FUNDAMENTALS OF IFRS CHAPTER 19 Leases (Exposure Draft) an Amitabha Mukherjee endeavour www.ifrsdemystified.com an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) FUNDAMENTALS OF IFRS 19.1 LEASES (EXPOSURE DRAFT) 19.2 19.2 CHAPTER NINETEEN Leases (Exposure Draft) 19 Introduction A lease is a contract in which the right to use a specified asset (the underlying asset) is conveyed, for a period of time, in exchange for consideration. Contract An agreement between 2 or more parties that create enforceable rights and obligations. Underlying asset The asset for which a right of use is conveyed in a lease. Lessee An entity that enters into a contract to provide another entity with consideration in return for the right to use an asset for a period of time. Lessor An entity that enters into a contract to provide another entity with the right to use an asset for a period of time in return for consideration. At the date of inception of a contract, an entity shall determine whether the contract is, or contains, a lease on the basis of the substance of the contract, by assessing whether the : Fulfilment of the contract depends on providing a specified asset(s); and In assessing whether fulfilment of the contract depends on providing a specified asset(s) to the lessee, it may be necessary to consider whether the asset(s) are implicitly or explicitly identified. Example 1 To be the subject of a lease, a physically distinct portion of a larger asset (eg, wheels of a truck) could be a specified asset, whereas a non-physically distinguishable portion of an asset (eg, 50% of the capacity of a fuel tank) would not qualify, as a specified asset. An asset is implicitly specified if it is – infeasible or impractical for a lessor to provide alternative assets in place of the underlying asset during the lease term; or if a lessor can substitute another asset for the underlying asset but rarely does so in practice. Example 2 In a lease of an aircraft, it may not be practical to substitute another aircraft if the lessee has made extensive changes to the underlying asset (the aircraft) to suit the lessee’s image, brand and requirements. A contract that permits an entity to substitute a similar asset for the specified asset after the commencement of the lease does not contain a lease because the underlying asset is not specified, even if the contract explicitly identifies a specified asset. an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.3 FUNDAMENTALS OF IFRS 19.3 If a supplier of a specified quantity of goods or services has the right and current ability to provide those goods or services using assets not specified in the arrangement, the underlying assets are not specified and the contract does not contain a lease. However, a contract that permits or requires the supplier to substitute other assets only when the specified asset is not operating properly may be a lease. In addition, a contractual provision (contingent or otherwise) that permits or requires a supplier to substitute other assets for any reason on or after a specified date does not preclude lease treatment before the date of substitution. Contract conveys the right to control the use of a specified asset for an agreed period of time. A contract conveys the right to use an asset if it conveys to an entity the right to control the use of the underlying asset during the lease term. The right to control the use of the underlying asset is conveyed if any one of the following conditions is met : The entity has the ability or right to – operate the asset or direct others to operate the asset in a manner that it determines while obtaining or controlling more than an insignificant amount of the output or other utility of the asset; or control physical access to the underlying asset while obtaining or controlling more than an insignificant amount of the output or other utility of the asset. The entity will obtain all but an insignificant amount of the output or other utility of the asset during the term of the lease, and the price that the entity will pay for the output is neither contractually fixed per unit of output nor equal to the current market price per unit of output as of the time of delivery of the output. If the price that the entity will pay is contractually fixed per unit of output or at the current market price as of the time of delivery of the output, then the entity is paying for a product or service rather than paying for the right to use the underlying asset. Example 4 A production company (the purchaser) enters into an arrangement with a third party (the supplier) to supply a minimum quantity of gas needed in its production process for a specified period of time. The supplier designs and builds a facility adjacent to the purchaser’s plant to produce the needed gas and maintains ownership and control over all significant aspects of operating the facility. The agreement provides for the following – The facility is explicitly identified in the arrangement, and the supplier has the contractual right to supply gas from other sources. However, supplying gas from other sources is not economically feasible or practicable. The supplier has the right to provide gas to other customers and to remove and replace the facility’s equipment and modify or expand the facility to enable the supplier to do so. However, at inception of the arrangement, the supplier