IFRS

16:LEASES
 IFRS 16: LEASES

 IAS 17 OLD STANDARD

 SIC 15 OPERATING LEASE INCENTIVES
IFRIC 4 DETERMINING WHETHER AN ARRANGEMENT CONTAINS A LEASE IFRS 16 NEW
 CLASSIFICATION BASED ON
 Risk and rewards (5…8)
 Lessor accounting still IAS 17
 For Lessee and Lessor
 First classify (5…) and do
 Finance lease/Operating lease finance or operating lease
 Lessee accounting single
accounting model (2 exemptions
(low value/<12 months)
 No classification needed
 Scope of IFRS16

Apply IFRS 16 to all leases, except:

Leases to explore for or use minerals, oil, natural gas and
similar non-regenerative resources
Lease of biological assets within scope of IAS41 held by lessee
Service concession arrangements within the scope of IFRIC12
Licences of intellectual property granted by lessor within the
scope of IFRS15
Rights held by lessee under licensing agreements for items
such as motion picture films, video recordings, plays, scripts,
patents and copyrights within the scope of IAS38
 MAIN FEATURES OF IFRS 16
 IFRS 16 introduces a single lessee accounting model and
requires a lessee to recognise assets and liabilities for all leases
with a term of more than 12 months, unless the underlying
asset is of low value.
 The new lease accounting standard (IFRS 16) will require
lessees to bring most leases onto their statement of financial
position.
 A lessee is required to recognise a right-of-use asset
representing its right to use the underlying leased asset and a
lease liability representing its obligation to make lease
payments.
 MAIN FEATURES OF IFRS 16

 A lessee measures right-of-use assets similarly to other non-

financial assets (such as PPE) and lease liabilities similarly to
other financial liabilities.
 Assets and liabilities arising from a lease are initially measured
on a present value basis.
 As a consequence, a lessee recognises depreciation of the
right-of-use asset and interest on the lease liability, and also
classifies cash repayments of the lease liability into a principal
portion and an interest portion and presents them in the
statement of cash flows applying IAS 7 Statement of Cash
Flows.
 Objective of IFRS16

To ensure that lessees and lessors:

• provide relevant information
• for users to assess the effect that leases have on
• the financial position,
• financial performance and
• cash flows of an entity.
  Overview
LESSOR
Legal form =
Asset belong to the lessor; lessee
can only use it.
Lessor keeps the asset in its book
& recognise rental income; lessee
recognises rental expense
This treatment applies to the:
Lessor → for operating leases
Lessee → for short-term or low-
value leases
LESSEE
Right of use
of asset
Substance =
Lessee’s right to use is an asset.
A lease is in substance a purchase
transaction with financing: Lessee
“purchases” the asset and
recognises a “loan” to repay the
lessor (in the form of lease
instalments)
This treatment applies to the:
Lessor → for finance leases
Lessee → for all leases except
short-term and low-value leases
 A selection of definitions
Lease (a contract or part of a contract that conveys the right of use of an
asset (underlying asset) for a period of time in exchange for
consideration)
Lessor’s perspective:
Finance lease (a lease that substantially transfers the risks and rewards of
ownership to the lessee)
Operating lease (any lease that is not a finance lease)
Lessee’s perspective:
Short-term lease (12 months or less)
Inception date of the lease:
Earlier of date of agreement or date committed to terms: IDENTIFICATION
AND CLASSIFICATION
Commencement date of the lease – date the asset is made available for use:
RECOGNITION
Lease term (includes extension option if reasonably certain will exercise
& exclude termination option if reasonably certain will NOT exercise)
Residual value guarantee (also called “guaranteed residual value”) (residual
value guaranteed by lessee or any party unrelated to lessor: final pmt)
Unguaranteed residual value Not guaranteed or only guaranteed by party
related to the lessor
 A selection of definitions (continued)
Fixed payments (payments for right of use, excluding variable
payments)
Variable lease payments (varies in response to changes in facts and
circumstances other than the passage of time)
Lease incentives (payments/reimbursements by the LESSOR to the
lessee)
Lease payments =
Fixed payments – Lease incentives + Variable lease payments +
Purchase option payments if reasonably certain + Penalties for
termination of lease + GUARANTEED residual value – Payments
for non-lease components
Economic life (total useful period)
Useful life (useful period for the LESSEE)
Initial direct costs (IDC) (e.g. professional fees like attorneys)
Implicit interest rate: Pmt, FV (both!!), PV (fair value + IDC of
LESSOR), N, Comp i
Lessee’s incremental borrowing rate (Rate of interest the lessee would have
to pay on a similar lease (market related interest rate) )
 FINANCIAL CALCULATOR
 Leases = probably where you are going to use the calculator
the most. Many students get poor marks because they don’t
know how to use the financial calculator
 PRACTICE USING YOUR CALCULATOR
 PV = “PRESENT VALUE” = FAIR VALUE (PURCHASE
PRICE) OF ASSET → ENTER AS A MINUS.
 PMT = “PAYMENTS” = LEASE PAYMENTS.
 FV = “FUTURE VALUE” = RESIDUAL VALUE
(GUARANTEED/UNGUARANTEED).
 N = “NUMBER OF PERIODS” = LEASE TERM (NUMBER OF
PAYMENTS, NOT NECESSARILY NUMBER OF YEARS).
 I = “INTEREST” = IMPLICIT INTEREST RATE (IF PAYMENTS
ARE MADE MORE THAN ONCE A YEAR, ADJUST THE
RATE TO MATCH THE “N”, E.G. BI-ANNUAL PAYMENTS: I =
ANNUAL RATE X 6/12).
 COMP = IF YOU HAVE ONE MISSING NUMBER OF THE
ABOVE, IT IS CALCULATED BY PRESSING “COMP” AND
ANY OF THE ABOVE-MENTIONED FUNCTIONS.
 VERY IMPORTANT INFORMATION

