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F2 Chapter 5 (Leases)

IFRS 16 defines leases as contracts granting the right to use an asset for a specified period in exchange for consideration, with the lessor providing the asset and the lessee utilizing it. Lessees must recognize a lease liability and a right-of-use asset at the lease's commencement, with specific guidelines for initial measurement and subsequent accounting treatment. Lessors classify leases as finance or operating leases based on criteria such as ownership transfer and lease term relative to the asset's useful life.

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6 views12 pages

F2 Chapter 5 (Leases)

IFRS 16 defines leases as contracts granting the right to use an asset for a specified period in exchange for consideration, with the lessor providing the asset and the lessee utilizing it. Lessees must recognize a lease liability and a right-of-use asset at the lease's commencement, with specific guidelines for initial measurement and subsequent accounting treatment. Lessors classify leases as finance or operating leases based on criteria such as ownership transfer and lease term relative to the asset's useful life.

Uploaded by

Abdulai O. Bangura
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We take content rights seriously. If you suspect this is your content, claim it here.
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Leases:

IFRS 16
Chapter 5

A lease is a contract, or part of a contract, that conveys the right to use


an 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.

As defined above, the lessee is the entity using the asset on a day-to-day
basis.
It has the right-of-use of the asset. The lessee will be paying rentals.

Lessee accounting is assumed knowledge which is covered in F1 but


I am putting it here so we can have a read.

Basic principle:

At the commencement of the lease, the lessee should recognise:


a lease liability, and a right-of-use asset.

As ever, the accounting treatment considers the initial measurement and the
subsequent treatment of a lease.
Initial measurement

Lease liability

Per IFRS 16

The lease liability is initially measured at the present value of the lease
payments that have not yet been paid.

Lease payments should include the following:

• Fixed payments over the lease term.

• Amounts expected to be payable under residual value guarantees.

• Options to purchase the asset that are reasonably certain to be


exercised.

• Termination penalties, if the lease term reflects the expectation that


these will be incurred.

• The discount rate should be the rate implicit in the lease

The right-of-use asset:

The right-of-use asset is initially recognised at cost

Per IFRS 16 Leases

The initial cost of the right-of-use asset comprises:

• The amount of the initial measurement of the lease liability

• Lease payments made at or before the commencement date

• Any initial direct costs

• The estimated costs of removing or dismantling the underlying asset, as


per the conditions of the lease
The lease term:

The lease term is the length of time that the lessee has the right-of-use of an
asset.

As per IFRS 16 Leases the lease term comprises:

• Non-cancellable periods

• Periods covered by an option to extend the lease

• Periods covered by an option to terminate the lease


Accounting Treatment:

The carrying amount of the lease liability is increased by the interest charge.

Interest is also recorded in the statement of profit or loss:

Dr Finance costs (SPL)


Cr Lease liability (SFP)

The carrying amount of the lease liability is reduced by cash repayments:

Dr Lease liability
Cr Cash
Lessor Accounting:

The lessor is the entity that provides the right to use an underlying asset
in exchange for consideration.

The lessor provides the asset to the lessee and receives payments.

A lessor must classify its leases as finance or operating leases.


Indications of a finance lease

To determine whether a lease is a finance or operating lease, the substance


of the lease agreement should be considered.

According to IFRS 16 Leases.

A lease is probably a finance lease if one or more of the following apply:

• Ownership is transferred to the lessee at the end of the lease.

• The lessee has the option to purchase the asset for a price substantially
below the fair value of the asset and it is reasonably certain the option
will be exercised.

• The lease term is for the major part of the asset's useful life.

• The present value of the minimum lease payments amounts to


substantially all of the fair value of the asset.

• The leased assets are of such a specialised nature that only the lessee
can use them without major modification.

• The lessee bears losses arising from cancelling the lease.

• Lessee has ability to continue the leas e for a secondary period at a rate
below market rent.
Illustration 1 – Classification of lease:

A company has entered into a four-year lease to provide a machine to a


customer. The lease rentals of $100,000 are payable annually in advance,
with an optional secondary period of three years at rentals of 80%, 60% and
40% of the previous annual rental within the primary period. It is agreed that
these rentals represent a fair commercial rate.

The machine has a useful life of eight years and a cash value of $600,000.
Would this lease agreement be a finance lease or an operating lease?

Solution:

The contracted lease term is only for half of the useful life of the machine and
there is no strong likelihood that the company will exercise the option in four
years' time, because the option is priced at fair value, not a discount. Thus,
the risks and rewards of ownership have not passed to the lessee and this
lease should be treated as an operating lease.

Operating leases

Accounting treatment for an operating lease:

• Lease receipts are shown as income in the statement of profit or loss on


a straight-line basis over the term of the lease, unless another
systematic basis is more appropriate.

• Any difference between amounts charged and amounts paid will be


recognised as prepayments or accruals in the statement of financial
position.
Finance leases:

At the inception of a lease, lessors present assets held under a finance lease as
a receivable.

Net Investment of the lease:

The finance lease receivable is equal to the net investment of the lease.

This is calculated as the present value of all unreceived:

a) Fixed rental payments


b) Variable rental payments
c) Residual value guarantees (amounts the lessee guarantees that the
leased asset will be worth at the end of the lease)
d) Unguaranteed residual values
e) Termination penalties
f) The payments are discounted at the rate implicit in the lease.
Subsequent treatment:

The carrying amount of the lease receivable is:

a) increased by the finance income earned


b) decreased by the cash receipts.

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