has no plans to modify or expand the facility. The facility is designed to meet only the purchaser’s needs. The supplier is responsible for repairs, maintenance and capital expenditures. The supplier must stand ready to deliver a minimum quantity of gas each month. Each month, the purchaser will pay a fixed capacity charge and a variable charge based on actual production taken. The purchaser must pay the fixed capacity charge irrespective of whether it takes any of the facility’s production. The variable charge includes the facility’s actual energy costs, which amount to about 90% of the facility’s total variable costs. The supplier is subject to increased costs resulting from the facility’s inefficient operations. If the facility does not produce the stated minimum quantity, the supplier must return all or a portion of the fixed capacity charge. The arrangement contains a lease. An asset (the facility) is explicitly identified in the arrangement and fulfillment of the arrangement is dependent on the facility. Although the supplier has the right to supply gas from other sources, its ability to do so is not substantive. The purchaser has obtained the right to use the facility because, on the facts presented – in particular, that the facility is designed to meet only the purchaser’s needs and the supplier has no plans to expand or modify the facility — it is remote that one or more parties other than the purchaser will take more than an insignificant amount of the facility’s output and the price the purchaser will pay is neither contractually fixed per unit of output nor equal to the current market price per unit of output as of the time of delivery of the output. an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) Example 3 LEASES (EXPOSURE DRAFT) 19.4 19.4 CHAPTER NINETEEN Example 5 A manufacturing company (the purchaser) enters into an arrangement with a third party (the supplier) to supply a specific component part of its manufactured product for a specified period of time. The supplier designs and constructs a plant adjacent to the purchaser’s factory to produce the component part. The designed capacity of the plant exceeds the purchaser’s current needs, and the supplier maintains ownership and control over all significant aspects of operating the plant. The arrangement provides for the following – The supplier’s plant is explicitly identified in the arrangement, but the supplier has the right to fulfil the arrangement by shipping the component parts from another plant owned by the supplier. However, to do so for any extended period of time would be uneconomic. The supplier is responsible for repairs, maintenance, and capital expenditures of the plant. The supplier must stand ready to deliver a minimum quantity. The purchaser is required to pay a fixed price per unit for the actual quantity taken. Even if the purchaser’s needs are such that they do not need the stated minimum quantity, they still pay only for the actually quantity taken. The supplier has the right to sell the component part to other customers and has a history of doing so (by selling in the replacement parts market), so it is expected that parties other than the purchaser will take more than an insignificant amount of the component parts produced at the supplier’s plant. The arrangement does not contain a lease. An asset (the plant) is explicitly identified in the arrangement and fulfillment of the arrangement is dependent on the facility. Although the supplier has the right to supply component parts from other sources, the supplier would not have the ability to do so because it would be uneconomic. However, the purchaser has not obtained the right to use the plant because the purchaser does not have the ability or right to operate or direct others to operate the plant or control physical access to the plant, and the likelihood that parties other than the purchaser will take more than an insignificant amount of the component parts produced at the plant is more than remote, on the basis of the facts presented. In addition, the price that the purchaser pays is fixed per unit of output taken. Separation of lease and service components An entity shall apply this Exposure Draft to a contract that contains service components and lease components, except as follows – A lessee (lessor) shall apply Revenue from Contracts with Customers to a service component of a contract that contains service components and lease components if the service component is distinct and the lessee (lessor) is able to do so. When a lessor applies the derecognition approach (discussed later), it shall apply Revenue from Contracts with Customers to a service component of a contract that contains service components and lease components, even if that service component is not distinct. An entity shall apply Revenue from Contracts with Customers to identify separate performance obligations within a contract that contains both service components and lease components. An entity shall determine whether a service component is distinct at the date of inception of the lease considering all concurrently negotiated contracts with another party. A service component is distinct if either the : entity, or another entity, sells an identical or similar service separately; or entity could sell the service separately because the service has a distinct – function, ie, it has a