CH 9. Leases - BPP 9 & KAP 8 Flashcards
IFRS 16 Define the following terms:
- Lease
- Lessor
- Lessee
- Right of use asset
A lease is a contract, or part of a contract, that conveys the right to use an asset for a period of time in exchange for consideration (income).
The Lessor is the entity that provides the “right-of-use asset” and, in exchange, receives consideration. e.g Car Leasing company providing cars.
Lessee is the entity that has the “right-of(to)-use asset” and, in exchange, transfers a consideration. e.g The entity leasing the car for use in its business operations.
A right-of-use asset is the lessee’s right to use an underlying asset over the lease term. e.g The right to use the Van for a period of time.
How do you Identify a Lease?
and
How is a lease impacted by:
- Restrictions
- Substitutions
- Exceptions to the rule
- Multiple components
Additional: What is the flow chart to identify a lease?
When a contract conveys the “right to use asset” for the lessee customer and when the supplier controls the identifiable asset provides the right to use, in return for an economic benefit.
Lessee has the right to:
- DIRECT THE USE OF THE ASSET OVER A SPECIFIC PERIOD.e.g has day to day control over its use.
&
- SUBSTANTIALLY OBTAIN ALL THE ECONOMIC BENEFITS FROM THE USE of the identified asset.
Definition :- “Identifiable Asset”
- Asset Can be specifically stated or be Implicit at the time the asset is supplied
* Restrictions on the use of the asset are allowed as it provides scope on the right to use the asset. (eg. Millage allowed per year)
* Substitution Note: If the Lessor has the right and practical ability to substitute an asset, the customer does not have the right to use it. (turns into a service contract), (likely to happen if the lessor can benefit from substituting the asset for another) eg. airport allows a coffee kiosk to rent a location on the airport but it is not specified where and can move the location as they feel like.
Multiple components: if a lease has multiple identifiable components then consideration should be split for:
- The lease element
- The service element
Applies to all leases EXCEPT in the case of:
- Licences To explore and use minerals. oils or similar similar non-regenerative resources
- Bio-Logical assets
- Licences of intellectual property
Define “Lease Term” and How is it affected by the option to extend or terminate?
Lease term: is the Non-cancellable period of the contract.
This could change and should be included in the lease term if:
- -The period covered by an option to extend the lease is reasonably certain to be exercised and should be added to the Non-cancellable period
- Periods covered by an option to terminate the lease if reasonably certain is not going to be exercised and should be added to the Non-cancellable period.
This is important when calculating:
- Right of use to the asset and allocating the amounts to the correct period
- Depreciating the right to use the asset
- Remeasurements
What is the basic principle of Lessee Accounting requirements for a lease?
IFRS 16: Requires the lessee to recognise the contract and its values on the commencement date (when the asset is made available for use).
Values must be presented on the reporting date for the:
- - Lease Liability at present value
- - value of the “Right of use asset”
How does a Lessee calculate the lease Liability?
- On the initial measurement
- Subsequent measurement
On recognition: PV of the lease liability not paid on the commencement date.
This amount includes which all have to be discounted to PV:
- + All fixed payments liable to pay
- + Amounts Payable under residual value guarantees ( when the lesser guarantees the value of the asset at the end of the term)
- + Purchase option if it is reasonably certain.
- Variable Payments that depend on the index rate e.g CPI or market rent, initially measured at the rate on the commencement date.
Other variable payments (e.g Payment to be made on a car lease going over the annual mileage allowance) are to be treated as a period cost and go through the P/L
The discount rate should be rate implicit in the contract If this cannot be determined, then the entity should use its incremental borrowing rate (the rate at which it could borrow funds to purchase a similar asset).
Subsequent Measurement:
- Reduce liability by the amount paid
- Increase liability for the interest on the liability (finance cost charged to P/L)
Presentation Note: in the accounts, the liability is split between the Current and long term Liabilities.
How does a lessee calculate the value of the “right of use asset”?
- On the initial measurement
- Subsequent measurement
Initially recognised: at the cost model which includes:
- + PV of lease payments not paid
- + Payments made on commencement
- - (Less) any incentives received
- + Initial direct costs (legal fees)
- + Estimate for any obligation to pay for dismantling or restoration costs
Subsequent Measurement:
-
(Usually) Cost Model: costs less accumulated depreciation or impairment losses.
-
Depreciated from the start date to the earlier of:
- the end of the lease term or
- useful life.
-
Depreciated from the start date to the earlier of:
Alternative Methods:
- The revaluation model (IAS 16) optional, if the asset relates to PPE and must be applied to assets to all assets in its class
- Fair Value Model (IAS 40) (Compulsory if the right of use asset meets the definition of investment property and lessee uses the fair value model for all the other assets in the class)
What are the F/S disclosures for a lessee?
