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LEASES
1
Definition and Identification of Leases
IFRS 16 defines Lease as a contract that conveys to the customer
(‘lessee’) the right to use an identified asset in exchange for
consideration for agreed period of time.
Period of time can also be expressed in terms of use of the
asset.
2
By way of illustration:
 an entity might want to transport a specified cargo by ship
from location A to location B, in accordance with a stated
timetable, for a period of five years. To achieve this, it
could either charter a ship over this period or it could
contract to buy the transport service from a freight
carrier/operator (for example, through a contract of
affreightment). In both cases, the goods will arrive at
location B — but the accounting might be quite different.
3
Identifying Leases
IFRS 16 provides more guidance for the identification of
Leases
Criteria
I. There is an identifiable asset- can be portion of an asset
II. Lessee obtains economic benefits- including benefit from
sub lease.
III. Lessee directs the use – how to use and for what purpose
The guidance helps to assesses whether the lease conveys the
right to control the use of an identified asset to the customer.
4
Identification of lease
No
- Yes
- No
Yes
Yes No
No
Yes Yes No
5
Is there an Identified asset?
Does the lessee have the right to obtain substantially all of the economic
benefits from the use of the asset through out the period of use?
Does the lessee have the right to Direct the use of the asset? i.e. how and for
what purpose the asset is used given the scope of lease contract
It is a Lease
Does the Lessee have the right to operate the
asset, without the lessor having the right to
change those operating instruction?
Did the Lessee design the asset in a way that
predetermines how and for what purpose
the asset will be used?
It is not
Lease
Cont...
 An asset is typically identified by being explicitly specified in a contract.
However, an asset can also be identified by being implicitly specified in a
contract.
 If an arrangement identifies the asset to be used, but the supplier has a
substantive contractual right to substitute that asset, the arrangement does not
contain an identified asset.
 A substitution right is substantive if (a) the supplier can practically use another
asset to fulfil the arrangement throughout the term of the arrangement, and (b)
it is economically beneficial for the supplier to do so.
 The supplier’s right or obligation to substitute an asset for repairs, maintenance,
malfunction, or technical upgrade does not preclude the customer from having
the right to use an identified asset.
6
Cont...
 An identified asset must be physically distinct. A physically distinct asset might
be an entire asset or a portion of an asset.
 For example, a building is generally considered physically distinct, but one
floor within the building could also be considered physically distinct if it can
be used independently of the other floors (for example, point of entry or exit,
access to lavatories, etc).
 A capacity portion of an asset is not an identified asset if (a) the asset is not
physically distinct (for example, the arrangement permits use of a portion of the
capacity of an oil tanker), and (b) a customer does not have the right to
substantially all of the economic benefits from the use of the asset (for example,
several customers share an oil tanker, and no single customer uses substantially
all of the capacity).
7
Cont...
 A customer controls the use of the identified asset by possessing
the right to:
 (a) obtain substantially all of the economic benefits from the use of
such asset (‘economics’ criterion); and
 (b) direct the use of the identified asset throughout the period of
use (‘power’ criterion).
 A customer meets the ‘power’ criterion if it holds the right to
make decisions that have the most significant impact on the
economic benefits derived from the use of the asset.
8
Cont...
 The standard gives several examples of relevant decision-making rights. The
following questions need to be considered when evaluating which party holds
the relevant decision-making rights in the shipping industry:
 Which party decides …
 which goods are transported?
 how often goods are transported?
 where goods are transported?
 how often the asset is used?
 the minimum capacity at which the asset operates?
 which route is taken?
 If the leasee makes the above decisions, the contract will meet the definition of a
lease.
9
Cont...
 In some cases, the above decisions are pre-determined in the
contract. If the use of the asset is pre-determined, the contract
contains a lease if the charterer has the right to direct the operations of
the asset without the owner having the right to change those operating
instructions, or if the charterer has designed the asset in a way that
pre-determines how and for what purpose the asset will be used
throughout the period of use.
10
Cont...
 There can be terms in the contract that are protective in nature.
Such terms might be included to protect the supplier’s asset, the
supplier’s personnel and to comply with regulations.
 For example, a charterer is normally prevented from sailing a ship
into waters with a high risk of piracy or from transporting
dangerous materials/cargo.
 The existence of such protective rights alone does not prevent a
customer from having the right to direct the use of an asset.
11
Facts 1:
 Charterer enters into a contract with ship owner for the transportation of cargo
from Rotterdam to Sydney. The ship is explicitly specified in the contract, and
ship owner does not have substitution rights. Charterer has not specified any
modifications to the ship. The cargo will occupy substantially all of the
capacity of the ship. The contract specifies the cargo to be transported on the
ship and the dates of loading and discharging. Ship owner operates and
maintains the ship and is responsible for the safe passage of the cargo on board
the ship. Charterer is prohibited from hiring another operator for the ship or
operating the ship itself during the term of the contract. Also, charterer cannot
alter the routes or the dates for the transportation.
