SIT Internal

ACC2007
COMPANY ACCOUNTING

Seminars 4 and 5: Accounting for Leases

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Learning Objectives
1. Understand the requirements of SFRS(I) 16 Leases

2. Account for leases in the financial statements of a

lessee under the single lessee accounting model

3. Determine the classification of Leases (Finance or

Operating Lease) by a lessor

4. Account for leases in the financial statements of a

lessor

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What is a Lease?

A Contractual Arrangement

Lessor Lessee
Right to control the
(owner) use of an asset
(user)

Periodic
cash
payments

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Why lease and not buy?

• Economic Driven Reasons

– A source of funding
– Manage the need for asset & remain flexible
– Tax benefits under some circumstances & in some countries

• Accounting Driven Reasons

– Off balance sheet debt if structured as operating lease (under IAS 17,
which was heavily criticized for this reason)

– May lower gearing ratios (debt-equity ratio), reduce the probability of

debt covenants violation, improve performance ratios (e.g., ROA,
interest coverage ratio)

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Revised Lease Accounting from 2019

Background:
• The lease accounting model in IAS 17 was criticised for failing to meet the
needs of users of financial statements.
• Because it did not always provide a faithful representation of leasing
transactions, in particular, it did not require lessees to recognise assets and
liabilities arising from operating leases.
– Thus, the IASB and the Financial Accounting Standards Board (FASB) of
the United States commenced a joint project in 2006 to develop a new
approach to lease accounting that requires a lessee to recognise assets
and liabilities for the rights and obligations created by leases.
• The IASB decided to adopt a single lessee accounting model that significantly
changes the lessee accounting requirements in IAS 17, that
– requires a lessee to recognise assets and liabilities for all leases subject
to exemptions, but
– substantially carries forward the lessor accounting requirements in IAS
17.
• IFRS 16 issued in January 2016. Effective date: 1 January 2019.
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Objective and Scope of SFRS(I) 16

• The objective of SFRS(I) 16 is to ensure that lessees and lessors provide
relevant information in a manner that faithfully represents those transactions

• An entity is required to apply SFRS(I) 16 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 held by a
lessee;
c. service concession arrangements within the scope of IFRIC 12;
d. licences of intellectual property granted by a lessor within the scope of
IFRS 16 15; and
e. rights held by a lessee under licensing agreements within the scope of IAS
38 for such items as motion picture films, video recordings, plays,
manuscripts, patents and copyrights. A lessee may, but is not required to,
apply IFRS 16 to leases of intangible assets other than those described in
this point
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Identifying a Lease in SFRS(I) 16

• Lease is defined as:

– 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.

• Underlying asset is defined as:

– An asset that is the subject of a lease, for which the right to use that
asset has been provided by a lessor to a lessee.
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Identifying a Lease in SFRS(I) 16

• The requirements imposed by SFRS(I) 16 implicitly demands an

entity to assess all the contracts and consider them whether
they are in substance a lease.
– The assessment performed at inception of a contract and, specifically,
an entity is required to assess whether the contract is a lease, or
contains a lease (SFRS(I) 16.9).
– After the inception, an entity is only required to reassess, if the terms
and conditions of the contract are changed.

What is “inception of the lease”?

• The inception date of the lease is the earlier of

– the date of the lease agreement and
– the date of commitment by the parties to the principal terms and
conditions of the lease.
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Identifying a Lease in SFRS(I) 16

• To be accounted as a lease, 2 conditions must be met:

An identified Asset Right to

Control the Use
1) Physically distinct 1) The right to obtain substantially
2) The supplier has no substantive all the economic benefits from
right to substitute the asset the use of the asset (e.g. having
throughout the period of use. exclusive use of the asset), and
A supplier’s right to substitute an asset is 2) The right to direct the use of the
substantive only if both of the following asset i.e. how and for what
conditions exist:
purpose the asset is used
(a)the supplier has the practical ability to
substitute alternative assets throughout
throughout the period of use
• See para B26 and B27 for
the period of use; and
(b)the supplier would benefit examples of decision-making
economically from the exercise of its right rights
to substitute the asset
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Is there a lease?
Example 1:

A fragrance company (Customer) enters into a contract with an airport operator

(Supplier) to use a space in the airport to sell its goods for a three-year period. The
contract states the amount of space and that the space may be located at any one of
several boarding areas within the airport. Supplier has the right to change the location
of the space allocated to Customer at any time during the period of use.

