IFRS 16 LEASE.ppt

Training Outline
Introduction
Definition of terms
Identifying a lease
Lessee Accounting
Lessor Accounting
Sales and lease back

Introduction
• IFRS 16 was issued in January 2016 and
applies to annual reporting periods
beginning on or after 1 January 2019.
• This is to address concept of assets and
labilities in line with conceptual framework.

Definition of Terms?
A lease is a contract, or part of 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-of-use asset and, in
exchange, receives consideration.
The lessee is the entity that obtains use of the right-of-use asset and,
in exchange, transfers consideration.
A right-of-use asset is the lessee's right to use an underlying asset
over the lease term

Identifying a lease
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. For this to be the
case, IFRS 16 says that the contract must give the customer:
• the right to substantially all the identified asset's economic benefits, and
• 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 within a contract (such as by capping the maximum mileage of a vehicle or
limiting which countries an asset can be used in). These restrictions define the scope
of a lessee's right of use, rather than preventing them from directing use.
IFRS 16 says that a customer does not have the right to use an identified asset if the
supplier has the practical ability to substitute the asset for an alternative and if it would
be economically beneficial for them to do so.

Illustration on Identifying a lease
Question
APIN enters a contract with NAUTH to use some space in its LAB to Screen clients'
samples for a three-year period. APIN owns the Lab Equipments.
The contract stipulates the amount of space and states that the space may be
located at any one of several LABs within the Hospital.
The LAB operator (NAUTH) can change the location of the space allocated to APIN
at any time during the period of use, and the costs that the NAUTH would incur to
do this would be minimal.
There are many areas in the Hospital that are suitable for the LAB Operations.
Required:
Does the contract contain a lease?

Illustration on Identifying a lease
Solution
The contract does not contain a lease because there is no identified
asset.
The contract is for space in the LAB, and the LAB operator (NAUTH)
has the practical right to substitute this during the period of use
because:
• There are many areas available in the Hospital that would meet the
contract terms, providing the NAUTH with a practical ability to
substitute.
• The LAB operator (NAUTH) would benefit economically from
substituting the space because there would be minimal cost
associated with it. This would allow the operator (NAUTH) to make
the most effective use of its available space, thus maximizing profits.

Group Activity on Identifying a lease
APIN enters into a contract with UMTH, the supplier, to use a specified Ambulance
for a five-year period. UMTH has no substitution rights.
During the contract period, APIN decides what Patient will be transported, when the
Ambulance will be use, and to which Hospital it will drive to.
However, there are some restrictions specified in the contract. Those restrictions
prevent APIN from carrying suicide bombers as Patient or from driving the
Ambulance into areas where terrorism is a risk.
UMTH operates and maintains the Ambulance and is responsible for renewal of the
Ambulance vehicle particulars. APIN is prohibited from hiring another driver for the
Ambulance, and from operating the Ambulance itself during the term of the contract.
Required:
Does the contract contain a lease?
.

Group Activity solution on Identifying a lease
APIN has the right to use an identified asset (An Ambulance) for a
period of time (five years). UMTH cannot substitute the specified
Ambulance for an alternative.
APIN has the right to control the use of the Ambulance throughout the
five-year period of use because:
1. it has the right to obtain substantially all of the economic benefits
from use of the Ambulance over the five-year period due to its
exclusive use of the Ambulance throughout the period of use.

Group Activity solution on Identifying a lease
2. it has the right to direct the use of the Ambulance. Although
contractual terms exist that limit where the Ambulance can sail and
what Patient can be transported, this acts to define the scope of
APIN’s right to use the Ambulance rather than restricting APIN's
ability to direct the use of the Ambulance. Within the scope of its right
of use, APIN makes the relevant decisions about how and for what
purpose the Ambulance is used throughout the five-year period of use
because it decides whether, where and when the Ambulance drives
to, as well as the Patient it will transport.
UMTH's operation and maintenance of the Ambulance does not
prevent APIN from directing how, and for what purpose, the
Ambulance is used.
Therefore, based on the above, the contract contains a lease.

Lessee Accounting
• Basic Principle
At the commencement of the lease, IFRS 16 requires that the lessee recognizes a lease liability and a
right-of-use asset
DR Right of Use Asset xx
CR lease Liability xx
Initial Measurement : How do you determine this lease liability at initial.
IFRS 16 states that lease payments include the following:
Fixed payments
Variable payments that depend on an index or rate
 Present Value Amounts expected to be payable under residual value guarantees
 Present value 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.

