Accounting for leases Flashcards
What is a lease iFRS 16?
It is a contract between 2 parties by which the owner ( lessor) grants the right to possess and use the contracted equipment to the other party ( lessee).
We will for focusing on accounting for Lesee.
Before IFRS 16 there was IAS 17, classified leases how?
Finance lease ( effectively a purchase) = on the balance sheet.
Operating lease ( rental) = off the balance sheet. Charged to income statement, so reduces EBITDA.
However IFRS 16 requires to recognise all lease contracts on the balance sheet with the only exception of short term leases and low value leases.
What is the present value of an annuity again?
: PVA = PMT*(1-(1+r)^(-n))/r
Where going to look at some key terminology now, so what is Lease term?
The non-cancellable period for which a lesee has the right to use an underlying asset plus periods covered by na extension if exercise of that option is reasonably certain.
At lease commencement a lesee recognises what?
A right of use asset ( OA) and a lease liability ( FO).
How do we initially measure the lease liability and RoU asset?
Right of use asset: initially measured at the amount of the lease liability plus any initial direct costs incurred by the lessee. ( cost model)
Lease liability It is the present value of the lease payments payable over the lease term, discounted at the rate implicit in the lease.
After the commencement of the lease how do we account for lease liability and asset?
The asset should be depreicated ( cost -AD) or can be revaluation model and the liability should be amortised ( gradual write off of the initial cost over the period. )
What is the interest rate implicit in the lease ( IRIL)?
What is the incremental borrowing rate?
The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security.
First of all what can we use when calculating IRIL?
We can use culumative present value factors table.
XYZ leases an asset under a non-cancellable lease
contract with a primary term of five years from 1 January 20X1. The rental is €650 per quarter payable in advance. In addition, the lessee is required to pay all maintenance and insurance costs, as they arise. The leased asset could have been purchased for cash at the start of the lease for €10,000 and has a useful life of seven years.
First of all at inception what do you put on B/S for lease liability and RoU asset?
What is important to recognise in the info given
IMPORTANT TO NOTE THAT WE MAKE A CLEAR DISTINCTION HERE, AS YOU CAN SEE 1 PAYMENT IS IN ADVANCE IF NOT WE WOULD SIMPLY DO 10000/650.
ABZ acquires the control over an asset through a lease contract. The lease term is nine non-cancellable years.
At the inception date, ABZ pays €1 million and at the end of each of the nine years also pays €1 million. The
implicit interest rate embedded in the lease contract is 10 %.
At what value should ABZ recognise the right-of-use asset in its balance sheet at the commencement of the
lease contract?
At commencement date remember the the lease liability = present value of all future payments.
RoU = the amount of lease liability + any initial direct costs incurred by lessee.
So what are our Go to steps in recognises lease on B/S and I/S?
- Estimate the discount rate to be used in the calculation of the present value( PV) of future lease payments.
- Calculate the PV of future lease payments.
- Adjust the balance sheet to incorporate the OA = PV) and the NFO = PV.
- Estimate the income statement effects of the new asset and new financial obligation. OA = depreciation expense and FO = financial expense.
Subsequent Measurement: Example
* Using the previous example: XYZ leases an asset on anon-cancellable lease contract with a primary term of five years from 1 January 20X1. The rental is €650 per quarter payable in advance. Assume the asset has a nil residual value. The fair value of the leased asset is €10,000.Implicit interest rate is 2.95 % per quarter.
We ideally only want to look at the second quarter, but what can we apply to do this and go over again and again,
Stock and flow equation
NFOt + NFEt+1 - Ft+1 = NFOt+1
NFOt = capital sum at start of period
NFEt+1 = NFO( during the period) x Implicit interest rate = effective interest rate last week.)
F = rental payment year.
So apply this each line and we will get same thing.
THE F is sumed up for the year as its in quarters to make NFE in income statement.
Example continuation we also need to depreciate the asset for 7 years
Using the previous example: XYZ leases an asset on anon-cancellable lease contract with a primary term of five years from 1 January 20X1. The rental is €650 per quarter payable in advance. Assume the asset has a nil residual value. The fair value of the leased asset is €10,000.Implicit interest rate is 2.95 % per quarter.
Work out depreication charge per year and how does it look on Balance sheet assets side, for subsequent measurement?
$10000 / 7 ( USEFUL LIFE OF THE LEASE NOT OTHER) = $1429
Work out for each year, the total rent charrge and take away the finance charge to find capital repayment for this example
Using the previous example: XYZ leases an asset on anon-cancellable lease contract with a primary term of five years from 1 January 20X1. The rental is €650 per quarter payable in advance. Assume the asset has a nil residual value. The fair value of the leased asset is €10,000.Implicit interest rate is 2.95 % per quarter.
Now using the amoritsed cost method how would the subsequent years look like for the 5 years, in terms of the lease obligation ( balance sheet( liabilities)?
Lets look at classwork.
On 1 January 2017 Letsleasagen plc entered into the following lease agreements with LaLaLeasing Limited:
i) The rental of plant “YI” for five years at a quarterly rental, payable in arrears, of £2,420, the first payment being due on 31 March. The plant has a useful economic life of five years, with no residual value, and Letsleasagen is responsible for all repairs and maintenance. The interest rate implicit in the lease is 3% per quarter.
Effects on the income statement and balance sheet ?
Steps
1) Work out the implicit interest rate ( already given)
2)Calculate the PV of future lease payments, this is your beginning NFO
Then follow the NFOt+1 stock and flow equation, till the end.
Question 2.
The rental of plant “ER”. The lease was for four years, with a quarterly rental of £3,864 payable in advance, the first payment being due on 1 January 2017. The fair value of the plant is £50,000. Letsleasagen is responsible for all repairs and maintenance of the plant, which has a useful economic life of four years with no residual value.
Effects on the income statement and balance sheet ?
HERE IT IS IN ADVANCE ( SO WE HAVE TO TAKE AWAY F). ARREARS IS AT THE END SO WE DONT HAVE TOO.
It you are given fair value = the present value of future payments, hence you only find out IRIL to calculate NFE.
We have to use culumative present value table.
What is annuity depreciation? How can we depict it similar to bond amortisation?
the difference between each years net operating cash flow and the interest on the asset’s beginning value . ( the r is the rate of return)
In other
We are going to look at an example where the capital structure, depreciation policies and profitability are all different and the valuation implications, so lets look at an example.
Its important here that we are recognising beg values, so that the date of inception RoU asset = lease liability for West centre and south.
Work out ROCE, RNOA, FLEV AND SPREAD?