Presentation of the right of RTUA
- Right of use asset to be presented as a separate line item on the face of the statement of financial position.
or
- If it is Included within another line item that would have been used if the assets were owned. The entity must disclose which line item includes right-of-use assets.
Presentation of lease liability - similar to any other liability.
IFRS 16 requires lessees to disclose the following amounts:
- Right-of-use asset additions.
- The carrying amount of right-of-use assets.
- The depreciation charged on right-of-use assets.
- The expense relating to short-term leases and leases of low-value assets.
- Interest expenses on lease liabilities.
- Cash outflows for leased assets.
- Maturity analysis of lease liabilities.
How are low-value assets or short leases treated?
IFRS 16:allows entities the optional exemption from the full requirements and allows for simple treatment.
This applies to:
- Short leases, which are 12 months or lower, and should be
- *recognised on a straight-line basis as an expense over the period of the contract.**
-
Low-value assets, are assessed on the underlying value on an “absolute basis” (value at new) and not based on materiality. e.g:
- 2nd hand car lease with a Market Value of £2000, but at the new list price was £20,000 is not a low-value asset.
- Phones, tablets, office furniture are of low value and can be treated as an expense.
-
Low-value assets, are assessed on the underlying value on an “absolute basis” (value at new) and not based on materiality. e.g:
When does a remeasurement occur for a lessee?
and
How are remeasurements accounted for?
Remeasurement occurs for any changes or reassessment of amounts payable.
Lease Liabilities are revised payments are:
Discounted based on the original rate for changes with:
- Residual value Guarantee
- Payments linked to an index rate
Discounted based on a revised rate (the new implicit rate or borrowing rate on the day) for changes with:
- Change in the lease term (Extension or shortened)
- Purchase option changes to likely
- Payments linked to a floating charge
Right of use asset
- The change in the lease liability is adjusted to the right of use asset and depreciated for the rest of the asset life.
Workings -
+ New PVLP
Less previous PVLP
= Difference to be accounted as:for an increase in Liability
Cr - Lease Liability
Dr - RTUA
What is the difference between a finance lease and an operating lease?
IFRS 16: basically classifies 2 types of leases for Lessors.
-
Finance Lease: is a lease that transfers substantially all the risks and rewards incidental to ownership of the underlying asset.
- Lease receivable recognised in B/S
- Derecognise the asset
-
Operating Lease: This is a lease that does not transfer all the risks and rewards of ownership.
- Keep asset on B/S
- Rental Income accounted for in P/L
How to identify a finance lease?
Usually
- Transfer of ownership at the end of term.
- Option to purchase the asset at a discount.
- Leased for a major part of the economic life even if ownership is not transferred.
- PV of the lease payments is at least substantially all of the fair value of the asset.
- The asset is specialised that only the lessee can use it without major modification.
Additional situations
- Any Loss on cancellation borne by the lessee
- Gains or loss on residual value charged to the lessee
- Continue to lease on a second term for substantially lower the market rate
How does a lessor account for a Finance lease?
Initial Recognition - On the commencement date - when asset is made available for use
Derecognise - The underlying asset
Recognise - A Receivable at an amount equal to the net investment in the lease
Cr - Asset made available
Dr - Lease Receivable payments
The calculation is the P.V of =
- Add: All fixed payments
- Add: Variable payments dependent on index rates or cpi on the lease commencement date
- Add: Guaranteed Residual Value
- Add: Unguaranteed Residual Values
- Add: Purchase option reasonably certain
- Add: Termination payments if expected
- = Total Value of Asset held under a finance lease (Net Investment in the lease)
Subsequent Meseurment
- Lease Receivables
- Less any payments received in advance
- Finance interest Income on balance
- Payments in arrears
- +/- Remeasuerments due to Purchase options, termination payments, extensions or change in residual value (Impairments).
How will a dealer or manufacturer treat a finance lease?
A Manufacturer will like want to treat the lease as a sale/revenue the will do this by:
+ Revenue = ( Lower of F.V of asset or PVLP)
- Less COS = ( Carrying Amount (cost of asset) - minus Unguaranteed Residual Value)
= Gross Profit
How does a lessor account for an operating lease?
Recognised as income on either:
- A Straight line basis
- Another systematic basis e.g (6 month discount period to be spread over the life of the asset)
What is a sale and leaseback transaction?
When an entity ( seller-lessee) transfers/sells an asset to another entity (Buyer-lessor) and then immediately leases it back.
The entity needs to apply (Ifrs15 revenue: from contracts with customers) to determine whether substance sales occur.