The contract does not contain a lease.

There is no identified asset. The contract is for space in the airport, and this space
can change at the discretion of Supplier. Supplier has the substantive right to
substitute the space Customer uses because:
(a)Supplier has the practical ability to change the space used by Customer
throughout the period of use.
(b)Supplier would benefit economically from substituting the space. There would be
minimal cost associated with changing the space used by Customer because the kiosk
can be moved easily. Supplier benefits from substituting the space in the airport
because substitution allows Supplier to make the most effective use of the space at
boarding areas in the airport to meet changing circumstances. 10
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Is there a lease?
Example 2:

Customer enters into a contract with Supplier for the use of a specified ship for a five-
year period. Customer decides what cargo will be transported, and whether, when and
to which ports the ship will sail, throughout the five-year period of use, subject to
restrictions specified in the contract. Those restrictions prevent Customer from sailing
the ship into waters at a high risk of piracy or carrying hazardous materials as cargo.

Supplier operates and maintains the ship and is responsible for the safe passage of the
cargo on board the ship. Customer is prohibited from hiring another operator for the
ship of the contract or operating the ship itself during the term of the contract.

The contract contains a lease.

There is an identified asset i.e. a specified ship, and Supplier does not have the right
to substitute that specified ship.

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Is there a lease?
Example 2 (cont’d)
Customer has the right to control the use of the ship throughout the five-year period
of use because:

(a)Customer has the right to obtain substantially all of the economic benefits from
use of the ship over the five-year period of use. Customer has exclusive use of the ship
throughout the period of use.

(b)Customer has the right to direct the use of the ship. The contractual restrictions
about where the ship can sail and the cargo to be transported by the ship define the
scope of Customer’s right to use the ship. They are protective rights that protect
Supplier’s investment in the ship and Supplier’s personnel. Within the scope of its
right of use, Customer makes the relevant decisions about how and for what purpose
the ship is used throughout the five-year period of use because it decides whether,
where and when the ship sails, as well as the cargo it will transport. Customer has the
right to change these decisions throughout the five-year period of use.

Although the operation and maintenance of the ship are essential to its efficient use,
Supplier’s decisions in this regard do not give it the right to direct how and for what
purpose the ship is used. Instead, Supplier’s decisions are dependent upon Customer’s
decisions about how and for what purpose the ship is used.
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Identifying a Lease in SFRS(I) 16

No
Is there an identified asset?
Yes
Does the customer have the right to obtain substantially No
all of the economic benefits from use of the asset
throughout the period of use?
Yes
Customer Does the customer, the supplier or neither party have the Supplier
right
to direct how and for what purpose the asset is used throughout
the periodNeither;
of use? how and for what purpose the
asset will be used is predetermined
Ye Does the customer have the right to operate the asset
s throughout the period of use, without the supplier having the
right to change those operating instructions?
No
Ye Did the customer design the asset in a way that predetermines
No
s how and for what purpose the asset will be used throughout the
period of use?
Contract contains a lease Contract does not contain a lease
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Lease Term in SFRS(I) 16

• When there is a lease or a lease component in a contract, an entity is
required to determine the lease term as the non-cancellable period of a
lease, together with both:
a. periods covered by an option to extend the lease if the lessee is reasonably
certain to exercise that option; and
b. periods covered by an option to terminate the lease if the lessee is reasonably
certain not to exercise that option.
Para B37-B40 provide a non-exhaustive list of facts and circumstances that should be
considered

• The lease term begins on the “commencement date” of the lease.