 Nominal vs. Effective rate

 EXAMPLE: R100 EARNS INTEREST @ 10% P.A. COMPOUNDED SEMI-ANNUALLY
 What is interest for year?
 (100 x 10% x 6/12) + (105 x 10% x 6/12) = 10.25 (effective interest rate is
therefore 10.25/100 = 10.25%)
 Conversion of EFFECTIVE (“EFF”) to nominal (“APR”):
 SHARP EL 735: NUMBER OF TIMES INTEREST IS COMPOUNDED → 2NDF → APR
→ INTEREST RATE → =
 SHARP EL 738: NUMBER OF TIMES INTEREST IS COMPOUNDED → (X,Y) →
INTEREST RATE → 2NDF → APR
 Similar process for conversion of effective to nominal
 Exam? Question will specify ‘nominal’ or ‘not nominal’
 ACCOUNTING FOR LESSEE

LESSEE’S
PERSPECTIVE
 Identifying a lease
IFRS 16 par. 9–17 & B9–B33
• Substance of agreement = NB!!
• A contract is, or contains, a lease if the contract conveys
the RIGHT TO CONTROL the use of an
identified asset. Such a contract conveys
the right to control the use of an
identified asset if the customer has both:
a) the right to obtain substantially all of the economic
benefits from use of the identified asset; and
b) the right to direct the use of the IDENTIFIED ASSET
throughout the period of use.
• These components are discussed individually in next slide
 Identifying a lease
a) RIGHT TO OBTAIN SUBSTANTIALLY ALL OF THE ECONOMIC
BENEFITS FROM USE
– Through exclusive use of an identified asset for a period of
time
• Provides lessee (customer) the right to obtain substantially all of
the economic benefits from using that asset throughout that
period
• Economic benefits relating to the ownership of the asset are
IGNORED
• If contract requires customer to pay the supplier a portion of the
cash flows derived from using the identified asset, those cash
flows paid shall be considered to be part of the economic
benefits that the customer obtains from using the asset
 Identifying a lease
b) RIGHT TO DIRECT USE OF IDENTIFIED ASSET
– Right to use ONLY IF EITHER:
• the customer has right to direct how and for what
purpose the asset is used throughout the period of
use; or
• the relevant decisions about how and for what
purpose the asset is used are predetermined
 Identifying a lease
• IDENTIFIED ASSET
– May be explicitly identify in contract (e.g serial number) or
implicitly.
– Lessor (supplier) may not have SUBSTANTIVE right to substitute
asset. If lessor has right then lessee (customer) does NOT have
RIGHT OF USE.
– Substantive right at inception date is evidenced by:
• Lessor (supplier) has PRACTICAL ABILITY to substitute
– Lessee can't prevent lessor and assets are readily available
• Lessor would BENEFIT ECONOMICALLY from substituting.
– Economic benefits associated with substituting the asset
are expected to exceed the costs associated with
substituting the asset
In terms of IFRS 16 does this arrangement
CONTAIN a lease? DA example 28.4
Consider the
following?
a) Does Boat have
the right to
obtain
substantially all
of the
economic
benefits?
b) Does Boat have
the right to
direct use
c) And is there an
IDENTIFIED
ASSET?
 SOLUTION
The application of IFRS 16 needs to be considered to determine whether the
arrangement contains a lease.