12
Cont...
 Discussion: The contract does not contain a lease.
 There is an identified asset. The ship is explicitly specified in the
contract, and ship owner does not have the right to substitute that
specified ship.
 Charterer has the right to obtain substantially all of the economic
benefits from use of the ship over the period of use. Its cargo will
occupy substantially all of the capacity of the ship, thereby
preventing other parties from obtaining economic benefits from use
of the ship.
13
Cont...
 However, charterer does not have the right to control the use of the
ship, because it does not have the right to direct its use. Charterer
does not have the right to direct how and for what purpose the ship is
used. How and for what purpose the ship will be used is pre-
determined in the contract (that is, the transportation of specified
cargo from Rotterdam to Sydney within a specified time frame), and
charterer did not design the ship. Charterer has no right to change
how and for what purpose the ship is used during the period of use.
14
Fact 2:
 Charterer enters into a contract with ship owner for the use of a specified ship
for a five-year period. The ship is explicitly specified in the contract, and ship
owner does not have substitution rights. Charterer decides what cargo will be
transported, and whether, when and to which ports the ship will sail,
throughout the five-year period of use, subject to restrictions specified in the
contract. Those restrictions prevent charterer from sailing the ship into waters
at a high risk of piracy or carrying hazardous materials as cargo. Ship owner
operates and maintains the ship and is responsible for the safe passage of the
cargo on board the ship. Charterer is prohibited from hiring another operator
for the ship or operating the ship itself during the term of the contract.
15
Cont...
 Discussion: The contract contains a lease. Charterer has the right to use the
ship for five years.
 There is an identified asset. The ship is explicitly specified in the
contract, and ship owner does not have the right to substitute that
specified ship.
 Charterer has the right to control the use of the ship throughout the
five-year period of use, because:
 a) Charterer has the right to obtain substantially all of the economic
benefits from use of the ship over the five-year period of use.
Charterer has exclusive use of the ship throughout the period of use.
16
Cont...
 b) Charterer has the right to direct the use of the ship, because the conditions in paragraph
B24(a) of IFRS 16 exist. The contractual restrictions about where the ship can sail, and the
cargo to be transported by the ship, limit the scope of charterer’s right to use the ship.
However, they are protective rights that protect ship owner’s investment in the ship and ship
owner’s personnel. Within the scope of its right of use, charterer makes the relevant
decisions about how and for what purpose the ship is used throughout the five-year period
of use, because it decides whether, where and when the ship sails, as well as the cargo that it
will transport. Charterer has the right to change these decisions throughout the five-year
period of use.
 Although the operation and maintenance of the ship are essential to its efficient use, ship
owner’s decisions in this regard do not give it the right to direct how and for what purpose
the ship is used. Instead, ship owner’s decisions are dependent on charterer’s decisions about
how and for what purpose the ship is used.
17
Components, contract consideration and allocation
 An arrangement might contain lease and non-lease components
that are subject to different accounting models. Non-lease
components are those items or activities that transfer a good or
service to the lessee.
 Arrangements might also contain multiple lease components.
IFRS 16 requires each separate lease component to be identified
and accounted for separately.
18
Fact 3
 Charterer enters into a time charter with ship owner in which ship owner will
provide transportation services to charterer for a five-year period, using a ship
that is explicitly specified in the contract. Ship owner does not have substitution
rights in relation to the ship that is specified in the contract. Ship owner is
responsible for operating the ship using its own crew, maintaining the ship and
insuring it. Also, ship owner is responsible for providing cleaning services
(‘holds cleaning’) throughout the contract period. Charterer will provide the
dates of travel and the arrival and departure locations. Ship owner cannot use
the ship for any other purpose when it is not being used by charterer. Charterer
will pay to ship owner: (a) a fixed amount per day for chartering the ship; (b) a
fixed amount per month for CVE (communication/victuals/entertainment);
and (c) a fixed amount for each holds cleaning.
 Question: What are the components in this arrangement? 19
Cont...
 Discussion: The contract contains one lease component, which is the lease of the ship, and
two non-lease components, which are the services to operate the ship and cleaning services.
 Insurance does not represent a separate good or service. Therefore, the element of
the fixed payment per day for chartering the ship, which covers the ship’s
insurance, is not considered a separate component, and it instead forms part of the
overall contract consideration to be allocated to the lease and non-lease
components.
 Charterer can either:
 a) separate the lease from the non-lease components and allocate consideration to
each component or;
 b) apply the practical expedient and account for both the lease and the associated
non-lease components as a single combined lease component.