Commencement date: The date on which the lessor makes an underlying
asset available for use by the lessee
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Determining the lease term
1. A lease with 2-year initial term and
another 2-year further term.
The lessor has an option to cancel
the further term.
2. A lease with 2-year initial term.
There is renewal option for
another 2 years at a bargain rental
(which is 70% below market rate).
3. A lease with 2-year initial term,
with a renewal option for another
1 year at market rate and a
purchase option to acquire the
asset at a bargain price (10% of the
market value of the used asset) 1
year after the initial term
Examples
• Lease term: 2 years
• The lessee has no discretionary
right to renew
• Lease term: 4 years
• It is reasonably certain that the
lessee will exercise the option
• Lease term: 3 years
• It is reasonably certain that the
lessee will exercise the purchase
option because of the economic
incentive
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Lessee Accounting in SFRS(I) 16

• The single lessee accounting model in SFRS(I) 16 requires a lessee to recognise
assets and liabilities for all leases, unless a lease with a term of less than 12
months, or the underlying asset of a lease is of low value

• Exemptions:
– Short-term leases (i.e. lease term of 12 months or less)
– Lease with low-value underlying asset (when new, are individually of low value)
If exemptions are applied, the lessee shall recognise the lease payments as an
expense on either a straight-line basis over the lease term or another systematic
basis (if that basis is more representative of the pattern of the lessee’s benefit).
[Para 6]

• General principle: at the commencement date, a lessee is required to

recognise
– a right-of-use asset, and
– a lease liability. Right-of-Use Asset
Lease Liability
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Short-term Lease Exemption

• A lease that contains a purchase option cannot be classified as
a short-term lease, irrespective of the probability that the
option will be exercised.

• The election to take the exemption for short-term leases is

required to be made by class of underlying asset (i.e. grouping
of underlying assets of a similar nature and use in an entity’s
operations)

• Example: items of office equipment are considered to be of

the same class, if the entity wishes to use the exemption, it
must apply that exemption for all of the leases with terms of
12 months or less.
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Low-value Asset Exemption

• “Low value” – when it is new, regardless of the age of the asset
• No explicit definition for what is meant by “low-value” assets
• US$5,000 or less [per Basis of Conclusions]
• Assessment as to whether an underlying asset is of low value is
performed on an absolute basis, i.e. the assessment is not
affected by the size, nature or circumstances of the lessee.
Accordingly, different lessees are expected to reach the same
conclusions about whether a particular underlying asset is of
low value.
• Examples: tablet and personal computers, small items of office
furniture, telephones etc.
• Exemption is available on a lease-by-lease basis.
• Assets highly dependent on, or highly interrelated with other
assets do not qualify as low-value assets.
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Accounting for Low-value assets

Co. A leases office equipment for 5 years. The total
value of the equipment when new is $5,000. Co. A
elects to apply the low-value asset exemption.
Lease payments are payable:
Year 1: Rent-free period
Years 2 and 3: $1,750 per year
Years 4 and 5: $1,500 per
year

What is the accounting

treatment of this lease?
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Accounting for Low-value assets

The lessee’s benefit under the lease is accounted for on a
straight-line basis over the lease term.

Total lease payments = ($1,750 x 2) + ($1,500 x 2) = $6,500

Yearly lease expense = $6,500 / 5 years = $1,300

Year 1: Year 2:
Dr. Rent expense $1,300 Dr. Rent expense $1,300
Cr. Rent payable $1,300 Dr. Rent payable $450
Cr. Cash

$1,750 20
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Implications when exemptions are
applied
• Treated as period expense

• Implication: Off Balance Sheet for the lessee

– No asset is recognized.
– No liability is recognized.
– Instead, lease payments for each period are charged as
operating expenses for that period. Accounted for as
executory contracts.

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Lessee Accounting in SFRS(I) 16

Initial Measurement

• At the commencement date, a lessee measures the lease liability at the

present value of the lease payments that are not paid at that date.