There is an identified asset: although the portholes manufacturing plant is not

mentioned in the long-term agreement between Boat Ltd and Part Ltd, this asset is
implicitly specified, because for Part Ltd to fulfil the requirements of the
arrangement, it has to erect the plant. It is also unlikely that Part Ltd can/would
substitute the plant with an alternative plant. Part Ltd would also not benefit
economically from substituting the asset – the costs associated with substituting
the plant would be too high.
Boat Ltd has the right to obtain all of the economic benefits from the plant – the
portholes are unique and Boat Ltd is the only user thereof.
Boat Ltd has the right to direct how and for what purpose the plant is used
throughout the period of use – Boat Ltd has the decision-making rights to, for
example, change the type of portholes that is produced, whether portholes are
produced and how much is produced.

Consequently, the arrangement conveys the right to Boat Ltd to control the use of
the plant and it can be concluded that the arrangement contains a lease.
 LESSEE'S PERSPECTIVE
• Legally, lessee not owner of the leased asset and is not required to take
ownership of the leased asset at the end of the lease term.
• However substance of the agreement and its financial reality is that the
lessee obtains the right to use the asset to generate economic
benefits for itself over the lease term
• ACCOUNTING - LESSEE
– Recognise both an asset (RIGHT-OF-USE ASSET) and a liability
(LEASE LIABILITY) in SoFP for all assets leased by it under lease
agreements, EXCEPT if the entity elects one of the two recognition
exemptions allowed by IFRS 16. already discussed above.
– A lessee may elect not to recognise underlying assets and liabilities
for:
1. leases of 12 months or less (short-term leases); and
2. leases for which the underlying asset is of low value, for example
tablets, personal computers and small items of office furniture.
 Short-term and low-value leases in
the books of the lessee
• Recognise as expense (do not use financial calculator)
• The total expense over the lease term (if > 1 year) is however
recognised on a straight-line basis: “lease equalisation” or “lease
smoothing”
– Difference between cash paid and equalised pmt = accrued
expense or prepaid expense
• Lease incentives (benefits that accrue to the lessee) are deducted
from lease expense
– Rent-free period as lease incentive = part of lease term used to
equalise lease expenses
• Initial direct cost – immediately expensed
• Inland Revenue does not apply lease smoothing – DT implication
 Example: low-value lease
(lessee's perspective)
• A Ltd leases out a printer to B Ltd for
4 years.
• Fair value of the printer is $45 000.
• First year is rent free. Rent of second year is
$1 000 per month and this escalates with 10%
every year thereafter
• B Ltd elected to apply the recognition exemptions
of IFRS 16
• Tax rate = 28%
• Required: journals for years 1 and 2 (B Ltd’s books)
Year 2 (1 000 x 12) 12 000
Year 3SOLUTION
(12 000 x 1.1) 13 200
Year 4 (13 200 x 1.1) 14 520
Total rent 39 720
Equalised amount per annum (39 720 / 4) 9 930

Journal year 1
Lease expense (p/l) 9 930
Accrued expense (SoFP) 9 930
Journal year 2
Lease expense (p/l) 9 930
Accrued expense (SoFP) 2 070
Bank 12 000
SOLUTION CONTINUED
DT calculation: CA (liab) TB TD DT asset
Accrued expense year 1 9 930 - 9 930 2 780
Movement in DT balance (579)
Accrued expense year 2 7 860 - 7 860 2 201

