Week 5 - Leases Flashcards
What is the motive behind new IFRS 16?
- To ensure companies’ faithful representation of its assets and liabilities
- To increase transparency
- To improve comparability between companies that borrow or buy assets
What is a lease?
- A lease is a contract that conveys to the lessee (i.e. the entity) that leases the asset the right to control the use of an asset for a period of time in exchange for consideration.
- This is not legal ownership of the asset.
What is the definition of a lease under IFRS 16?
A contract, or part of a contract, that conveys the right to use an asset for a period of time (i.e. control the asset) in exchange for consideration. In order for such a contract to exist the user of the asset needs to have the right to:
- The right to direct the use of the asset.
- Obtain substantially all of the economic benefits from the use of the asset.
1 - Entity has a right to control the use of
2 - An identified asset
3 - For a period of time in exchange for
4 - A consideration
What happens at the commencement date of the lease contract?
At the commencement date of the lease contract, the lessee shall recognise a right-of-use asset and lease liability which is equal to the present value of the lease payments that are not paid at that date.
What is the right-of-use asset comprised of?
The cost of a right-of-use asset shall comprise:
- The amount of the initial measurement of the lease liability
- Any lease payments made at or before the commencement date
- Any initial direct cost incurred by the lessee and
- Cost or removing or dismantling and removing the underlying asset
How is the lease liability calculated?
The lease liability Is equal to present value of lease payments
In calculating the present value of the minimum lease payments, the discount factor is the interest rate implicit in the lease contract, if this is practicable to determine; if not, the lessee’s incremental borrowing rate should be used.
How does IFRS 16 define the rate implicit in the lease?
IFRS 16 defines the rate implicit in the lease as the discount rate that yields a present value of:
- the lease payments; and
- the unguaranteed residual value equal to the sum of (i) the fair value of the underlying asset; and (ii) any initial direct costs of the lessor
The right-of-use asset is depreciated over what?
Depreciation is over the shorter of the useful life of the asset and the lease term, unless the title to the asset transfers at the end of the lease term, in which case depreciation is over the useful life.
Can a lease with a purchase option be a short-term lease?
A lease that contains a purchase option cannot be a short-term lease.
Lessees can elect to treat short-term leases by recognising the lease rentals as an expense over the lease term rather than recognising a ‘right of use asset’ and a lease liability.
Why does IFRS 16 result in a front-loaded expense profile?
A front-loaded expense profile arises, under IFRS 16, because a lessee recognises:
(i) - a right of use asset which is typically amortised on a straight line basis; and
(ii) a liability to pay lease rentals, which would be accounted for like a mortgage loan with higher interest charges in the early years.
The combined effect is a front-loaded expense in the income statement, even if the lessee pays the same amount of rent each period.
Control exists where the company (lessee) has both the right to what?
- Direct the asset’s use
2. Obtain substantially all the economic benefits from its use
What does it meant to:
Direct the asset’s use?
A lessee has the right to direct use of an asset if:
- The lessee has the right to direct how and for what purpose the asset is used throughout the period.
- How and for what purpose the asset is used are pre-determined and the lessee has the right to operate the asset (or direct others to do so) throughout the period of use.
What does it mean to obtain substantially all the economic benefits from its use?
The lessee must have the right to:
- Obtain substantially all of the economic benefits from use of the identified asset throughout the period of use.
- Direct the use of the identified asset.
- Economic benefits?
The asset’s primary output, by-products or other benefits
What is a sale and leaseback transaction?
- A sale and leaseback transaction involves the sale of an asset by the vendor and the leasing of the same asset back by the vendor.
- Principle of substance over form is fundamental to the accounting treatment of this transaction.
- The transaction is a means whereby the lessor provides finance to the lessee, with the asset as security. For this reason it is not appropriate to regard an excess of sales proceeds over the carrying amount as income because there has, in substance, been no sale. Such excess is deferred and amortised over the lease term
Discuss fair value in relation to sale and leaseback transactions.
If the fair value at the time of the sale and leaseback transaction is less than the carrying amount of the asset, then no recognition of the difference between the two is necessary (again, because there has in substance not been a sale). However, such a difference might indicate an impairment in accordance with IAS 36, Impairment of Assets, which Standard would then be applied.