20
Then, how lessee account for leases?
 In the book of Lessee , IFRS 16 requires that :
 all leases are treated as if lessee acquired “the right of use asset.”
and
 Lessee recognizes and reports lease asset (Right of use) and lease
liability (if payment made over time) on the balance sheet.
Cont..
 Should all Leases reported on B/sheet as an asset (right-of-use) and liability?
 Exemptions: Optional to exclude from B/Sheet. i.e. lessee can elect not to recognize assets and liabilities(rules). Both
of the following qualify for exemption
 Lease payments are reported as an operating expenses in P/L, on either
straight line basis or other systematic basis.
Short term leases
• of Less than 12 months
• But consider the likelihood of
renewal option
Leases of low value
•Leased assets in order of magnitude
of <$5,000 (<+ETB100,000),
•assessed independently
•Eg. Tablet, PC, Small office
furniture
Recognition & Measurement of Leases-Lessee
 Lessees will recognize almost all leases on the balance sheet (as a
“right of-use asset "and “lease liability”)-Single model
 The lessee recognizes:
 a lease liability at the present value of future lease payments;
 a right-of-use asset at an amount prepaid plus lease liability plus initial
direct costs
 Subsequently: Recognize depreciation on ROU-Asset and Interest expense
on Lease liability. Apply IAS 36 for impairment of ROU asset.
 Practical expedient: for Short term lease and lease of low value assets
23
Initial measurement and recognitions of leases
I. LESSEE
 Initial measurement and recognition
 The lessee recognizes, at commencement date, the right to use as ‘an asset’ at cost and a
lease liability at present value.
How much is the cost?
Right-of use asset = Lease Liability…………………………………………………………….XX
+ Initial Direct cost………………………………………………………XX
+ Prepaid lease payment …………………………………………….XX
- lease incentives………………………………………………………(XX)
+ Estimated cost to dismantle, remove or restore………..XX
Right of use asset…………………………………………………………………XXX
Lease Liability = Present Value of rental payments + Present value of guaranteed Residual value
24
Initial measurement and recognitions of leases -
Lessee
 Discount rate to compute the PV of lease liability:
 Implicit rate or Incremental borrowing rate (if the lessee cannot determine the former)
 Lease term (discounting period):
 non-cancellable period of lease contract plus any additional period of renewal option (if
extension is certain).
 Once cost is determined, initial recognition:
Debit: Right-of-use asset(lease)……..XX
Credit: Cash/Lease Liability………………………………XX
25
Subsequent measurement and recognition -Lessee
 A lessee measures right of use asset and leases liability as follows:
Subsequent measurement
26
Right-of-use
• Apply cost model or
• Elect to apply Revaluation model
• Accumulated Depreciation applying
IAS 16 and Accumulated
impairment loss applying IAS 36
• Depreciation period:
• Useful life if ownership transfers or
exercisable purchase option or
• The earlier of lease term or UL
• Report depreciation expense in p/L
Lease liability
•Determine the carrying value
applying amortized cost
approach
•Increase lease liability by
amount of interest and decrease
by principal payment(rent)
•Use the rate used for
determination of PV of liability
•Report Interest expense(finance
charge) in P/L
Examples on measurement and recognition of leases -
Lessee
Example 1: Initial measurement and recognition
ESC enters in to a 10 year non cancellable lease of a building, with expected UL of 20 years.
Lease payment is 50,000 ETB per year payable at the beginning of every year. To obtain a lease
ESC incurred initial direct cost of 20,000 Birr, of which 15,000 ETB is related to payment for the
former tenant occupying that the building and 5,000 ETB relates to the commission for broker
that arranged the lease. As an incentive the lessor reimburse to the ESC, the broker’s
commission of 5000 ETB and ESC’s leasehold improvement of 7000 ETB. The interest rate
implicit in the lease is not readily determinable. The incremental borrowing rate is 5% per
annum. PVOA of 1 for 9 rents at 5%=7.1078
How does the ESC initially measures and recognizes the asset and liability in relation to this
lease?
27
Examples on measurement and recognition of leases -
Lessee
Example 1: Solution
At the commencement date, ESC makes lease payment for the first year, incurs initial direct costs,
receives lease incentive(note that reimbursement for leasehold improvement is not an incentive)
and measure lease liability as the present value of the remaining nine payments of 50,000 ETB,
discounted at 5% equal to ETB 355,391.
