ACCOUNTING FOR LEASES – PFRS 16

WHAT IS A LEASE?

A lease is a contract, in whole or part, that involves the transfer of rights of

an asset of one party called the lessor, to another party called the lessee, in
exchange for a consideration, usually, a sum certain in money. A contract
of lease exists when the following conditions are satisfied:

1.There should be a transfer of rights over the asset, from the lessor to the
lessee such that, the lessee can determine how, and for what the asset is to
be used.

2. The lessee should be able to benefit substantially, from the use of the
asset.
IFRS 16 Leases - Summary - CPDbox - Making IFRS Easy
SUBSTITUTABILITY OF THE ASSET

Assets that are substitutable such that the lessor is in a position to gain
substantially from such substitution would strip the identity of “lease” from
the contract.
IDENTIFIED ASSET

An identified asset is simply an asset that has been specifically identified, either
implicitly or explicitly in a lease contract.

For example, An acre of land, three houses behind the Meri Cresent mosque,
and in front of the Paris hotel. (Explicitly).

Where say, the lessor mass produces the asset for leasing, or solely deals in such
an asset, the terms of the contract may be implied.

The right-of-use asset and lease liability should be separately presented in the
balance sheet. This helps in the distinguishing of ownership from control,
decision making, etc.
RIGHT-OF-USE (ROU) ASSET

The value of the right of use asset is computed by determining the Net
Present Value (NPV) of all lease payments, including expenses incurred
directly in the prior to, and the day of acquisition of the asset, less any form
of lease incentives. It also involves cost of removal of the asset, and
restoration of land on which the asset is set.

Where the asset is used in the production of inventories, then removal and
restoration costs would be treated in accordance to IAS 2 (Accounting for
Inventories). 
Usually, the NPV is given to avoid long calculations. However, where it is not
given, you must compute it. This is done by multiplying the annual installment
by the discounting factor. Another way of calculating for it is by using the
formula below, where the annual payments are of equal amounts:
                                    A{(1+i)ˆn-1} 
                                     i{(1+i)ˆn}
Where;
A= Equal annual installment of lease to be paid.
i= Implicit interest rate.
n= Lease term.
USEFUL LIFE OR LEASE TERM?

Where depreciating the right of use asset, the accountant may use either its useful life or
lease term depending on the situation at hand.
Where the ownership of the asset is expected to be transferred to the lessee at the end of
the lease term, then, the useful life should be used. However, if that is not the case, then
the lower of the useful life and the lease term should be used.
LEASE IN ARREARS

Leases paid in arrears are coneventional because people are expected to receive
salary and other similar payments at the end of the period. Leases are said to be paid
in arrears if the annual installments are made at the end of the year (On the last day of
the period).

Since such lease payments is conventional, where a question is silent on whether

annual installments were paid in arrears or in advance, we assume such payments
were made in advance.
XYZ Ltd acquired a two-storey building under a contract of lease on
1/1/x5. The agreement entailed an initial deposit of P 5,000, followed by
8-year installments of P1,500. The implicit interest rate estimated by the
auditors was 8%. The useful life however was estimated as 5years, and
the lease liability was initially measured as P 13,620.
(figures in kPhp)

Required:

a.Determine the value of the Right of Use (ROU asset) as at 12/31/x5.

b.The value of current and non-current liabilities as at 12/31/x5.

c.The value to be expensed in the Income Statement.