• Refer to next slide for components of lease payments

• To determine the present value of the lease payments, SFRS(I) 16 requires

the lease payments to be discounted by using
– the interest rate implicit in the lease,
if that rate can be readily determined; and Lease Liability
– then, the lessee’s incremental borrowing rate,
if the interest rate implicit in the lease cannot be readily determined
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Lease Payments****
Appendix A:
Payments made by a lessee to a lessor relating to the right to use an underlying asset
during the lease term, comprising the following:
(a)fixed payments (including in-substance fixed payments), less any lease incentives
receivable;
(b) variable lease payments that depend on an index or a rate;
(c)the exercise price of a purchase option if the lessee is reasonably certain to exercise
that option; and
(d)payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease.

For the lessee, lease payments also include amounts expected to be payable by the lessee under residual
value guarantees.

For the lessor, lease payments also include any residual value guarantees provided to the lessor by the
lessee, a party related to the lessee or a third party unrelated to the lessor that is financially capable of
discharging the obligations under the guarantee.

Exclude:
• Variable payment not based on an index or rate (e.g. based on sale)
• Payment for non-lease component, e.g. payment for services such as security or maintenance
services
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Lessee Accounting in SFRS(I) 16

Initial Measurement

• In general, assets and liabilities arising from a lease for a lessee are initially
measured on a present value basis.
• Specifically, SFRS(I) 16 requires, at the commencement date, a lessee to
measure the right-of-use asset at cost.
• The cost of the right-of-use asset comprises:
a. the amount of the initial measurement of
the lease liability in SFRS(I) 16; Right-of-Use Asset
b. any lease payments made at or before the commencement date, less any lease
incentives received;
c. any initial direct costs incurred by the lessee; and
d. an estimate of costs to be incurred by the lessee in dismantling and removing
the underlying asset, restoring the site on which it is located or restoring the
underlying asset to the condition required by the terms and conditions of the
lease, unless those costs are incurred to produce inventories
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Initial Direct Costs

Appendix A: Incremental costs of obtaining a lease that would not

have been incurred if the lease had not been obtained, except for
such costs incurred by a manufacturer or dealer lessor in
connection with a finance lease.

Example: costs incurred in negotiating and securing lease

arrangements (commissions, legal fees)
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Lessee Accounting in SFRS(I) 16

Subsequent Measurement
Right-of-Use Asset
• After the commencement date, a lessee
subsequently measures the right-of-use
asset and the lease liability.
• In subsequent measurement of the right-of-
use asset, an entity is required to measure
the right-of-use asset by
Cost
– applying a cost model, Model
– unless it applies one of Measurement
the other measurement models Models
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Lessee Accounting in SFRS(I) 16

Right-of-Use Asset
• To apply a cost model, a lessee is required to
measure the right-of-use asset at cost:
– less any accumulated Cost
Model
depreciation;
– less any accumulated impairment
losses; and
– adjusted for any remeasurement
of the lease liability when
there is any reassessment or
lease modification.
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Depreciation for ROU Assets

A lessee shall apply the depreciation requirements in SFRS(I) 1-16
Property, Plant and Equipment in depreciating the right-of-use
asset, subject to the following:
If the lease transfers ownership of the underlying asset to the
lessee by the end of the lease term or if the cost of the right- of-use
asset reflects that the lessee will exercise a purchase option, the
lessee shall depreciate the right-of-use asset from the
commencement date to the end of the useful life of the underlying
asset.

Otherwise, the lessee shall depreciate the right-of-use asset from

the commencement date to the earlier of the end of the useful life
of the right-of-use asset or the end of the lease term.
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Lessee Accounting in SFRS(I) 16

Right-of-Use Asset
• In addition to measure the right-of-use asset by applying a cost model after
the commencement date, a lessee is required to subsequently measure or
may subsequently measure the right-of-use asset by applying one
of the following other measurement models:
Measurement
Models
– Revaluation model in SFRS(I) 1- 16
When right-of-use assets relate to a class of property, plant and equipment
to which the lessee applies the revaluation model in SFRS(I) 1- 16, a lessee
may elect to apply that revaluation model to all of the right-of-use assets
that relate to that class of property, plant and equipment.