 Lease liability = 50,000*7.1078 = ETB 355,391
 Right of use asset = 355,391 + 50,000 + 20,000 – 5000 = 420,391 ETB
Initial Recognition shown as follows:
Dr. Right-of-use asset(lease)……..405,391
Cr. Lease liability………………….355,391
Cr. Cash………………………………..50,000
28
Examples on measurement and recognition of leases -
Lessee
Dr. Right of use assets…20,000
Cr. Cash………………………..20,000
(initial direct cost)
Dr. Cash………5000
Cr. Right-of-use asset……..5000
(lease incentives received by lessee)
Note: ESC accounts for the reimbursement of leasehold improvements from lessor applying other
standards and not as lease incentive. Because the costs incurred on leasehold improvements are
not included within the cost of the right-of-use asset.
29
Examples on measurement and recognition of leases -Lessee
Example : Subsequent measurement-for Lease liability and Right of use-Schedule for 1st 5 years
30
Lease liability Right-of-use asset(leased
building)
Beginni
ng of
year
periodic payt.
at the
beginning
Principal
payment
Beg. Liability
balance after
principal
payment
Interest
expense(5
%) at the
end of
Bal. with
accrued
interest at
the end of
Beg. Bal. Depreciati
on
End Bal.
1 - - 355,391 17,770 373,161 420,391 (42,039) 378,352
2 50,000 32,230 323,161 16,158 339,319 378,352 (42,039) 336.313
3 50,000 33,842 289,319 14,466 303,785 336,313 (42,039) 294,274
4 50,000 35,534 253,785 12,689 266,474 294,274 (42,039) 252,232
5 50,000 37,311 216,474 10,823 227,297 252,232 (42,039) 210,196
10 50,000 0 0 0 42,039 (42,039) 0
Examples on measurement and recognition of leases -
Lessee
Example : Subsequent recognition and reporting assuming that the firm recognizes finance
charge on the date of payment
End of first year/Beginning of 2nd year:
Dr. Lease liability………………….32,230
Dr. Finance charge(interest)……. 17,770
Cr. Cash…………….50,000
Dr. Depreciation expense….42,039
Cr. Accumulated depreciation…..42,039
End of 2nd year/Beginning of 3rd year:
Dr. Lease liability………………..33,842
Dr. Finance charge(interest)..16,158
Cr. Cash………………………50,000
31
Examples on measurement and recognition of leases -Lessee
Example : Subsequent reporting
For First year:
In the statement of P/L:
Interest Expense………………. ETB 17,770
Depreciation Expense………………42,039
In the statement of F/P:
Assets
Non-current(PPE)
Right-of-use asset(leased building)…..ETB 420,391
Accumulated depreciation…………………… .(42,039)
Carrying Value(Book Value)…………………… 378,352
Liability
Current-Lease liability(50,000-16,158)……………….33,842
Non-current- Lease liability(323,161-33,842)………289,319
Total…………………………………………………………………. ETB 323,161
32
CNH Capital and Ivanhoe Mines Ltd. sign a lease agreement dated January 1,
2015, that calls for CNH to lease a front-end loader to Ivanhoe beginning January
1, 2015. The terms and provisions of the lease agreement and other pertinent
data are as follows.
• The term of the lease is five years. The lease agreement is non-cancelable,
requiring equal rental payments of $23,981.62 at the beginning of each year
(annuity-due basis).
• The loader has a fair value at the inception of the lease of $100,000, an
estimated economic life of five years, and no residual value.
• The lease contains no renewal options. The loader reverts to CNH at the
termination of the lease.
• Ivanhoe’s incremental borrowing rate is 11 percent per year.
Exercise
Lessor Accounting - No significant change
 IFRS 16 requires that Lessor classifies leases in to two : Financing Lease
and an Operating Lease
₋ A lease is classified as a finance lease if it transfers substantially all
the risks and rewards incidental to ownership of an underlying asset.
 Other wise, Operating Lease.
 Finance leases- de-recognize the asset and recognize a lease receivable
 Operating leases- continue to recognize the underlying asset and rent
income
34
Finance Lease-If any of the following indicators exist
Finance
Lease
Is there a
transfer of
ownership?
Is there an
exercisable
bargain
Purchase
option?
Is the lease
term for the
major part of
economic life
of an asset?
Is the present value of
the lease payment
equal to substantially
all of the fair value of
the asset?
Is an asset has a
specialized nature that
only the lessee can use
it?
