Leases - Lessee Accounting

Question 1

ROU asset - initial measurement

Answer 1

ROU asset cost includes:
* the initial measurement of the lease liability
* any lease payments made at or before the commencement date, less any lease incentives
* any initial direct costs incurred by the lessee
* an estimate of restoration costs to be incurred by the lessee at the termination of the lease

Question 2

ROU asset - Subsequent measurement

Answer 2

• If the lease transfers ownership, depreciate over useful life of the asset.
• If the lease does not transfer ownership, depreciate over the lease term.

Question 3

Lease liability - Initial measurement

Answer 3

Lease liability cost includes:
* fixed lease payments
* variable payments that are dependent on an index or rate
* exercise price of reasonably certain bargain purchase options
* expected payment for guaranteed residual values
* termination penalties if the lease term
intended will require this payment

Discounted at rate implicit in the lease if it is readily determinable, and if not, then the entity’s incremental borrowing rate.

Question 4

Lease liability - Subsequent measurement

Answer 4

Measured at amortized cost. Interest expense is recognized using the rate used to present value the lease payments.

Question 5

Sale and leaseback transactions - Step 1: Has a sale occurred?

Sale has not taken place because control has not been transferred:

Answer 5

Sale has not taken place because control has not been transferred:
The seller continues to recognize the asset and recognizes a loan payable equal to the amount received from the buyer-lessor. As lease payments are made to the buyer, interest expense is recognized using the effective interest rate, and the loan payable is reduced.

Question 6

Sale and leaseback transactions - Step 1: Has a sale occurred?

**Sale has taken place and control has been transferred: **

Answer 6

**Sale has taken place and control has been transferred: **
The seller derecognizes the asset. The amount of the gain recognized at the time of the sale is limited to the portion of the claims on the asset that were transferred to the buyer. The lease is then recognized as an ROU asset and a lease liability.

Question 7

Step 2: If sale has taken place, seller-lessee entries required:

Proportion of claim on the asset retained by the seller-lessee

Answer 7

Proportion of claim:
on the asset retained by the seller-lessee:
= PV of lease payments / fair value of asset given up

Question 8

Step 2: If sale has taken place, seller-lessee entries required:

Buyer-lessor’s proportionate claim

Answer 8

Buyer-lessor’s proportionate claim:
= (fair value of asset sold – PV of lease payments) / fair value of asset sold

Question 9

Step 2: If sale has taken place, seller-lessee entries required:

ROU asset

Answer 9

ROU asset:
= (PV of lease payments / fair value of asset given up)
× book value of asset given up

Question 10

Step 2: If sale has taken place, seller-lessee entries required:

Gain on sale recognized

Answer 10

Gain on sale recognized:
= Buyer-lessor’s proportionate claim
× (fair value of asset sold – book value of asset sold)

Question 11

Leases: accounting vs legal POV

Answer 11

From a legal perspective, all leases are rental agreements. The owner of the asset (the lessor) leases (rents) the asset to the user of the asset (the lessee).

From an accounting perspective, however, the transaction is usually accounted for according to its substance (the economic essence of the agreement) rather than its form (the legal contract).

The lease arrangement may be very simple or quite complex, and how to account for and quantify the lease depends on its terms.

Question 12

3 part test to identify if there is a lease in a contract:

Answer 12

1. Identification of the asset — An asset is identified in the contract to be considered a leased asset. Even if an asset has been identified, the customer isn’t considered to have exclusive use
if the supplier can substitute it with another asset. For example, if a company uses a car share service where cars are used when available, this will not be a lease agreement even if negotiated
in a long-term contract. This may contrast with the lease of a single, identifiable vehicle in a car
lease.

2. Right to economic benefits from use — The customer must have exclusive right to the economic
benefits of using the asset. This includes primary output and by-products, as well as other economic benefits from using the asset that can be sold to another party.

3. Right to direct use of the asset — The customer must have the right to direct the use of the asset, or the use of the asset is predetermined in the contract.

Question 13

Benefits of leasing

Answer 13

Leasing is popular in Canada, as there can be substantive benefits to the lessee:
*The lessee can receive financing for up to 100% of the value of the asset, which is more than it could typically arrange for a loan secured by the same asset.
*Leasing companies tend to be more flexible than traditional lenders in tailoring payment schedules to meet the needs of the lessee.
*Some entities, particularly not-for-profits and unprofitable companies, find that the cost of financing is less under a lease than under other forms of financing. This is because the leasing company is entitled to deduct the capital cost allowance (CCA) on the underlying asset. It can then pass on some of its tax savings to the lessee in the form of lower interest rates.

Question 14

Tax implications of leasing

Answer 14

Lease payments are 100% deductible by the lessee from its taxable income, whereas the interest component of the lease payment and depreciation expense on the ROU asset are not.

Question 15

Initial measurement

Answer 15

• IFRS 16 Leases requires all leases to be recognized at the commencement date of the contract as an asset with a corresponding lease obligation. The asset represents an ROU asset for a period of time, referred to as the lease term, and the obligation represents the payments required under the
  lease agreement.