DT journals
Year 1:
DT (SoFP) 2 780
DT (p/l) 2 780

Year 2:
DT (p/l) 579
DT (SoFP) 579
 VAT IMPLICATIONS

• Assume the amounts in the low value/short term leases

example exclude VAT; journals are then as follows:
Debit Credit
Journal year 1
Lease expense (p/l) 9 930
Accrued expense (SoFP) 9 930
Journal year 2
Lease expense (p/l) 9 930
Accrued expense (SoFP) 2 070
VAT input (12 000 x 15%) (SoFP) 1 800
Bank (12 000 x 115%) 13 800
 RECOGNITION AND INITIAL MEASUREMENT
• INITIAL MEASUREMENT OF RIGHT-OF-USE ASSET
@ commencement date AT COST:
– Initial measurement of lease liability +
– Any lease payments made at (e.g initial deposit) or before
commencement date +
– Any initial direct costs incurred by LESSEE +
– An estimate of any dismantling and removing costs to be incurred
by LESSEE ALWAYS use
IIR unless
• INITIAL MEASUREMENT OF LEASE LIABILITY not readily
@ commencement date AT PRESENT VALUE OF LEASE available!!!
PAYMENTS
• Discounted over lease term using implicit interest rate
– If implicit rate is NOT available use incremental borrowing
rate
Aquila Ltd (lessee) leases a machine under a lease agreement from
1 June 20.12. from Aquiries Ltd (lessor). Aquila Ltd did not elect the
simplified accounting treatment for the machine. The details of the
lease agreement are as follows (assume all amounts are material
and ignore VAT):

Required:
Calculate
the cost
of the
RIGHT-
OF-USE
ASSET
 SOLUTION
Lease liability (pva of future lease payments)=
PVA=PMT((1+i)^(-n)-1)/I
=20368((1+.1566)^(-3) -1)/0.1566
=46 000+ IDC(2500-1250+5000)+LP(before)(15 000) +dismantling
cost( pv=7500/(1+.09)^3 )5791
ROUA= N$73 041
Journal Entry
DR ROUA 73 041 CR lease liability 46 000;dismantling costs 5
791;prepaid expense 15 000;bank 6250.
 Implicit Interest rate
• The interest rate implicit in the lease is the rate of interest that causes
the aggregate present value of:
– the minimum lease payments (i.e lease payments + unguaranteed
residual value)
Guaranteed
RV already
included in
lease
payments
The sum of the fair value of the underlying asset initial
direct costs of the lessor (for example legal costs and commissions
in negotiating and arranging a lease)

If impracticable to calculate IIR use

incremental borrowing rate
 SUBSEQUENT MEASUREMENT
SUBSEQUENT MEASUREMENT OF RIGHT-OF-USE ASSET
• BY APPLYING THE COST MODEL (UNLESS IT APPLIES OTHER
MEASUREMENT MODELS)
– Initial cost (as per initial measurement) &
– Accumulated depreciation (ito IAS 16) and impairment losses (ito IAS
36)
• If ownership transfers at END of lease term or purchase option will be
exercised, USE USEFUL LIFE
• If not depreciated over SHORTER of USEFUL LIFE or LEASE TERM
• Adjusted for subsequent re-measurements of LEASE LIABILITY
SUBSEQUENT MEASUREMENT OF LEASE LIABILITY
– Increasing carrying amount (CA) to reflect INTEREST on the lease liability
– Reducing the CA to reflect the LEASE PAYMENTS (PMT) made; and
– Re-measuring the carrying amount to reflect lease modifications or
revised in-substance fixed lease payments.
 Accounting for a Lease
Initial In a nutshell: the journal entries come down to:
recognitio Asset measured
n
dr “Right-of-use “ Asset at PV of lease
pmts
cr Long-term liability

dr Depreciation
Subsequent
cr Accumulated depreciation
measurement
dr Long-term liability
dr Finance charges
cr Bank – finance lease installment
 calculating PV of lease pmt, consider the following

Payments to receive –
• LEASE TERM –
• DISCOUNT RATE

Fixed payments less lease incentives

+
Variable lease pmts depending on index/rate
+
Residual guarantees
+
Use implicit i or incremental Exercise price of purchase option by lessee
borrowing rate if the former +
not practically determinable Payments for termination of lease

Non–cancellable period (enforceable period)

+
Optional renewable periods
+
Periods after optional termination date
 Subsequent measurement

“right of use asset” Lease liability measured at

Measurement according to amortised cost
IAS 16 and model adopted Meaning that
- cost or revaluation • Minimum lease
or When does payments apportioned
IAS 40 – fair value model depreciation start? between finance
and Period of depreciation charges and reduction
of outstanding liability
Must apply IAS 36 (beware )
  Subsequent measurement

dt Depreciation According to measurement model

and depreciation policy calculated
cr Accumulated depreciation
in accordance with IAS16 & 40

dt Lease liability
dt Finance charges Apportioned between finance
charge and reduction in
cr Bank – lease installments outstanding liability
 Class example
Orion Ltd (lessee) entered into a lease agreement with
Cygnus Ltd (lessor) on 1 January 20.12. Orion Ltd’s year end
is 31 December. The terms of the lease agreement are as
follows

On this date, the economic useful life is estimated at eight years.