35

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lease and lease computation lecture note

  • 2. Definition and Identification of Leases IFRS 16 defines Lease as a contract that conveys to the customer (‘lessee’) the right to use an identified asset in exchange for consideration for agreed period of time. Period of time can also be expressed in terms of use of the asset. 2
  • 3. By way of illustration:  an entity might want to transport a specified cargo by ship from location A to location B, in accordance with a stated timetable, for a period of five years. To achieve this, it could either charter a ship over this period or it could contract to buy the transport service from a freight carrier/operator (for example, through a contract of affreightment). In both cases, the goods will arrive at location B — but the accounting might be quite different. 3
  • 4. Identifying Leases IFRS 16 provides more guidance for the identification of Leases Criteria I. There is an identifiable asset- can be portion of an asset II. Lessee obtains economic benefits- including benefit from sub lease. III. Lessee directs the use – how to use and for what purpose The guidance helps to assesses whether the lease conveys the right to control the use of an identified asset to the customer. 4
  • 5. Identification of lease No - Yes - No Yes Yes No No Yes Yes No 5 Is there an Identified asset? Does the lessee have the right to obtain substantially all of the economic benefits from the use of the asset through out the period of use? Does the lessee have the right to Direct the use of the asset? i.e. how and for what purpose the asset is used given the scope of lease contract It is a Lease Does the Lessee have the right to operate the asset, without the lessor having the right to change those operating instruction? Did the Lessee design the asset in a way that predetermines how and for what purpose the asset will be used? It is not Lease
  • 6. Cont...  An asset is typically identified by being explicitly specified in a contract. However, an asset can also be identified by being implicitly specified in a contract.  If an arrangement identifies the asset to be used, but the supplier has a substantive contractual right to substitute that asset, the arrangement does not contain an identified asset.  A substitution right is substantive if (a) the supplier can practically use another asset to fulfil the arrangement throughout the term of the arrangement, and (b) it is economically beneficial for the supplier to do so.  The supplier’s right or obligation to substitute an asset for repairs, maintenance, malfunction, or technical upgrade does not preclude the customer from having the right to use an identified asset. 6
  • 7. Cont...  An identified asset must be physically distinct. A physically distinct asset might be an entire asset or a portion of an asset.  For example, a building is generally considered physically distinct, but one floor within the building could also be considered physically distinct if it can be used independently of the other floors (for example, point of entry or exit, access to lavatories, etc).  A capacity portion of an asset is not an identified asset if (a) the asset is not physically distinct (for example, the arrangement permits use of a portion of the capacity of an oil tanker), and (b) a customer does not have the right to substantially all of the economic benefits from the use of the asset (for example, several customers share an oil tanker, and no single customer uses substantially all of the capacity). 7
  • 8. Cont...  A customer controls the use of the identified asset by possessing the right to:  (a) obtain substantially all of the economic benefits from the use of such asset (‘economics’ criterion); and  (b) direct the use of the identified asset throughout the period of use (‘power’ criterion).  A customer meets the ‘power’ criterion if it holds the right to make decisions that have the most significant impact on the economic benefits derived from the use of the asset. 8
  • 9. Cont...  The standard gives several examples of relevant decision-making rights. The following questions need to be considered when evaluating which party holds the relevant decision-making rights in the shipping industry:  Which party decides …  which goods are transported?  how often goods are transported?  where goods are transported?  how often the asset is used?  the minimum capacity at which the asset operates?  which route is taken?  If the leasee makes the above decisions, the contract will meet the definition of a lease. 9
  • 10. Cont...  In some cases, the above decisions are pre-determined in the contract. If the use of the asset is pre-determined, the contract contains a lease if the charterer has the right to direct the operations of the asset without the owner having the right to change those operating instructions, or if the charterer has designed the asset in a way that pre-determines how and for what purpose the asset will be used throughout the period of use. 10
  • 11. Cont...  There can be terms in the contract that are protective in nature. Such terms might be included to protect the supplier’s asset, the supplier’s personnel and to comply with regulations.  For example, a charterer is normally prevented from sailing a ship into waters with a high risk of piracy or from transporting dangerous materials/cargo.  The existence of such protective rights alone does not prevent a customer from having the right to direct the use of an asset. 11
  • 12. Facts 1:  Charterer enters into a contract with ship owner for the transportation of cargo from Rotterdam to Sydney. The ship is explicitly specified in the contract, and ship owner does not have substitution rights. Charterer has not specified any modifications to the ship. The cargo will occupy substantially all of the capacity of the ship. The contract specifies the cargo to be transported on the ship and the dates of loading and discharging. Ship owner operates and maintains the ship and is responsible for the safe passage of the cargo on board the ship. Charterer is prohibited from hiring another operator for the ship or operating the ship itself during the term of the contract. Also, charterer cannot alter the routes or the dates for the transportation. 12
