C4 Leases

Question 1

What is a lease?

Answer 1

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.

Question 2

When does a lease arise?

Answer 2

A lease arises where the customer obtain the right to use the asset.

When the supplier retains control of the asset, a service rather than lease arises.

Question 3

How can an entity identify whether a contract contains a lease?

Answer 3

A contract contains a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

Question 4

When does the right to control an asset arise?

Answer 4

The right to control an asset arises where, throughout the period of use, the customer has:
1. The right to obtain substantially all of the economic benefits from use of the identified asset; and
2. The right to direct the use of the identified asset.

Question 5

How does the lessee recognise a lease?

Answer 5

At the commencement date, the lessee recognises:
* a lease liability
* a right of use asset

Question 6

How is the lease liability intially measured?

Answer 6

The lease liability is initally measured at the present value of future lease payments, which are those lease payment not paid on or before the commencement date, discounted at the interest rate implicit in the lease (or the lessee’s incremental borrowing rate if not readily determinable).

Question 7

How is a lease liability subsequently measured?

Answer 7

The lease liability is subsequently measured by:
* increasing it by interest on the lease liability
* reducing it by lease payments made

Question 8

How is a right-of-use asset intially measured?

Answer 8

The right-of-use asset if initally measured at cost, which includes:
* the amount og the intial measurement of the lease liability
* payments made at/before the lease commencement date
* initial direct costs incurred by the lessee
* an estimate of dismantling and restoration costs (where an obligation exists)

Question 9

How is the right-of-use asset usually subsequently measured?

Answer 9

The right of use asset is normally measured subsequently at cost less accumulated depreciation and impairment losses in accordance with the cost model of IAS 16 Property, Plant and Equipment.

The right of use asset is depreciated from the commencement date to the earlier of the end of its useful life or end of the lease term.

Question 10

Besides the cost model under IAS 16, how else may the right-of-use asset be accounted for?

Answer 10

Alternative, the right-of-use asset is accounted for in accordance with:
1. The revaluation model of IAS 16 (optional where the right-of-use asset relates to a clasee of property, plant and equipment measured under the revaluation model, and where elected, must apply to all right-of-use assets relating to that class)
2. The fair value model of IAS 40 Investment Property (compulsory if the right-of-use asset mets the definition of investment property and lessee uses the fair value model for its investment property)

Question 11

How are right-of-use assets presented?

Answer 11

Right-of-use assets are presented either as a separate line item in the statement of financial position or by disclosing which line items include right-of-use assets.

Question 12

What is the effect of an entity being granted tax relief as lease rentals are paid?

Answer 12

If an entity is granted tax relief as lease rentals are paid, a temporary difference arises, as the tax base of the lease is zero.

This results in a deferred tax asset.

Question 13

What is the difference between a finance lease and an operating lease?

Answer 13

A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset, whereas an operating lease is a lease that does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.

Question 14

What are some examples of situations which would normally lead to a lease being classified as a finance lease?

Answer 14

Situations which would 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 expected to be sufficiently lower than fair value at the exercise date, so that it is reasonably certain, at the inception date, that the option will be exercised.
3. The lease term is for a major part of the economic life of the underlying asset even if the title is not transferred.
4. The present value of the lease payments at the inception date amounts to at lease substantially all of the fair value of the underlying asset.
5. The underlying asset asset is of such specialised nature that only the lessee can use it without major modifications.

Question 15

How are lease payments from finance leases recognised?

Answer 15

At the commencement date, the lessor
* derecognises the underlying asset; and
* recognises a receivable amount equal to the net investment in the lease

Question 16

How do you calculate the net investment in the lease?

Answer 16

The net investment in the lease is the sum of:
* present value of lease payments reeivable by the lessor
* present value of any unguaranteed residual value accruing to the lessor

Question 17

When does an unguaranteed residual value arise?

Answer 17

An unguaranteed residual value arises where a lessor expects to be able to sell an asset at the end of the lease term for more than any minimum amount guaranteed by the lessee in the lease contract.

Question 18

How is a manufacturer or dealer lease recognised?

Answer 18

A lessor which is a manufacturer or dealer of the underlying asset needs to recognise entries for finance leases in a similar way to items sold outright (as well as the lease receivable):
* Revenue - FV of underlying asset (or present value of lease payments if lower)
* Less Cost of sales cost (carrying amount) of the underlying asset less present value of the unguaranteed residual value

Question 19

How are lease payments from operating leases recognised?

