Chapter 7 - Leases Flashcards
What international accounting standards are we concerned with in this chapter?
- IFRS16 - Leases
Briefly outline what IFRS16 establishes
IFRS 16 is governs the accounting for leases and ensures that lessees and lessors provide relevant, faithful, and transparent information about leasing activities, including the impact of leases on the financial position, performance, and cash flows.
According to IFRS16, what is the definition of a lease?
A contract, or part of a contract, between a lessor and a lessee that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.
According to IFRS16, what is the definition of a lessor and a lessee?
- The lessor is owner and supplier of the asset
- The lessee has the right to use the underlying asset
According to IFRS16, what is the definition of an underlying asset?
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. The asset in question must be identified in the contract. This could be a physical asset like a building, equipment, or even an intangible asset like intellectual property, provided it is identifiable.
According to IFRS16, what is the definition of a right-to-use-asset?
An asset that represents a lessee’s right to use an underlying asset for the lease term. The lease contract must give the lessee the right to use an identified asset for a specified period.
According to IFRS16, how should the value of right-of-use-assets be initially measured? Outline journal entries
- The right-of-use asset is the present value of future lease payments (PVFLP), plus any initial deposit
and the first lease instalment if being paid in advance. - The right-of-use asset should also include any initial direct costs incurred in arranging the lease and the present value of any dismantling or removal costs at the end of the lease term, for which a seperate provision liability must be made.
- The initial lease liability is measured at the present value of future lease payments, excluding the first instalment (if being paid in advance) or deposit.
What does IFRS16 specify regarding depreciation of right-of-use-assets?
The right-of-use asset should be depreciated over the shorter of the lease term or the asset’s useful life. This would include any secondary period if it is reasonably certain that the lessee will exercise this option
Under IFRS16, how do we account for lease payments?
Each lease payment is comprised partly of a repayment of capital and partly of a finance charge for the period. The way we account for lease payments will depend on if the payments are made in advance or arrears
Outline the method to account for the lease of a right-of-use-asset where payments are made in arrears
1) At commencement of the lease, the right-of-use-asset must be recognised as per IFRS16 under non-current assets (see earlier card)
2) We then needed to determine what finance charge will be recognised at the year end and the closing liabilty balance - set out the table pictured.
3) For each year, take the brought forward lease liability balance and multiply it by the given interest rate - this will give the interest charge to be recognised in the P&L for the year
4) Add the interest charge for the year to the b/f balance and deduct the lease payment for the year to give the c/f balance.
5) At the end of each financial year the lease liability must be presented in the statement of
financial position split into its non-current and current components. The non-current component can be calculated by just running the next years calculations and taking the balance c/f, the current liability will be the current years balance c/f less the next years jsut calculated.
6) Repeat this over the course of the lease period, at the end of the lease the balance c/f will be 0
Outline the method to account for the lease of a right-of-use-asset where payments are made in advance
1) At commencement of the lease, the right-of-use-asset must be recognised as per IFRS16 under non-current assets (see earlier card)
2) We then needed to determine what finance charge will be recognised for each year and the closing liabilty balance - set out the table pictured.
3) For the first year: take the brought forward lease liability balance and multiply it by the given interest rate - this will give the interest charge to be recognised in the P&L for the year (NOTE There will be no lease payment recognised for the first year in the calculation as the balance b/f is the PVFLP which will have already taken that payment into account). Add the interest charge for the year to the b/f balance to give the c/f balance.
3) For the second year: take the brought forward lease liability balance and deduct the payment made at the beginning of the year. Multiply this remaining balance by the given interest rate - this will give the interest charge to be recognised in the P&L for the year. Add the interest charge for the year to the remaining balance to give the c/f balance.
5) At the end of each financial year the lease liability must be presented in the statement of
financial position split into its non-current and current components. The non-current component can be calculated by just running the next years calculations and taking the balance c/f, the current liability will be the current years balance c/f less the next years jsut calculated.