– Fair value model in SFRS(I) 1-40

• When a lessee applies the fair value model in SFRS(I) 1-40 to its
investment property
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Example for Lessee Accounting

Refer to Lecture Illustration

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Example for Lessee Accounting: Extension

• Using the lecture illustration and assume there is variable

lease payment (a.k.a. contingent rent)
• Without variable lease payment,
On 31 December 20X1
Dr Lease Payable $8,104
Dr Interest Expense $1,896
Cr Cash $10,000
(To record the yearly lease payment)

• With variable lease payment (let’s say $500) which is

dependent of some future events e.g. sales
On 31 December 20X1
Dr Lease Payable $8,104
Dr Interest Expense $1,896
Dr Variable Lease Expense $500
Cr Cash $10,500
(To record the yearly lease payment)
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Recap components of ROU asset & Lease
Liability
At commencement

ROU Asset Lease Liability

PV (LP) + Lessee’s IDC
+ lease prepayment
made
- lease incentive PV (LP)
received
+ dismantling restoration
cost if already
recognized as provision

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Lessor Accounting in SFRS(I) 16

• SFRS(I) 16 significantly changes the lessee accounting requirements

in SFRS(I) 1-17, but it substantially carries forward the lessor
accounting requirements in SFRS(I) 1-17 and a lessor continues the
existing practices in SFRS(I) 1-17.

• Accordingly, SFRS(I) 16 continues to require a lessor to classify each

of its leases as either an operating lease or a finance lease (SFRS(I)
16.61) and to account for those two types of leases differently.

Finance Lease Operating Lease

Direct Sales-type
Finance Lease
Lease
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Classification of Leases by Lessor

Lease classification is made at the inception of the lease. Reassessed
only if there is a lease modification
What is “inception of the lease”?

• The inception of the lease is the earlier of

– the date of the lease agreement and
– the date of commitment by the parties to the principal
terms and conditions of the lease.
Finance
Lease
• As at this date:
a) a lease is classified as either or a finance or an operating
lease; and
b) in the case of a finance lease,
Operating Lease
• the amounts to be recognised at the commencement
of the lease term are determined.
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Classification Criteria by Lessor

Operatin
Finance Lease
g Lease

“transfers substantially all the risks and rewards of

ownership of an asset to the lessee”:
Examples of situations that normally lead to a lease being classified as a
finance lease:
1. the lease transfers ownership of the underlying asset to the lessee by the
end of the lease term;
2. 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;
3. the lease term is for the major part of the economic life of the underlying
asset even if title is not transferred;
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Classification Criteria by Lessor

Operatin
Finance Lease
g Lease

“transfers substantially all the risks and rewards of

ownership of an asset to the lessee”:
4. 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
5. the underlying asset is of such a specialised nature
that only the lessee can use it without major
modifications.
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IFRS versus U.S. GAAP

Lease accounting under IFRS and U.S. GAAP provides a good general
comparison of “principles-based accounting” as IFRS often is
described and “rules-based
accounting” which often is the description assigned to U.S.GAAP.

• Situations that normally would lead to • Lease classification rules.

classification as a finance lease are: 1. Transfer of title.
1. Transfer of title. 2. Contains a BPO.
2. Contains a BPO. 3. 75% or more of asset’s
3. Term is “major portion” of asset’s life. life.
4. PV of lease payments greater than 4. 90% or more of fair
“substantially all” of the fair value of the value.
asset.
5. Specialized asset.
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Professional Judgment Required

Three suggestive indicators of a finance lease:

1. if the lessee can cancel the lease, the lessor’s losses associated
with the cancellation are borne by the lessee;
2. gains or losses from the fluctuation in the fair value of the residual
accrue to the lessee; and
3. the lessee has the ability to continue the lease for a secondary
period at a rent that is substantially lower than market rent.

These 5 examples and 3 indicators are not always conclusive. If it is clear from
other features that the lease does not transfer substantially all the risks and
rewards incidental to ownership of an underlying asset, the lease is classified
as an operating lease.
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Operating Leases

Lease Criteria for a

agreement finance lease
exists. not met.