utility either (1) on its own; or (2) together with other nonleasing goods and services that the lessee has acquired from the lessor or is provided separately by the lessor or by another entity; profit margin, ie, it is subject to distinct risks and the lessor can separately identify the resources needed to provide the service. If the payments required by a contract that contains both lease and service components change after the commencement of the lease, an entity shall determine the change attributable to the lease and service components. If the amount of the change attributable to each component cannot be determined, the entity shall allocate the change to the service components and lease components in the same proportion as determined at the date of commencement of the contract. an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.5 FUNDAMENTALS OF IFRS 19.5 If the service component is distinct, the entity allocates the payments required by the contract between the service components and lease components using the principles of Revenue from Contracts with Customers. However, if a lessee or a lessor that applies the performance obligation approach is unable to allocate the payments, the lessee or lessor applies this Exposure Draft to the whole contract. If the service component is not distinct, a lessee and a lessor that applies the performance obligation approach shall account for the whole contract as a lease. If a service component is not distinct and a lessor applies the derecognition approach, the lessor shall allocate the payments between service components and lease components on a reasonable basis, eg, based on the stand-alone selling price of the service. The lessor recognises a receivable for the lease component only and recognises the service component in accordance with the principles of Revenue from Contracts with Customers. Example 6 An entity goes into a 3-year lease of equipment. The contract entails the entity to make fixed monthly payment of 360 to cover the 3 components of the contact, ie, lease, maintenance and training. Scenario 1 The entity ascertains the stand-alone selling price for each of the components and calculates the amount allocated to each component as follows – Component Lease Stand-alone selling price Allocation Monthly allocation 320 80% (320 400 100) Maintenance 60 15% (60 400 100) 54 (360 15%) Training 20 5% (20 400 100) 18 (360 5%) 400 100% 288 (360 80%) 360 The entity would allocate 288 of the monthly payments to the equipment lease, and would recognise and measure the right-of-use asset and the liability to make lease payments using this Exposure Draft. The payments allocated to the maintenance (54) and training (18) would be accounted for as per Revenue from Contracts with Customers. Scenario 2 Except for the maintenance, stand-alone selling prices exist for the other 2 components, which are same as Scenario 1. The lessor offers the lease of the equipment with a maintenance plan and charges a fixed monthly payment of 360. Without the maintenance service, the charge is 340 per month. No other vendor offers a maintenance plan separately. The entity would allocate 320 to the lease, 20 to training and the balance 20 (360 – 340) to maintenance. Scenario 3 The stand-alone selling price for the maintenance services exists which is 60 per month. But for lease and training, stand-alone selling prices are not available. In this case, the training component would be accounted for together with the lease, which is 300 (360 – 60) per month. The 60 per month maintenance services will be accounted for as per Revenue from Contracts with Customers. Scenario 4 The stand-alone selling price of any of the components does not exist. In such a case, the entire payment of 360 per month will be accounted for using this Exposure Draft. Distinguishing between a lease and a purchase or sale An entity shall not apply this Exposure Draft to contracts that meet the criteria for classification as a purchase or sale of an underlying asset. A contract represents a purchase or sale of an underlying asset if, at the end of the contract, an entity transfers to another entity control of the entire underlying asset and all but a trivial amount of the risks and benefits associated with the entire underlying asset. That determination is made at inception and is not subsequently reassessed. an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) An entity shall account for each component as follows – LEASES (EXPOSURE DRAFT) 19.6 CHAPTER NINETEEN 19.6 An entity shall consider all relevant facts and circumstances when determining whether control of the underlying asset is transferred at the end of the contract. A contract normally transfers control of an underlying asset when the contract – automatically transfers title to the underlying asset to the transferee at the end of the contract term; or includes a bargain purchase option, which is an option to purchase the asset at a price that is expected to be significantly lower than the fair value of the asset at the date that the option becomes exercisable. If the exercise price is significantly lower than fair value, it would be reasonably certain at the inception of the lease that such options will be exercised. An entity that has a bargain purchase option is in an economically similar portion to an entity that will automatically obtain title to