Subsequent Measurement : How do you account for the lease liability thereafter.
IFRS 16 states that lease payments include the following:
1. The carrying amount of the lease liability is increased by the interest charge.
This interest is also recorded in the statement of profit or loss:
Dr Finance costs (P/L XX
Cr Lease liability XX
2. The carrying amount of the lease liability is reduced by cash repayments:
Dr Lease liability XX
Cr Cash XX
Lessee Accounting cont’d

Initial Measurement of Right-of-Use-Asset
The right-of-use asset is initially recognized at cost.
IFRS 16 says that the initial cost of the right-of-use asset comprises
• The amount of the initial measurement of the lease liability (see above)
• Lease payments made at or before the commencement date
• Initial direct costs
• The estimated costs of removing or dismantling the underlying asset as per the
conditions of the lease

Subsequent Measurement of Right-of-Use-Asset
The right-of-use asset
The right-of-use asset is measured using the cost model (unless another
measurement model is chosen). This means that it is measured at its initial
cost less accumulated depreciation and impairment losses.
Depreciation is calculated as follows:
• If ownership of the asset transfers to the lessee at the end of the lease
term then depreciation should be charged over the asset's remaining
useful economic life,
• Otherwise, depreciation is charged over the shorter of the useful life
and the lease term (as defined previously).

Example 1: Example of Residual value Guarantee
Effect of Residual Value Guarantee on lease liability according to IFRS 16
The RVG only affects the calculation of the lease liability when:
a) The lease contain a guaranteed residual value, and
b) The lessee’s expected residual value is lower than the RVG
A little more complication may arise : for instance,
What if the ERV is less than the GRV and the shortfall is greater than the lessee
has anticipated.
Summary
S/N
Situation Effect on the computation of
lease liability
1
Expected Residual Value > Guarantee residual
value No effect
2
Expected Residual Value < Guarantee residual
value
The present value of diff
between(a) and (b) is included in
the compuation of lease liability
3No Guarnateed Residual Value No effect

Example 2: Example of Residual value Guarantee
APIN rented a lab equipment from FHI and guaranteed a
residual value of N15,000. FHI’s Expected Residual Value
is N10,000. But the actual Residual Value turned out to be
just N8,000 at the end of the lease.
Show the calculation and accounting entry in the book of
the lessee

solution 2: Example of Residual value Guarantee
The lessee would pay the lessor a total of N7,000 at the
end of the lease. N2,000 of the N7,000 corresponds to the
loss. The other N5,000 is treated as final lease payment.
See Journal below. For the extra N2000
DR loss on lease N2,000
CR Bank N2,000

Initial Measurement of Right-of-Use-Asset
The lease term
To calculate the initial value of the liability and right-of-use asset, the lessee must consider the length of
the lease term.
IFRS 16 says that 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.

Illustrations to buttress points made so far
APIN enters into a lease of a lab with National Hospital, the following details are
available.
Required:
• Lease liability
• ROUA
• Extract of p or l
• Extract of SOFP
Lease terem 3
Lessors incremental Borrowing rate 6%
Unguaranteed Residual Value 15,000.00
Rental Payment made at the begening of the year 20,000.00
Present value of lease payments 56,668.00
Present value of the residual value 12,594.00
Fair value of the asset being leased 62,262.00
Bargain purchase option 5,000.00
Present value of bargain purchase option 4,198.00
Economic Life of the Asset in years 4

Activity 1: Accounting by Lessees-Asset
• On 1 January 20X1, APIN entered into a two-year lease for a Lab
equipment. The contract contains an option to extend the lease term
for a further year. APIN believes that it is reasonably certain to
exercise this option. Lorries have a useful economic life of ten
years.
• Lease payments are $10,000 per year for the initial term and
$15,000 per year for the option period. All payments are due at the
end of the year.
• To obtain the lease, APIN incurs initial direct costs of $3,000. The
lessor reimburses $1,000 of these costs.
• The interest rate within the lease is not readily determinable. APIN’s
incremental rate of borrowing is 5%.

Lessors Accounting
A lessor must classify its leases as finance leases or operating
leases.
IFRS 16 provides the following definitions:
• A finance lease is a lease where the risks and rewards of the
underlying asset substantially transfer to the lessee.
• An operating lease is a lease that does not meet the definition
of a finance lease.

Lessors Accounting
Initial treatment measurement
At the inception of a lease, lessors present assets held under a finance
lease as a receivable.
The value of the receivable should be equal to the net investment in the
lease.
DR Receivable xx
CR Asset xx
Subsequent treatment
The carrying amount of the lease receivable is increased by finance
income earned, which is also credited to the statement of profit or loss.
The carrying amount of the lease receivable is reduced by cash
receipts

Lessors Accounting
IFRS 16 Leases states that 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 less than its
expected fair value at the date the option becomes exercisable, and it is
reasonably certain that the option will be exercised
• The lease term (including any secondary periods) is for the major part of
the asset's economic life
• At the inception of the lease, the present value of the lease payments
amounts to at least substantially all of the fair value of the leased asset
How to classify a lease by lessor

Lessors Accounting
• The leased assets are of a specialized nature so that only the lessee can
use them without major modifications being made
• The lessee will compensate the lessor for their losses if the lease is
cancelled
• The lessee can continue the lease for a secondary period in exchange for
substantially lower than market rent payments.
How to classify a lease by lessor contd

Lessors Accounting
APIN is a lessor and is drawing up a lease agreement for a building.
The building has a remaining useful economic life of 50 years. The lease
term, which would commence on 1 January 20X0, is for 30 years.
APIN would receive 40% of the asset’s value upfront from the lessee. At the
end of each of the 30 years, APIN will receive 6% of the asset’s fair value as
at 1 January 20X0.
Legal title at the end of the lease remains with APIN, but the lessee can
continue to lease the asset indefinitely at a rental that is substantially below
its market value. If the lessee cancels the lease, it must make a payment to
APIN to recover its remaining investment
Required:
Per IFRS 16 Leases, should the lease be classified as an operating
lease or a finance lease?
Group Activity