Record lease as an
Operating Lease.
Finance
Lease
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Lessor Accounting
Initial Measurement

At commencement date in statement of financial position

Finance Lease Operating Lease
- Derecognize the underlying - Continue to recognize the
asset and underlying asset and
- Recognize a finance lease - Add any initial direct costs
receivable incurred to obtain the lease
to the carrying amount of the
underlying asset

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Lessor Accounting – Finance Lease
Receivable

At commencement date, lessor measures the finance lease

receivable at the present value* of (a) future lease payments and
(b) unguaranteed residual value accruing to lessor.
*Calculated using the interest rate implicit in the lease

Refer to slide 23
Future lease payments include:
(a) Fixed payments (including in-substance fixed payments) less any lease
incentives payable,
(b) Variable payments that depend on an index or a rate,
(c) Guaranteed residual value or bargain purchase option, and
(d) Penalty payment of termination, which is reflected in the lease term.

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Lessor Accounting
Subsequent Measurement
Finance Lease
Statement of Financial Position
- Adjust finance lease receivable
by lease payments
Statement of Profit or Loss
- Recognize finance income on
finance lease receivable on the
effective interest method
Operating Lease
Statement of Profit or Loss
- Recognize lease payments as
income on either a straight-line
basis or another systematic
basis if it is more representative
of the pattern in which benefit
from the use of the asset is
diminished.
- Recognize depreciation charges
on underlying asset
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Example: Accounting for Operating
Leases by Lessor
On January 1, 2011, Sans Serif Publishers, a computer services and
printing firm, leased a color copier from CompuDec Corporation.
The lease agreement specifies four annual payments of $100,000
beginning January 1, 2011, the inception of the lease, and at each
January 1 thereafter through 2014.The useful life of the copier is
estimated to be six years. Before deciding to lease, Sans Serif considered
purchasing the copier for its cash price of $479,079. If funds were
borrowed to buy the copier, the interest rate would have been 10%.

At each of the Four Payment Dates

CompuDec Corporation (Lessor)
Cash
100,000
Unearned rent revenue

100,000
Example: Accounting for O p e r S IT In ter na l

ating Leases by Lessor

At the End of each Year

CompuDec Corporation (Lessor)

Unearned rent revenue 100,000

Rent revenue 100,000

Depreciation expense xxx

Accumulated depreciation xxx

The lessor retains the asset on

its books and accordingly
records depreciation on the
asset.

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Example: Accounting for Finance Leases
by Lessor

Refer to Lecture Illustration

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Sales-Type Leases
If the lessor is a manufacturer or dealer, the fair value of the leased asset
generally is higher than the cost of the asset.

The manufacturer or dealer lessor earns 2 distinct types of income:

(1) Gross profit on sales, and
(2) Interest income on financing

Any initial direct costs are expensed at the inception of the lease.

Cost Fair Value Gross Investment

Gross Profit Interest Income

or P.V. of Lease
Payments (if
lower)
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Example of Sales-Type Lease

On January 1, 2011, Sans Serif Publishers, leased a copier from
CompuDec Corp. at a price of $479,079 (i.e. P.V. of the lease
payments).

The lease agreement specifies annual payments of $100,000

beginning January 1, 2011 (the inception of the lease), and at
each December 31 thereafter through 2015. The six year lease
term ending December 31, 2016, is equal to the estimated
useful life of the copier.

CompuDec manufactured the copier at a cost of $300,000.

CompuDec’s interest rate for financing the transaction is 10%.

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Example of Sales-Type Lease

Lease Classification
1. The lease term (6-years) is equal to 100% of the useful life of the
copier, and
2. Fair market value is different from the cost of the leased asset.