  • 13. Cont...  Discussion: The contract does not contain a lease.  There is an identified asset. The ship is explicitly specified in the contract, and ship owner does not have the right to substitute that specified ship.  Charterer has the right to obtain substantially all of the economic benefits from use of the ship over the period of use. Its cargo will occupy substantially all of the capacity of the ship, thereby preventing other parties from obtaining economic benefits from use of the ship. 13
  • 14. Cont...  However, charterer does not have the right to control the use of the ship, because it does not have the right to direct its use. Charterer does not have the right to direct how and for what purpose the ship is used. How and for what purpose the ship will be used is pre- determined in the contract (that is, the transportation of specified cargo from Rotterdam to Sydney within a specified time frame), and charterer did not design the ship. Charterer has no right to change how and for what purpose the ship is used during the period of use. 14
  • 15. Fact 2:  Charterer enters into a contract with ship owner for the use of a specified ship for a five-year period. The ship is explicitly specified in the contract, and ship owner does not have substitution rights. Charterer decides what cargo will be transported, and whether, when and to which ports the ship will sail, throughout the five-year period of use, subject to restrictions specified in the contract. Those restrictions prevent charterer from sailing the ship into waters at a high risk of piracy or carrying hazardous materials as cargo. Ship owner operates and maintains the ship and is responsible for the safe passage of the cargo on board the ship. Charterer is prohibited from hiring another operator for the ship or operating the ship itself during the term of the contract. 15
  • 16. Cont...  Discussion: The contract contains a lease. Charterer has the right to use the ship for five years.  There is an identified asset. The ship is explicitly specified in the contract, and ship owner does not have the right to substitute that specified ship.  Charterer has the right to control the use of the ship throughout the five-year period of use, because:  a) Charterer has the right to obtain substantially all of the economic benefits from use of the ship over the five-year period of use. Charterer has exclusive use of the ship throughout the period of use. 16
  • 17. Cont...  b) Charterer has the right to direct the use of the ship, because the conditions in paragraph B24(a) of IFRS 16 exist. The contractual restrictions about where the ship can sail, and the cargo to be transported by the ship, limit the scope of charterer’s right to use the ship. However, they are protective rights that protect ship owner’s investment in the ship and ship owner’s personnel. Within the scope of its right of use, charterer makes the relevant decisions about how and for what purpose the ship is used throughout the five-year period of use, because it decides whether, where and when the ship sails, as well as the cargo that it will transport. Charterer has the right to change these decisions throughout the five-year period of use.  Although the operation and maintenance of the ship are essential to its efficient use, ship owner’s decisions in this regard do not give it the right to direct how and for what purpose the ship is used. Instead, ship owner’s decisions are dependent on charterer’s decisions about how and for what purpose the ship is used. 17
  • 18. Components, contract consideration and allocation  An arrangement might contain lease and non-lease components that are subject to different accounting models. Non-lease components are those items or activities that transfer a good or service to the lessee.  Arrangements might also contain multiple lease components. IFRS 16 requires each separate lease component to be identified and accounted for separately. 18
  • 19. Fact 3  Charterer enters into a time charter with ship owner in which ship owner will provide transportation services to charterer for a five-year period, using a ship that is explicitly specified in the contract. Ship owner does not have substitution rights in relation to the ship that is specified in the contract. Ship owner is responsible for operating the ship using its own crew, maintaining the ship and insuring it. Also, ship owner is responsible for providing cleaning services (‘holds cleaning’) throughout the contract period. Charterer will provide the dates of travel and the arrival and departure locations. Ship owner cannot use the ship for any other purpose when it is not being used by charterer. Charterer will pay to ship owner: (a) a fixed amount per day for chartering the ship; (b) a fixed amount per month for CVE (communication/victuals/entertainment); and (c) a fixed amount for each holds cleaning.  Question: What are the components in this arrangement? 19
  • 20. Cont...  Discussion: The contract contains one lease component, which is the lease of the ship, and two non-lease components, which are the services to operate the ship and cleaning services.  Insurance does not represent a separate good or service. Therefore, the element of the fixed payment per day for chartering the ship, which covers the ship’s insurance, is not considered a separate component, and it instead forms part of the overall contract consideration to be allocated to the lease and non-lease components.  Charterer can either:  a) separate the lease from the non-lease components and allocate consideration to each component or;  b) apply the practical expedient and account for both the lease and the associated non-lease components as a single combined lease component. 20
  • 21. Then, how lessee account for leases?  In the book of Lessee , IFRS 16 requires that :  all leases are treated as if lessee acquired “the right of use asset.” and  Lessee recognizes and reports lease asset (Right of use) and lease liability (if payment made over time) on the balance sheet.