Lessors Accounting
A finance lease is defined by IFRS 16 as a lease where the risks and
rewards of ownership transfer from the lessor to the lessee.
Key indications, according to IFRS 16, that a lease is a finance lease are
as follows:
• The lease transfers ownership of the asset to the lessee by the end of the lease
term.
• The lease term is for the major part of the asset’s economic life.
• At the inception of the lease, the present value of the lease payments amounts to
at least substantially all of the fair value of the leased asset.
• If the lessee can cancel the lease, the lessor’s losses are borne by the lessee.
• The lessee can continue the lease for a secondary period in exchange for
substantially lower than market rent payments.
The lease term is only for 60% (30 years/50 years) of the asset’s useful
life. Legal title also does not pass at the end of the lease. These factors
suggest that the lease is an operating lease.
Group Activity Solution

Lessors Accounting
However, the lessee can continue to lease the asset at the end of the lease term for
a value that is substantially below market value. This suggests that the lessee will
benefit from the building over its useful life and is therefore an indication of a finance
lease.
The lessee is also unable to cancel the lease without paying DanBob.
This is an indication that DanBob is guaranteed to recoup its investment
and therefore that they have relinquished the risks of ownership.
It also seems likely that the present value of the minimum lease payments will be
substantially all of the asset’s fair value. The minimum lease payments (ignoring
discounting) equate to 40% of the fair value, payable upfront, and then another 180%
(30 years × 6%) of the fair value over the lease term. Therefore this again suggests
that the lease is a finance lease.
All things considered, it would appear that the lease is a finance lease
Group Activity Solution contd

Accounting for lease by Lessors Accounting
At the inception of a lease, lessors present assets held under a finance
lease as a receivable.
The value of the receivable should be equal to the net investment in the
lease..
• Fixed payments
• Variable payments
• Residual value guarantees
• Unguaranteed residual values
• Purchase options that are reasonably certain to be exercised
• Termination penalties, if the lease term reflects the expectation that
• these will be incurred.
Initial Measurement : if it is a finance lease

Accounting for lease by Lessors Accounting
On 31 December 20X1, APIN leases a machine to MSH on a three year
finance lease and will receive $10,000 per year in arrears. MSH has
guaranteed that the machine will have a market value at the end of the lease
term of $2,000. The interest rate implicit in the lease is 10%.
Required:
Calculate APIN’s net investment in the lease at 31 December 20X1..
.
Calculation of net investment in the lease

Activity 2: Accounting by Lessors
• Please include example as per comments
Question
APIN leases machinery to SFH. The lease is for four years at an annual
cost of $2,000 payable annually in arrears. The present value of the
lease payments is $5,710. The implicit rate of interest is 15%. Required:
How should APIN account for their net investment in the lease?

Solution
APIN recognises the net investment in the lease as a receivable.
This is the present value of the lease payments of $5,710.
The receivable is increased by finance income. The receivable is
reduced by the cash receipts.
Year Opening Bal
Finance
Income
Cash
Received
Clossing
Balance
1 5,710 856 -2,000 4,566
2 4,566 685 -2,000 3,251
3 3,251 488 -2,000 1,739
4 1,739 261 -2,000 –

Solution Contd
Extract from the statement of financial position at the end of
Non-current assets: $
Net investment in finance leases (see note) 3,251
Current assets: –––––
Net investment in finance leases 1,315
–––––
Note: the current asset is the next instalment less next year’s interest
($2,000 – $685). The non-current asset is the remainder ($4,66-1,315)

Solution Contd
Operating leases
A lessor recognizes income from an operating lease on a straight line basis
over the lease term.
Any direct costs of negotiating the lease are added to the cost of the
underlying asset. The underlying asset should be depreciated in accordance
with IAS 16 Property, Plant and Equipment or IAS 38 Intangible Assets assets:

Sale and leaseback transactions
• To determine whether the transfer of an asset is
accounted for as a sale an entity applies the
requirements of IFRS 15 for determining when a
performance obligation is satisfied.
• If an asset transfer satisfies IFRS 15’s requirements to
be accounted for as a sale the seller measures the
right-of-use asset at the proportion of the previous
carrying amount that relates to the right of use retained.
Accordingly, the seller only recognizes the amount of
gain or loss that relates to the rights transferred to the
buyer.

Sale and leaseback transactions( cont)
• If the fair value of the sale consideration
does not equal the asset’s fair value, or if
the lease payments are not market rates,
the sales proceeds are adjusted to fair
value, either by accounting for prepayments
or additional financing.

Disclosure
• The objective of IFRS 16’s disclosures is for
information to be provided in the notes that,
together with information provided in the
statement of financial position, statement of
profit or loss and statement of cash flows,
gives a basis for users to assess the effect
that leases have.

IFRS 16 LEASE.ppt

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