Chapter 8 Leases Flashcards
Lease (IFRS 16)
A contract, or part of a contract, that requires the right to use an asset (the underlying asset) for a period of time in exchange for consideration.
Lease term
The lease term is the non-cancellable period for which a lessee has the right to use an underlying asset together with both:
- Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option.
- Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise the option.
Recognition
At the commencement date, the lessee recognises
CR: A lease liability
DR: A right of use asset
Lease liability
Initially measured at the present value of lease payments not paid at the commencement date, discounted at the interest rate implicit in the lease.
The lease liability includes:
- Fixed payments
- Variable payments that depend on an index or rate.
- Amounts expected to be payable under residual value guarantees.
- Purchase options.
Other variable payments are accounted for as period costs in profit or loss as incurred.
The lease liability is subsequently measured by:
- Increasing it by interest on the lease liability.
- Reducing it by lease payments made.
Right of use asset
Initially measured at its cost, which includes
- The initial measurement of the lease liability (the present value of lease payments not paid at the commencement date).
- Payments made at/before the lease commencement date (less any lease incentives received).
- Initial direct costs (e.g. Legal costs) incurred by the lease.
- An estimate of dismantling and restoration costs (where an obligation exists).
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.
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.
Optional recognition exemptions
IFRS 16 provides an optional exemption from the full requirements of the standard for:
- Short term leases (leases < 12 months lease term).
- Leases which the underlying asset is low value.
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.
Finance lease (IFRS 16)
A lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset.
Operating lease (IFRS 16)
A lease that does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.
Finance lease (IFRS 16) examples normally lead to a lease being classified as a finance lease
- The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
- 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, that it is reasonably certain, a the inception date, that the option will be exercised.
- The lease term is for a major part of the economic life of the underlying asset even if title is not transferred.
- The present value of the lease payments at the inception date amounts to at least substantially all of the fair value of the underlying asset.
- The underlying asset is of such specialised nature that only the lessee can use it without major modifications.
Additional examples that could lead to a lease being classified as a finance lease
- Any losses on cancellation are borne by the lessee.
- Gains/loss on changes in residual value accrue to the lessee.
- The lessee can continue to lease for a secondary term at a rent substantially lower than market rent.
Recognition and measurement
At the commencement date, the lessor derecognises the underlying asset and recognises a receivable at amount equal to the net investment in the lease.
The net investment in the lease is the sum of:
Present value of lease payments receivable by the lessor X
Present value of any unguaranteed residual value
according to the lessor X
—
X
—
Operating leases recognition and measurement
Lease payments from operating leases are recognised as income on either a straight line basis or another systematic basis.
Any initial direct costs incurred in obtaining the lease are added to the carrying amount of the underlying asset.
IAS 16 PPE or IAS 38 Intangible Assets then applies to the depreciation or amortisation of the underlying asset as appropriate.
Sale and leaseback transactions
A sale and leaseback transaction arises where an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and then leases it back.
Transfer of the asset is in substance a sale
Seller-lessee
As a sale has occurred in the seller-lessee’s books, the carrying amount of the asset must be derecognised.
The seller-lessee recognises a right of use asset measured at the proportion of the previous carrying amount that relates to the right of use retained.
A gain/loss is recognised in the seller-lessee’s financial statements in relation to the rights transferred to the buyer-lessor.
DR Cash DR ROU Asset CR Lease liability CR p/l CR Asset
If the consideration received for the sale of the asset does not equal that asset’s fair value, the sale proceeds are adjusted to fair value as follows:
- Below-market terms
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 for initial measurement of a right of use asset. - Above market terms
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 split between:
- the additional financing (the difference) which is in substance a loan
- the present value of lease payments at market rates (the balance)
Buyer-lessee
The buyer-lessee accounts for the purchase as a normal purchase and for the lease in accordance with IFRS 16.
Transfer of the asset is not in substance a sale
Seller-lessee
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 Financial Instruments).
Buyer-lessor
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).