Ownership of the underlying asset will not transfer to the lessee at the
end of the lease term
Required: What is initial measurement of right-of-use asset and lease liability?
Solution: initial measurement
Calculate IIR using a financial calculator
PV= 280 000; PMT -75760; FV-55 000;n 5years comp I ? = 15.182
Calculate present value of lease payments:
75 760((1+.15182)^(-5)-1)/.15182=252 869
50 000/(1+.15182)^5=24 663
PV= 277 532=ROUA
Dr ROUA 277 532 Cr Lease liability 277 532
Subsequent measurement of ROUA=(277 532-( 277 532/5)=222 026 SFP)
DR Depn N$55 506 Cr Acc Depn N$55 506
Dr lease liability 33 625 Dr finance cost 42 135 Cr Bank 75 760
SFP NCL 2015 177 CL 38 730
Subsequent measurement: lease liability
Lease payment Interest Capital Outstanding
N$ N$ N$ balance N$
YR 0 277 532
YR 1 75 760 42 135 33 625 243 907
Yr 2 75 760 37 030 38 730 205 177
yr3 75 760 31 150 44 610 160 567
Yr 4 75 760 24 377 51 383 10 184
75 760 16 576 59 184 50 000
Guaranteed residual 50 000
value
 TAX

'
IMPLICATION
E S
The Income Tax Act
SS
S
E V E
defines lease
LE C T I
E
agreements as
either lease
agreements OR
RS P
instalment sale
agreements.
PE
 Inland Revenue= Based on legal form of the agreement rather than on
its faithful representation
 Difference in treating lease agreement between ACCOUNTING and TAX
 Leads to TEMPORARY DIFFERENCES = DEFERRED TAX 37

 And adjustment to PROFIT BEFORE TAX = INCOME TAX

 CURRENT TAX

 Total lease payments (PMT) are usually deductible for tax purposes IF the requirements
for deduction are met (expenses incurred in production of income)
 NO distinction is made between the capital and interest portions.
 Lessee receives NO TAX ALLOWANCES (W&T) on the asset
 From tax point of view LEGAL perspective lessee is NOT owner of asset
 With termination of the lease, ownership of the particular asset is transferred to the lessee
for no consideration or for an inadequate consideration
 Lessee (who at this stage is the owner) will be taxed in accordance with requirements
of the Income Tax Act
FINANCE LEASES
CURRENT TAX
Item Effect on Effect on Temp diff?
Acc Profit? Tax profit?
Depr / wear & tear Yes No Yes
Finance costs Yes No Yes
Lease expense No Yes Yes
 DEFERRED TAX - LEASE

 ACCOUNTING PURPOSES
 The RIGHT-OF-USE ASSET is capitalised and a
Calculation of deferred tax (SoFP method)
corresponding lease liability is
recognised. Item Carrying Tax base? Temp diff
 Therefore Asset AND Liability is recognised amount?

 TAX BASE
Right-to-use asset (+) $x $0 Yes
 Right-to-use ASSET
Lease liability (-) $x $0 Yes
 Amount deductible for tax purposes in future
 R0 as lessee receives NO tax allowance on
asset (asset doesn’t exist for Tax purposes)
 Lease LIABILITY
 Carrying Value – Amount deductible in future
 The full PMT is deductible for tax purposes
THUS Tax base = R 0 (xxx – xxx)
39
 Unless VAT is financed (example later)
 Lessee: taxation (basic format)
 Presentation
par 28.8.8
Statement of Financial Position
- “Right-of use” asset separate from other assets
- Lease liability separate from other liabilities
Statement of Profit or Loss and Other
Comprehensive Income
- Interest expense on lease liability (component of
finance cost)
- Depreciation charge
Statement of Cash flow
- Cash payments for principal part
- Cash payments for interest part
 DISCLOSURE
Lessee shall disclose the following (tabular format)
a) Depreciation for right-of-use assets by class of underlying asset;
b) Interest expense on lease liabilities;
c) For short-term leases where the recognition exemptions were elected:
i. fact that the recognition exemptions were elected.
ii. the expense relating to such short-term leases;
iii. the amount of its lease commitments for such short-term leases if its
portfolio of short-term leases, to which it is committed at the end of the
reporting period, is dissimilar to the portfolio of short-term leases to which
the disclosed short-term lease expense relates;
d) For low value asset leases where the recognition exemptions were elected:
i. the fact that the recognition exemptions were elected;
ii. the expense relating to such low value assets;
e) The expense relating to variable lease payments not included in the
t req uire the
measurement of lease liabilities, for example contingent rentals; es n o
I FRS 16 do sclosure of the
f) Income from subleasing right-of-use assets; di
separate accumulated
g) Total cash outflow for leases cost and of right-of-use
ation
h) Additions to right-of-use assets; depreci assets.
i) Gains or losses arising from sale and leaseback transactions; and
j) The carrying amount of right-of-use assets at the end of the reporting period
by class of underlying asset.
 Lessee: disclosure