SO
The lease agreement is classified as a Sales-Type lease from the
viewpoint of CompuDec (lessor).
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Example of Sales-Type Lease

At inception of the Lease – January 1, 2011

CompDec Corp. (Lessor)
Lease receivable 479,079
Cost of goods sold 300,000
Sales 479,079
Inventory
revenue of equipment 300,000

Receipt of the First Lease Payment – January 1, 2011

CompDec Corp.(Lessor)
Cash 100,000
Lease receivable 100,000
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One Major issue with Sales-type Lease

Seller-Lessor charges artificially low interest rate for

the lease financing in order to attract sale

Should the reduction in total

income be deducted from the
gross profit or interest income?

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 [para 73].
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Special Leasing Arrangement

Sale-Leaseback Arrangement – the owner of an asset sells it

and immediately leases it back from the new owner. The
lessee is the seller and the lessor is the buyer of the asset.

• Two things that happen in a sale-leaseback transaction:

– Seller-lessee receives cash from the sale of the asset
– Seller-lessee pays periodic rent payments to the buyer-
lessor to retain the use of the asset

• Common reasons that motivate sale-leaseback:

– Effectively refinance at a lower rate
– To generate cash
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Special Leasing Arrangement

Potential Issues with Sales-Leaseback Arrangements:

Is the transfer of asset a genuine

sale plus a lease transaction?
Can the seller-lessee recognize
the profit or loss on sale
immediately?
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Sale and Leaseback Transactions

1. If transfer of asset satisfies SFRS(I) 15, the transfer is

accounted for as sale of asset.
 Seller-lessee measures ROU asset from leaseback at the proportion
of previous carrying amount of asset relating to the retained right of
use and recognizes any gain or loss relating to the transferred right.

lease liability
ROU asset book value ×
fair value
= (fair value − lease liability)
= (fair value − book value) ×
fair value
Gain/loss on
rights transferred
 Buyer-lessor accounts for the transfer as purchase and the lease per
SFRS(I) 16

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Sale and Leaseback Transactions

2. If transfer of asset does not satisfy SFRS(I) 15 (i.e.

not a sale):
 Seller-lessee continues to recognize the transferred
asset and recognizes a financial liability per SFRS(I) 9 for
the transfer proceeds.
 Buyer-lessor does not recognize the transferred asset
and recognizes a financial asset per IFRS 9 for the
transfer proceeds.

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Example: Sale-Leaseback Arrangement

Transfer of the asset is a sale

On 1 January 20X1, M Airlines sold one of its aeroplanes to S Leasing Co and

immediately leased it back.

This aeroplane was purchased by M Airlines 5 years ago for $200m. Its useful
life was estimated to be 20 years, no residual value and straight-line
depreciation applied.

The selling price was based on the fair value of the aeroplane as at 1 January
20X1 of $180m. At this time, book value of the aeroplane was $150m.

Assume M Airlines leased back for only 5 years (out of the remaining 15 years
of useful life), rate of return on the lease was 10%.

Assume financial year-end on 31 December, lease payments of $23.665m

payable on 31 December each year, starting on 31 December 20X1.
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Example: Sale-Leaseback Arrangement

M Airlines (“seller-lessee”)

Annual lease payment = $23,665,000

No. of payments = 5
Interest rate = 10%

Lease liability = P. V. lease payments = $89,709,000

Gain / Loss on rights transferred

= (FV – BV) x [ (FV – Lease
liability) / FV]
= ($180m – 150m) x [ ($180m -
$89.709m) / 180m]
ROU Asset $15,048,500
= BV x (Lease liability / FV)
= $150m x ($89.709m /
180m)
= $74,757,500
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Example: Sale-Leaseback Arrangement

M Airlines (“seller-lessee”)
(In $’000)

1 January 20X1
Dr Cash 180,000 (Sales
Proceeds)
Dr ROU Asset 74,758 (Calc)
Dr Accumulated Depreciation 50,000
Cr Aeroplane 200,000
Cr Gain on sale (P/L) 15,049 (C)
Cr Lease payable 89,709 (C)

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Example: Sale-Leaseback Arrangement

S Leasing Co. (“buyer-lessor”)

(In $’000)

1 January 20X1
Dr Aeroplane 180,000
Cr Cash 180,000

Assuming that this does not meet the criteria of “finance lease”, hence it is
accounted for as an “operating lease”.

