2019  
Dr  Interest  expense   7,290    
Dr  Lease  liability   12,710    
         Cr  Cash     20,000  
 
(6)   Subsequent  measurement  of  right-­‐of-­‐use  asset  
o   Lease  assets  should  be  depreciated  using  the  depreciation  policies  
normally  followed  by  the  lessee  

30  June  2019  
Dr  Depreciation  expense   16,149    
         Cr  Accumulated  depreciation     16,149  
 
Classification  of  leases  by  lessor  
◊   Two  different  types  of  leases:  
-­‐   Finance  lease  
-­‐   Operating  lease  
◊   Classification  depends  on  the  substance  of  the  transaction  rather  than  the  form  of  the  
contract  (para.10,  AASB  117)