Show year 1
–5
separately
then the
rest
DISCLOSURE EXAMPLE
 UNAM Ltd entered into a lease agreement with Coca Sprite Ltd for a soft drink
dispenser machine on 1 January 2016 for a period of 5 years (in arrears). Coca Sprite
incurred direct initial costs of $10 000. The rate implicit to the lease is 12,2%. The fair
value of the machine on 1 Jan 2016 amounted to $150 000.
 Required:
 Disclose the relevant information relating to the lease in the financial statements of
UNAM for the year ended 31 December 2016 in the records of the lessee.
Payment Interest Principle Balance
FV = 0
PV = $150 000 1 Jan 2016 $150 000

I = 12.20% 31 Dec 2016 ($41 818) $18 300 $23 518 $126 482
N = 5 years
31 Dec 2017 ($41 818) $15 431 $26 387 $100 095
Comp Pmt =
$41 818 31 Dec 2018 ($41 818) $12 212 $29 606 $70 489

31 Dec 2019 ($41 818) $8 600 $33 218 $32 271

31 Dec 2020 ($41 818) $4 547 $37 271 $0

DISCLOSURE EXAMPLE
Notes to the AFS for year ended 31 Dec 2016

1. Leases
1.1 Right of use assets:
Carrying amount at start of period $150 000
Depreciation ($30 000)
Total $120 000
1.2 Maturity analysis of lease payments to be paid at reporting date:
Future lese payments
- For 2017 $41 818
- For 2018 $41 818
- For 2019 $41 818
- For 2020 $41 818
Total future lease payments $167 272
Total future finance costs ($40 790)
Lease Liability $126 482
Long term portion presented under non-current liabilities $100 095 45

Short term portion presented under current liabilities. $26 387

LESSOR’S
PERSPECTIVE
 LESSOR – CLASSIFICATION OF THE LEASE
Example 1: Classification of a lease
a) Equipment Solutions Ltd (ESL) enters into a non-cancellable lease contract with
Paul Ltd, a chain of bakeries. The contract requires ESL to lease bakeries to Paul
Ltd for a period of 4 years, at an annual rental of N$23 660 in arrears.

The fair value of the baking equipment is N$75 000 and it has an estimated useful
life of 10years. this type of baking equipment is commonly used by bakeries.

The contract has no provision allowing Paul Ltd to purchase the equipment or to
extend the lease.

The interest rate implicit in the lease is 10%.

Required:

Discuss in terms of IFRS 16, whether this contract should be classified as an

operating lease or a finance leasein the books of ESL. (10)
Solution ex 1
• A lease is classified as a finance lease if it transfers substantially all the
risks and rewards incidental to ownership of the underlying asset.(1) A
lease is an OL if it is not a FL.1)
• The lease is for a period f 4 years whist the asset’s useful life is 10 years.
(1) Paul Ltd does not have the option to purchase the equipment (1) or
extend the lease period (1). This means that Paul ltd enjoys 4/10 f the
economic benefits of the leased asset and does not substantially enjoy
all the economic benefits of the asset.(2)
• However, the PV of the ROUA is : PMT 23 660;N=5;I=10% PVA=N$74
999(2).which is 99,99% (substantially equally to the FV of the asset)
which makes it a FL. (1)
EX 2
Equipment Solutions Ltd (ESL) enters into a non-cancellable lease contract with Paul Ltd,
a chain of bakeries. The contract requires ESL to lease bakeries to Paul Ltd for a period of
4 years, at an annual rental of N$23 660 in arrears.
• The fair value of the baking equipment is N$75 000 and it has an estimated useful life
of 4 years. Baking equipment specifically designed for Paul Ltd.
• The contract has no provision allowing Pau Ltd to purchase the equipment or to extend
the lease
•The interest rate implicit in the lease is 10%.
•Required: Discuss in terms of IFRS 16, whether this contract should be classified as an operating
lease or a finance leasein the books of ESL. (10
Soln EX2
• A lease is classified as a finance lease if it transfers substantially all the
risks and rewards incidental to ownership of the underlying asset.(1)
A lease is an OL if it is not a FL.1)
The baking equipment has been specifically designed for Paul Ltd thus it
is likely that no other party will enjoy economic benefits of the asset
The lease is for a period of 4 years which is also the economic life of
the asset hence Paul enjoys all the economic benefits of the asset.
The PV is N$74 999 which is 99.99% of the FV of the asset and
substantially al the economic benefits of the asset hence it is a FL.
 WHAT DOES THE LESSOR HAVE TO DO in his
records?
• FOR LESSEES - IF YOU ENTERED INTO A FINANCE LEASE - RAISED A
RIGHT-OF-USE ASSET (PPE) AND A CORRESPONDING LEASE LIABILITY
– Asset was then depreciated and lease payment were allocated between
interest expense and a capital reduction of the finance liability above
• WHAT WOULD THE LESSOR HAVE TO DO FOR THE SAME
TRANSACTION?
– De-recognise the asset
– Recognise gain/loss on de-recognition
– Recognise a receivable equal to the net investment in the lease (net
investment = gross investment discounted at the interest rate implicit in the
lease);
– the interest rate implicit in the lease includes both the guaranteed and
unguaranteed residual values and is defined in such a way that the initial
direct costs are automatically included in the net investment in the lease;
– recognise finance income in accordance with the effective interest rate
method;
– and recognise lease payments against the gross investment when the
payments are received.
 Lease of land and buildings
• LAND USUALLY OPERATING LEASE; BUILDINGS CAN
BE FINANCE LEASE
– Why?
– Indefinite economic life
• SPLIT PAYMENTS ACCORDING TO THE RELATIVE FAIR
VALUES OF THE RESPECTIVE LEASEHOLD
INTERESTS OF THE LAND AND BUILDING ELEMENTS.
– If allocation cannot be reliably done, the lease will be
classified as a finance lease
• DISCUSSION QUESTIONS ON THIS VERY POPULAR!
• DA EXAMPLE 28.25 (SELF STUDY)
 ADDITIONAL DEFINITIONS I.R.O. LESSORS

Gross investment
in the lease (GI):
Total Minimum MINUS
lease payments
plus unguaranteed
residual value (no
discounting)

