Leases Flashcards
Introduction to IFRS 16 Leases 1.1 IFRS 16 Leases
You learned about leases in FAR at professional level. This knowledge remains
highly examinable, but at this level we will also extend your knowledge of sale and
leaseback transactions and consider lessor accounting which is very different to the
lessee accounting treatment you’ve become familiar with.
Introduction to IFRS 16 Leases 1.2 Definitions
A lease is a ‘contract that conveys the right to use an underlying
asset for a period of time in exchange for consideration’.
The lessor is the ‘entity that provides the right to use an underlying
asset in exchange for consideration’.
The lessee is the ‘entity that obtains the right to use an underlying
asset in exchange for consideration’.
A right-of-use asset ‘represents a lessee’s right to use an
underlying asset for the lease term’.
(IFRS 16, Appendix A)
Introduction to IFRS 16 Leases 1.3 Identifying a lease
It is important to assess if a contract contains a lease or whether it is simply a
contract for a service.
A contract contains a lease if it conveys the ‘right to control the use of
an identified asset for a period of time in exchange for
consideration’ (IFRS 16, para 9).
For this to be the case, the contract must give the customer:
the right to substantially all of the identified asset’s economic benefits
throughout the period of use
the right to direct the identified asset’s use.
The right to direct the use of the asset can still exist if the lessor puts restrictions on
its use in a contract. These restrictions define the scope of a customer’s right of use.
A customer does not have the right to use an identified asset if the supplier has the
practical ability to provide an alternative asset and if it would be economically
beneficial for them to do so.
Introduction to IFRS 16 Leases 1.4 Separating components
A contract may contain a lease component and a non-lease component.
For example, a contract could provide a company with a specific lorry and also the
use of a driver from a pool.
This contract would normally be separated into a lease component, representing the
lorry (which would be recognised as a right-of-use asset) and a non-lease
component, representing the service provided by a driver (which would be
recognised as an expense).
The lease payments under the contract should be allocated to each component
based on the stand-alone selling price of each component.
Note: The entity can elect not to separate the components and
to treat the entire contract as a lease. If this election is made, it
must be applied consistently to the entire class of assets.
Lessee accounting 2.1 Measurement
At inception of lease recognise
1. Right-of-use asset
Recognise at cost, which equals:
Initial value of lease liability
Payments made at or before commencement
Initial direct costs
Estimated costs of asset removal or dismantling as per lease conditions.
2. Lease liability
Recognise at present value of payments not yet made:
Fixed payments
Variable payments that depend on an index (e.g. price indices or market rental rates)
Amounts expected to be paid under residual value guarantees
Options to purchase that are reasonably certain to be exercised
Termination penalties if lease term reflects expectation that they will be incurred.
Lessee accounting 2.1 Measurement To calculate the lease liability and right-of-use asset,
Entities must establish the length of the lease term.
The lease term comprises:
Non-cancellable periods
Periods covered by an option to extend the lease if reasonably certain to be exercised
Periods covered by an option to terminate the lease if reasonably certain not to be exercised.
The lease payments are discounted using the:
interest rate implicit in the lease, or if unavailable
the lessee’s incremental borrowing rate.
Lessee accounting 2.2 The lease liability table
See table in textbook :D
Lessee accounting 2.3 Right-of-use asset
To reflect substance over form, the lessee recognises the right-of-use asset on its statement of financial position and hence must recognise a depreciation charge in the statement of profit or loss.
The asset is depreciated:
over the shorter** of the lease **term** and the useful **life of the asset if ownership does not transfer to the lessee (at the end of the lease term), or
over the useful life of the asset if ownership does transfer to the lessee.
If the entity has a policy of revaluation for a class of property, plant and equipment, the entity can elect to apply the revaluation model to all the right-ofuse assets in that class.
Lessee accounting 2.4 Short-life and low-value assets
If the lease is short-term (less than or equal to 12 months at the inception date), or of
a low value, then a simplified treatment is allowed.
In these cases, the lessee can choose to recognise the lease payments in profit or
loss on a straight-line basis. No lease liability or right-of-use asset would therefore be
recognised.
‘Examples of low-value underlying assets can include tablet and personal computers, small items of office furniture and telephones.’ (IFRS 16, Para B8)
Sale and leaseback transactions
Under a sale and leaseback transaction, an entity sells one of its own assets
and immediately leases the asset back.
This is a common way of raising finance whilst retaining the use of the related
asset. The buyer/lessor is normally a bank.
Sale and leaseback transactions 3.1 Is the transfer a ‘sale’?
If an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor)
and then leases it back, both entities must assess whether the transfer should be
accounted for, in substance, as a sale.
Entities must apply IFRS 15 Revenue from Contracts with Customers to determine
whether a performance obligation has been satisfied, which occurs when control is
deemed to have passed to the lessor.
An example of where the transfer is not classed as a sale would be if
the lessee has a substantive right to repurchase the asset.
However, in most cases, the transfer will be classed as a sale.
Sale and leaseback transactions 3.2 Accounting treatment
Transfer is not a sale:
Continue to recognise asset.
Recognise a financial liability equal to proceeds received.
Transfer is a sale:
Derecognise the asset.
Recognise a right-of-use asset as the proportion of the previous carrying amount that relates to the rights retained.
Recognise a lease liability.
A profit or loss on disposal will arise.
Sale and leaseback transactions Proceeds = FV
Where the transfer is a sale and the proceeds are at fair value, the double entries would be as follows:
*Dr Cash (Proceeds)
Cr PPE (Carrying amount)
Dr Right-of-use asset X (Carrying amount × Lease Liability/FV)
Cr Lease liability X (PV of lease payments)
Dr/Cr Loss/Profit on disposal (β)
Sale and leaseback transactions Proceeds below FV
The ICAEW have indicated that they will not examine a scenario where
proceeds are below FV so the pro-forma working below and the
following illustration are included for your awareness.
Where the transfer is a sale and the proceeds are below fair value, we will treat the
difference as a prepayment against future lease payments. The double entries would
be as follows:
Dr Cash (Proceeds) X
Dr Prepayment X
(FV – proceeds)
Cr PPE X
(Carrying amount)
Dr Right-of-use asset X
(Carrying amount × Lease liability/FV)
Cr Lease liability X
(PV of lease payments + prepayment)
Dr/Cr Loss/profit on disposal X X
(β)
Note: We are assuming that the lease rentals will be lower to compensate us for the
reduced proceeds. Hence, the prepayment reflects the benefit we will receive in
future from these reduced payments. The lease liability will be settled by making
rental payments and releasing the prepayment.
Sale and leaseback transactions Proceeds above FV
Where the transfer is a sale and the proceeds are above fair value, we will treat the difference as additional finance received from the lessor/buyer. The double entries would be as follows:
Dr Cash (Proceeds)
Cr PPE (Carrying amount)
Dr Right-of-use asset(Carrying amount × (Lease liability – additional finance)/FV)
Cr Lease liability (PV of lease payments)
Dr/Cr Loss/profit on disposal (β)
Note: We are assuming that the lease rentals will be higher in order to repay the
extra amount advanced to us. Hence, some of the lease rentals relate to the lease of
the asset, whilst the excess is simply repaying the extra finance. When calculating
the value of the right-of-use asset, we exclude this extra finance.