  • 22. Cont..  Should all Leases reported on B/sheet as an asset (right-of-use) and liability?  Exemptions: Optional to exclude from B/Sheet. i.e. lessee can elect not to recognize assets and liabilities(rules). Both of the following qualify for exemption  Lease payments are reported as an operating expenses in P/L, on either straight line basis or other systematic basis. Short term leases • of Less than 12 months • But consider the likelihood of renewal option Leases of low value •Leased assets in order of magnitude of <$5,000 (<+ETB100,000), •assessed independently •Eg. Tablet, PC, Small office furniture
  • 23. Recognition & Measurement of Leases-Lessee  Lessees will recognize almost all leases on the balance sheet (as a “right of-use asset "and “lease liability”)-Single model  The lessee recognizes:  a lease liability at the present value of future lease payments;  a right-of-use asset at an amount prepaid plus lease liability plus initial direct costs  Subsequently: Recognize depreciation on ROU-Asset and Interest expense on Lease liability. Apply IAS 36 for impairment of ROU asset.  Practical expedient: for Short term lease and lease of low value assets 23
  • 24. Initial measurement and recognitions of leases I. LESSEE  Initial measurement and recognition  The lessee recognizes, at commencement date, the right to use as ‘an asset’ at cost and a lease liability at present value. How much is the cost? Right-of use asset = Lease Liability…………………………………………………………….XX + Initial Direct cost………………………………………………………XX + Prepaid lease payment …………………………………………….XX - lease incentives………………………………………………………(XX) + Estimated cost to dismantle, remove or restore………..XX Right of use asset…………………………………………………………………XXX Lease Liability = Present Value of rental payments + Present value of guaranteed Residual value 24
  • 25. Initial measurement and recognitions of leases - Lessee  Discount rate to compute the PV of lease liability:  Implicit rate or Incremental borrowing rate (if the lessee cannot determine the former)  Lease term (discounting period):  non-cancellable period of lease contract plus any additional period of renewal option (if extension is certain).  Once cost is determined, initial recognition: Debit: Right-of-use asset(lease)……..XX Credit: Cash/Lease Liability………………………………XX 25
  • 26. Subsequent measurement and recognition -Lessee  A lessee measures right of use asset and leases liability as follows: Subsequent measurement 26 Right-of-use • Apply cost model or • Elect to apply Revaluation model • Accumulated Depreciation applying IAS 16 and Accumulated impairment loss applying IAS 36 • Depreciation period: • Useful life if ownership transfers or exercisable purchase option or • The earlier of lease term or UL • Report depreciation expense in p/L Lease liability •Determine the carrying value applying amortized cost approach •Increase lease liability by amount of interest and decrease by principal payment(rent) •Use the rate used for determination of PV of liability •Report Interest expense(finance charge) in P/L
  • 27. Examples on measurement and recognition of leases - Lessee Example 1: Initial measurement and recognition ESC enters in to a 10 year non cancellable lease of a building, with expected UL of 20 years. Lease payment is 50,000 ETB per year payable at the beginning of every year. To obtain a lease ESC incurred initial direct cost of 20,000 Birr, of which 15,000 ETB is related to payment for the former tenant occupying that the building and 5,000 ETB relates to the commission for broker that arranged the lease. As an incentive the lessor reimburse to the ESC, the broker’s commission of 5000 ETB and ESC’s leasehold improvement of 7000 ETB. The interest rate implicit in the lease is not readily determinable. The incremental borrowing rate is 5% per annum. PVOA of 1 for 9 rents at 5%=7.1078 How does the ESC initially measures and recognizes the asset and liability in relation to this lease? 27
  • 28. Examples on measurement and recognition of leases - Lessee Example 1: Solution At the commencement date, ESC makes lease payment for the first year, incurs initial direct costs, receives lease incentive(note that reimbursement for leasehold improvement is not an incentive) and measure lease liability as the present value of the remaining nine payments of 50,000 ETB, discounted at 5% equal to ETB 355,391.  Lease liability = 50,000*7.1078 = ETB 355,391  Right of use asset = 355,391 + 50,000 + 20,000 – 5000 = 420,391 ETB Initial Recognition shown as follows: Dr. Right-of-use asset(lease)……..405,391 Cr. Lease liability………………….355,391 Cr. Cash………………………………..50,000 28
  • 29. Examples on measurement and recognition of leases - Lessee Dr. Right of use assets…20,000 Cr. Cash………………………..20,000 (initial direct cost) Dr. Cash………5000 Cr. Right-of-use asset……..5000 (lease incentives received by lessee) Note: ESC accounts for the reimbursement of leasehold improvements from lessor applying other standards and not as lease incentive. Because the costs incurred on leasehold improvements are not included within the cost of the right-of-use asset. 29