NB: Minimum
Unearned Finance income
Lease Payments =
(UFI)
Lease payments +
guaranteed RV
 UNGUARANTEED RESIDUAL
• THE VALUE OF THE ASSET THAT WILL BE RETURNED
TO THE LESSOR AT THE END OF THE LEASE
• ONLY NB (IMPORTANT) TO THE LESSOR
• ONLY TAKEN INTO ACCOUNT WHEN:
– Calculating the rate implicit in the lease, and
– In doing the accounting for the lessor
 INITIAL RECOGNITION AND MEASUREMENT
 SUBSEQUENT Measurement
Example: Finance lease
• The lease in Q td’s building expired on 31 Dec 20x0 and it had t find
new premises from 1 January 2021 The company decided t sign a
lease contract for a new factory building with R Ltd. Q ltd will lease
the new factory building for a period of 10 years starting 1 January
20x1 for N$7,5m per annum payable in arreas. At the end of the lease
term, Q Ltd has guaranteed a residual value of at least N$60m foor
the factory building. On 1 January 20x1, R td expects that the factry
buiding wi be sd fr N$75m at the end f the lease term The fair vaue
equa t the cost and CA ) of the factory buildingis N$80m on 1 Jan 20x1
and R Ltd did not incur any initial direct costs in respect of this lease.
Assume that this is a finance lease.
• Rqd: Journalise the Net investment in the lease
Solution
• Calculation of IIR
PV=80 000 000;N=10;FV=75 000 000;PMT=7 500 000 comp i=8,9629 o
%
Journal
DR Gross investment in the lease 150 000 000
CR Unearned finance income 70 000 000
Fctoruy building 80 000 000
Subsequent measurement
Usage Ltd leased a new item of plant from Fines Ltd on 1 Jan 20x3 in
return for 5 annual payments of N$90 000 each, as well as a balloon
payment of N$100 000, payable 31 Dec 20x7. The terms of the lease
indicate that ownership of the asset will pass to Usage Ltd upon
payment of the balloon payment and that the interest rate implicit in
lease is 10,2846%. Usage Ltd will carry all the risks and rewards
incidental to ownership of the plant. Usage Ltd considers the plant to
have a scrap value of N$10 000 at the end of its 6 years economic life.
The plant has a fair value of N$400 000 on 1 Jan 20x3. Depreciation is
recognized on the straight line basis. Both companies have a 31 DEC
year end.
Date Period Capital b/d Payment capital interest Capitl c/d
31/1203 1 400 000 90 000 48 862 41 138 351 138
31/12/04 2 351 138 90 000 53 887 36 113 297 251
31/12/05 3 297 251 90 000 59 429 30 571 237 822
31/12/06 4 237 822 90 000 65 541 24 459 172 281
31/12/07 5 172 281 90 000 72 281 17 719 100 000
31/12/07 5 100 000 100 000 100 000
550 000 400 000 150 000
Solution (cont)
• J1 DR Gross inv in lease 550 000 CR Plant 400 000 CR Unearned income 150 0000
• J2 Dr Cash 90 000 Cr Gross Inv 90 000
• J3 unearned income 41 138 Cr Interest Income
• J4 cash 90 000 Grss inv 90 000
• J5 Unearned incme 36 113 Cr Interest incme 36 113
• J6 cash 90 000 Gross inv 90 000
• J7 unearned income 30 571 Cr Interest Income 30 571
• J8 Cash 90 000 cr Gross Inv 90 000
• J9 Unearned income 24 459 Cr interest inc 24 459
• J10 Cash 190 000 Gross INV 190 000
• J11 Unearned finance inc 17 719 Cr Interest Income 17 719
 TAX IMPLICATIONS
The following disclosures, in addition to the disclosure requirements of IFRS 7 ,
will give a basis for users of financial statements to assess the effect that finance
leases will have on the financial position (SFP), financial performance (P/L),
and cash flows of the lessor:
• selling profit or loss, finance income on the net investment in the lease,
and lease income relating to variable lease payments not included in the
measurement of the lease receivable in a tabular format, unless another format
is more appropriate;
• qualitative and quantitative information to help users of financial statements
assess the nature of the lessor’s leasing activities and how the lessor manages
the risk associated with any rights it retains in underlying assets;
• qualitative and quantitative explanations of the significant changes in the
carrying amount of the net investment in the lease;
• a maturity analysis of lease payments receivable, showing the undiscounted
lease payments to be received on an annual basis for a minimum of each of
the first five years and a total of the amounts for the remaining years; and
• a reconciliation of the undiscounted lease payments to the net investment in
the lease, identifying the unearned finance income relating to the lease
payments receivable and any discounted unguaranteed residual value.
 Example: operating ease
P Ltd entered int a ease agreement with Q Ltd (lessor) for a period of 5
years. T encourage Q Ltd to enter into this lease P Ltd offered an initial
rent free period of six months. There after the lease payments are to
increase by 10% annually on the anniversary of the signing date of the
lease. The lease payments in the last six months of the first year of the
lease will amount to N$20 000 per month. The lease is classified as an
OL in the records of P Ltd.
SOLUTION
Year 1 1st six months -
2nd 6 months 120 000
Year 2 20 000*1.1*12 264 000
Year 3 20 000*(1,1)^2*12 290 400
Year 4 20 000*(1,)^3 *12 319 440
Year 5 20 000*(1,1)^4*12 351 384
1 345 224
Equalised monthly as 1345224/60 22 420
SOLUTION
Year 1 1st six months -
2nd 6 months 120 000
Year 2 20 000*1.1*12 264 000
Year 3 20 000*(1,1)^2*12 290 400
Year 4 20 000*(1,)^3 *12 319 440
Year 5 20 000*(1,1)^4*12 351 384
1 345 224
Equalised monthly as 1345224/60 22 420