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Summary

Lessee (“renter”)
• Right-of-Use

Lessor (“owner”)
• Transfer of Risk/Rewards to Lessee
So for the same lease, lessee and lessor may account differently.

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Lessee Accounting
E.g.
Recognize ROU asset and Dr ROU asset
lease liability at Cr Lease liability
commencement date Cr Provision for dismantling
unless exemptions elected Cr. Cash

Depreciate ROU asset over the Reduce Lease liability balance and
lease term or useful life* recognize interest expense when
*if assume ownership transfers or cash is paid throughout the lease
purchase option exercised term

Dr Depreciation expense Dr Interest expense

Cr AD – ROU asset Dr Lease liability
Cr Cash

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Lessor Accounting
Transfer of Risk/Rewards
to Lessee?

Use the 5 examples to assess

Yes No

Finance Lease Operating Lease

Reduce Lease Receivable and Asset remains in Lessor’s

Derecognize asset, recognize interest income books, subject to depreciation
instead recognize when cash is received
Lease receivable throughout the lease term
Recognize rental income
throughout the lease term
Direct Finance vs. Sales-Type
Lease
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Other Technicalities

Annuity due
vs Ordinary Identifying All conditions to be met to be
annuity a Lease accounted as a lease

Use of
Determining implicit
a Lease interest rate
term in the lease

Lease Payments =
Fixed / Variable
payments* – Lease Cost of ROU Asset = P.V. Lease
incentive receivable + Composition Composition Payments + Initial direct costs (Lessee)
Purchase Option* + of Lease of ROU + P.V. estimated
Termination Option* Payments Assets dismantling/restoration costs – Lease
+ Guaranteed incentive received
residual value *
*Refer to lecture slide 23 for
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Appendix

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Practical Expedient – Applying to a
portfolio of Leases

• SFRS(I) 16 specifies the accounting for an individual lease but

as a practical expedient, an entity may apply it to a portfolio
of leases with similar characteristics

• Example: an entity enters into a single contract to lease a

number of identical assets (e.g. 20 commercial printers)

• The practical expedient allows the entity to account for the

leases as one portfolio, rather than recognizing and
accounting for 20 leases separately.

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Combining Contracts

• 2 or more contracts that are interdependent should be

combined and accounted for as a single contract. This
requirement applies when:
• The contract are entered into at or near the same
time, and
• The contracts are with the same counterparty (or related
parties of the counterparty), and
• One or more of the following criteria are met:
– The contracts are negotiated as a package with an overall commercial
objective that cannot be understood without considering the contracts
together; or
– The amount of consideration to be paid in one contract depends on
the price or performance of the other contract; or
– The rights to use underlying assets conveyed in the contracts (or some
rights to use underlying assets conveyed in each of the contracts) form
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Separating components of a contract –
Lessee’s perspective

• If a contract is, or contains, a lease, an entity is required to

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 (a lessee may
elect not to separate non-lease components from lease
components and hence, account as a single lease component)

• Examples: a contract for a car may combine a lease with

maintenance services or a single contract may include leases
of land, building and equipment

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Separating components of a contract –
Lessor’s perspective
• A lessor needs to separate lease and non-lease
components

• No practical expedient allowed, unlike lessee as IASB

believes that a lessor should be able to separate payments
for lease and non-lease components. This is because the
lessor would need to have information about the value of
each component or a reasonable estimate of it when
pricing the contract.

• A lessor should allocate the consideration in the contract

by applying paragraphs 73 to 90 of SFRS(I) 15 Revenue
from Contracts with Customers
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Disclosure Requirements
The objective of the disclosures is for lessees / lessors to
disclose information in the notes that, together with the
information provided in the statement of financial position,
statement of profit or loss and statement of cash flows, gives a
basis for users of financial statements to assess the effect that
leases have on the financial position, financial performance and
cash flows of the lessee / lessor.
Paragraphs 52–60 specify lessee’s requirements on how to meet
this objective.
Paragraphs 90–97 specify lessor’s requirements on how to
meet this objective.