  • 30. Examples on measurement and recognition of leases -Lessee Example : Subsequent measurement-for Lease liability and Right of use-Schedule for 1st 5 years 30 Lease liability Right-of-use asset(leased building) Beginni ng of year periodic payt. at the beginning Principal payment Beg. Liability balance after principal payment Interest expense(5 %) at the end of Bal. with accrued interest at the end of Beg. Bal. Depreciati on End Bal. 1 - - 355,391 17,770 373,161 420,391 (42,039) 378,352 2 50,000 32,230 323,161 16,158 339,319 378,352 (42,039) 336.313 3 50,000 33,842 289,319 14,466 303,785 336,313 (42,039) 294,274 4 50,000 35,534 253,785 12,689 266,474 294,274 (42,039) 252,232 5 50,000 37,311 216,474 10,823 227,297 252,232 (42,039) 210,196 10 50,000 0 0 0 42,039 (42,039) 0
  • 31. Examples on measurement and recognition of leases - Lessee Example : Subsequent recognition and reporting assuming that the firm recognizes finance charge on the date of payment End of first year/Beginning of 2nd year: Dr. Lease liability………………….32,230 Dr. Finance charge(interest)……. 17,770 Cr. Cash…………….50,000 Dr. Depreciation expense….42,039 Cr. Accumulated depreciation…..42,039 End of 2nd year/Beginning of 3rd year: Dr. Lease liability………………..33,842 Dr. Finance charge(interest)..16,158 Cr. Cash………………………50,000 31
  • 32. Examples on measurement and recognition of leases -Lessee Example : Subsequent reporting For First year: In the statement of P/L: Interest Expense………………. ETB 17,770 Depreciation Expense………………42,039 In the statement of F/P: Assets Non-current(PPE) Right-of-use asset(leased building)…..ETB 420,391 Accumulated depreciation…………………… .(42,039) Carrying Value(Book Value)…………………… 378,352 Liability Current-Lease liability(50,000-16,158)……………….33,842 Non-current- Lease liability(323,161-33,842)………289,319 Total…………………………………………………………………. ETB 323,161 32
  • 33. CNH Capital and Ivanhoe Mines Ltd. sign a lease agreement dated January 1, 2015, that calls for CNH to lease a front-end loader to Ivanhoe beginning January 1, 2015. The terms and provisions of the lease agreement and other pertinent data are as follows. • The term of the lease is five years. The lease agreement is non-cancelable, requiring equal rental payments of $23,981.62 at the beginning of each year (annuity-due basis). • The loader has a fair value at the inception of the lease of $100,000, an estimated economic life of five years, and no residual value. • The lease contains no renewal options. The loader reverts to CNH at the termination of the lease. • Ivanhoe’s incremental borrowing rate is 11 percent per year. Exercise
  • 34. Lessor Accounting - No significant change  IFRS 16 requires that Lessor classifies leases in to two : Financing Lease and an Operating Lease ₋ A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset.  Other wise, Operating Lease.  Finance leases- de-recognize the asset and recognize a lease receivable  Operating leases- continue to recognize the underlying asset and rent income 34
  • 35. Finance Lease-If any of the following indicators exist Finance Lease Is there a transfer of ownership? Is there an exercisable bargain Purchase option? Is the lease term for the major part of economic life of an asset? Is the present value of the lease payment equal to substantially all of the fair value of the asset? Is an asset has a specialized nature that only the lessee can use it? 35

Editor's Notes

  1. Criterion 1. Is there an identified asset? Explicitly specified or implicitly specified? For a portion of an asset, capacity portion of an asset is an identified asset if: Physically distinct Represents substantially all of the capacity of the asset if not physical distinct An identified asset is not a lease if the lessor has a substantive right to substitute during the lease term. Substantive – practical ability (such as minimal cost) & economic benefit Substitution should not just be contractual rather practical Criterion II. Lessee obtains economic benefits Whether the lessee has the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use. These includes cash flows obtained from primary out puts, by products and other economic benefits arising from transactions with third parties (sub leasing) Tax incentives from ownership of the assets can be disregarded. Criterion III The right to direct the use of an asset A lessee has the right to direct the use of an asset if has the right to direct how and for what purpose the asset is used for the period of the lease, (eg when to start/open, and shutdown/close equipment or office), how much of the output, and If relevant decisions about how and for what purpose the asset is to be used are predetermined the lessee has the right to operate the asset throughout the period with out the lessor having the right to change those operating instructions The lessee designs the asset in such a way it predetermines the use of the asset
  2. At commencement date it records an asset and a lease liability. Lease Liability = PV of lease payments – Previous Payments Lease Payments include: Fixed payments & certain variable payments (those based on index) Residual Value Guarantee Purchase option /termination costs
  3. Implicit interest rate- the rate of interest that causes: the PV of the lease payments + The PV of Unguaranteed residual value, to equal The Fair value of the underlying asset + the lessor’s initial direct cost of the lease Incremental borrowing rate: interest rate that lessee should have to pay on loan for similar purpose Guaranteed residual value- Expected payment by lessee at the end of the lease term Unguaranteed residual value: the unguaranteed carrying value of the asset at the end of the lease term