6) Repeat this over the course of the lease period, at the end of the lease the balance c/f will be 0
What is the main difference between the recognition of the finance charges of lease payments when paid in arrears compared to in advance under IFRS16?
When paying in arrears you pay the interest charge for that year in the payments made at the year end, when paying in advance you accrue the interest over the course of the year and the paymenets at the years beginning is paying off the previous years interest
What exemptions to the standard accounting of leasing are allowed under IFRS16?
IFRS16 provides optional exemptions from the standard accounting for a lease under the following circumstances:
* Short term leases – lease term 12 months or less with no purchase option.
* Leases of low value assets – being the lease of assets with low individual value when new, such as laptops computers, mobile phones, small items of furniture
The exemption allows these leases to be expensed on a straight-line basis over the lease term
What is important to remember regarding IFRS16 exemptions and cars?
Cars are never considered “low value” assets therefore their leases must be accounted for in full using the standard method
Outline the method to account for the lease of a right-of-use-asset, taking the short term lease or lease of low value asset exemption, where payments are made in arrears
Questions for payments in arrears will typically involve leases where a rent holiday is given and thus giving rise to an accrual
1) Calculate the full value of the lease and work out the expense to be spread over the lease period
2) The first years payment made will be lower (likely due to rent holiday) so when it is made at the end of the year, we must recognise the annual charge in the P&L (as per the calculation) and the difference between that and the payment made as an accrual for future periods.
3) In subsequent years, the same expense will go to the P&L but as the cash payments will be higher (no rent holdiay in subsequent years) the difference will be debited to accruals, slowing reducing its balance - at the end of the lease the accrual balance will be 0
Outline the method to account for the lease of a right-of-use-asset, taking the short term lease or lease of low value asset exemption, where payments are made in advance
Questions for payments in advance will typically involve leases where an inital amount is due plus the first years payment and thus giving rise to a prepayment
1) Calculate the full value of the lease and work out the expense to be spread over the lease period
2) The first payment made will have had an initial cost plus the annual expenseso when this is made in advance at the commencement of the lease, we must recognise the annual charge in the P&L (as per the calculation) and the difference between that and the payment made as a prepayment for future periods.
3) In subsequent years, the same expense will go to the P&L but as the cash payments will be lower (only annual expense and no additional initial payment) the difference will be credited to prepayments, slowing reducing its balance - at the end of the lease the prepayment balance will be 0
What is a sale and leaseback transaction described under IFRS16?
A sale and leaseback transaction under IFRS 16 (Leases) is a financial arrangement in which an entity sells an asset (such as property, plant, or equipment) to another party and then immediately leases it back from the buyer. This allows the seller to retain the right to use the asset while also converting its ownership into cash.
Under IFRS16, how do we account for sale and leaseback transaction?
The accounting treatment of a sale and leaseback transaction depends on whether the transfer of the asset qualifies as a sale under IFRS 15 (Revenue from Contracts with Customers):
Recognition of Sale: If the transfer meets the criteria for a sale under IFRS 15, the seller-lessee must:
* Derecognize the asset sold.
* Recognize a lease liability for the leaseback.
* Recognize a right-of-use (ROU) asset, which reflects the right to use the asset under the lease agreement.
No Recognition of Sale: If the transfer of the asset does not meet the criteria for a sale under IFRS 15 (e.g., because control has not transferred to the buyer-lessor), the transaction is treated as a financing arrangement rather than a sale.
* The seller-lessee keeps the asset on its balance sheet.
* The proceeds received are recognized as a financial liability (not as revenue).
* The liability is reduced over time as lease payments are made.
Outline the method for accounting for the sale and leaseback transaction where a sale is recognised
Outline the method for accounting for a sale and leaseback transaction where a sale is not recognised
If the transfer is not a sale under IFRS15 Revenue from contracts with customers then the seller/lessee will continue to recognise the transferred asset and the proceeds will be treated as a financial liability under IFRS 9 Financial Instruments.
Outline the key differences between UK GAAP and IFRS for leases