Answer 19

Lease payments from operating leases are recognised as income on either a straight-line basis or another systematic basis.

Question 20

Why might a lease liability be remeasured?

Answer 20

The lease liability is remeasured (if necessary) for any reassessment of amounts payable.

Question 21

Where the change relates to an expected payment on a residual value guarantee or payments linked to an index rate, how are the lease payments discounted?

Answer 21

The revised lease payments are discounted using the original discount interest rate.

Question 22

Where there is a change in lease term, purchase option or payments linked to a floating interest rate, how are the lease payments discounted?

Answer 22

The revised lease payments are discounted using a revised duscount rate.

Question 23

How are changes in the lease liability recognised?

Answer 23

The change in the lease liability is recognised as an adjustment to the right-of-use asset (or in profit or loss if the right-of-use asset is reduced to zero).

Question 24

Are lease and non-lease components of a lease contract accounted for separately?

Answer 24

Yes, IFRS 16 requires entities to account for the lease component of the contract separately from the non-lease component. The entity must split the rental of lease payment and:
* account for the lease component under IFRS 16; and
* account for the service element separately, generally as an expense in profit or loss.

Question 25

Why are non-lease components of a lease contract accounted for separately?

Answer 25

Non-lease components of a lease contract do not transfer goods or services to the lessee. These activities and costs might, for example, include maintenance, repairs or cleaning.

Question 26

What recognition exemptions are provided by IFRS 16 Leases?

Answer 26

IFRS 16 provides an optional exemption from the full requirements of the standard for:
* Short-term leases (leases with a lease term of 12 months or fewer)
* Leases for which the underlying assets is low value (e.g. a tablet and personal computers, small items of office furniture and telephones)

Question 27

How are lease payments recognised if the optional recognition exemption is taken?

Answer 27

If the entity elects to take the exemption, lease payments are recognised as an expense on a straight-line basis over the lease term or another systematic basis (if more representative of the lessee’s benefits).

Question 28

How is it determined whether or not an asset is low value?

Answer 28

The assessment of whether an underlying asset is of low value is performed on an absolute basis based on the value of the asset when it is new. It is not a question of materiality: different lessees should come to the same conclusion about whether assets are low-value, regardless of the entity’s size.

Question 29

What is a sale and leaseback transaction?

Answer 29

A sale and leaseback transaction arises where an entity (the seller-lessee) transfers (‘sells’) an asset to another entity (the buyer-lessor) and then leases it back.

The entity applies the requirements of IFRS 15 Revenue from Contracts with Customers to determine whether in substance a sale occurs (i.e. whether a performance obligation is satisfied or not).

Question 30

How is a sale leaseback transaction accounted for in the seller-lessee’s books, where the transfer is in substance a sale?

Answer 30

As a sale has occurred, the carrying amount of the asset must be derecognised.

A right-of-use asset is recognised at the proportion of the previous carrying amount that relates to the right-of-use asset retained.

Question 31

If the consideration received for the sale of the asset is
below-market terms, how are the sales proceeds adjusted to FV?

Answer 31

The difference is accounted for as a prepayment of lease payments and so is added to the right-of-use asset as per the normal IFRS 16 treatment for initial measurement of right-of-use asset.

Question 32

If the consideration received for the sale of the asset is
above-market terms, how are the sales proceeds adjusted to FV?

Answer 32

The difference is treated as additional financing provided by the buyer-lessor to the seller-lessee.

The lease liability is originally recorded at the present value of lease payments. This amount is then split between:
* The present valuue of lease payments at market rates; and
* The additional financing (the difference), which is in substance a loan.

Question 33

How does the buyer-lessor account for a sale and leaseback transaction, where the transaction is in substance a sale?

Answer 33

The buyer-lessor accounts for the purchase as a normal purchase and for the lease in accordance with IFRS 16.

Question 34

**How does the seller-lessee account for a sale and leaseback where the transfer of the asset is not in substance a sale?

Answer 34

The seller-lessee continues to recognise the transferred asset and recognises a financial liability equal to the transfer proceeds (and accounts for it in accordance with IFRS 9).

Question 35

How does the buyer-lessor account for a sale and leaseback where the transfer of the asset is not in substance a sale?

Answer 35

The buyer-lessor does not recognise the transferred asset and recognises a financial asset equal to the transfer proceeds (and accounts for it in accordance with IFRS 9).