the underlying asset at the end of the lease term. By exercising its bargain purchase option, the transferee would be able to direct the use of, and receive the benefits from, the whole of the underlying asset for the whole of its life. Determining the lease term The lease term is the longest possible term that is more likely than not to occur. An entity determines the lease term considering all explicit and implicit options included in the contract and given effect by the operation of statutory law. Example 7 An entity may have a lease that has a non-cancellable 10-year term, an option to renew for 5 years at the end of 10 years, and an option to renew for an additional 5 years at the end of 15 years. Assume that the entity determines the probability for each term as follows : Probability Term (years) 40% 10 30% 15 30% 20 The term will be at least 10 years, there is a 60% change that the term will be 15 years or longer, but only a 30% change that the term will be 20 years. Therefore, there is a 60% chance that the term will be 15 years, which is the longest possible term more likely than not to occur. Therefore, the lease term is 15 years. An entity considers the following factors in assessing the probability of each possible term – contractual factors, which are the explicit contractual terms that could affect whether the lessee extends or terminates the lease. Example 8 Examples of contractual factors are the level of lease payments in any secondary period (bargain, discounted, market or fixed rate), the existence and amount of any contingent rentals or other contingent payments such as payments under term option penalties and residual value guarantees, the existence and terms of any renewal options and costs associated with returning the underlying asset in a contractually specified condition or to a contractually specified location. non-contractual factors, such as statutory law or the financial consequences of a decision to extend or terminate the lease that the contract does not state explicity. Example 9 Examples of non-contractual features are local regulations that affect the lease term, the existence of significant leasehold improvements that would be foregone if the lease were terminated or not extended, non-contractual relocation costs, costs of lost production, tax consequences and costs associated with sourcing an alternative item. an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.7 FUNDAMENTALS OF IFRS 19.7 business factors, such as whether the underlying asset is crucial to the lessee’s operations, or whether the underlying asset is a specialised asset or the location of the asset. other lessee-specific factors, such as lessee’s intentions and past practice. Leases sometimes include options and residual value guarantees, ie, a guarantee made by the lessee that the fair value of the underlying asset that the lessee will return to the lessor will be at least a specified amount. If the fair value is less than that amount, the lessee is obliged to pay the difference to the lessor. Example 10 A lease contract includes a guarantee by the lessee that the lessor will realise 10 from selling the asset at the expiration of the lease. At the commencement of the lease, the lessee estimates that the underlying asset will have a fair value of 5 at the expiration of the lease. Therefore, the lessee expects to pay the lessor the gross guaranteed amount minus the expected value of the underlying asset, ie, 5 (10 – 5) under the residual value guarantee. Example 11 A lease may have a term of 10 years. At the end of 10-year period, the contract permits the lessee to return the underlying asset to the lessor or to extend the lease for an additional 5 years. If the lessee returns the leased asset to the lessor, the contract may specify that the lessee will pay the lessor the difference between the expected residual value of the leased asset at the end of 10 years and the actual residual value at the end of 10 years (a residual value guarantee). At the date of inception of the lease, a lessee or lessor shall determine whether exercising the option to extend its more likely than not to occur. At the date of commencement of the lease, the lessee recognises a liability to make lease payments and the lessor recognises a right to receive lease payments that is consistent with that outcome. Thus : if the lessee or lessor determines that returning the asset at the end of the 10-year period is more likely than not to occur, the lease term for the lessee or lessor is 10 years. In that case – the lessee would recognise a liability to make lease payments equal to the present value of 10 years of lease payments plus an estimate of the amount payable under the residual value guarantee. if the lessor retains exposure to significant risks or benefits associated with the underlying asset, the lessor would recognise a receivable and a liability equal to the present value of 10 years of lease payments plus an estimate of the amount receivable under the residual value guarantee. The lessor would continue to recognise the underlying asset. if the lessor does not retain exposure to significant risks or benefits associated with the underlying asset, the lessor would recognise a receivable equal to the present value of 10 years of lease payments plus an estimate of the amount receivable under the residual value guarantee and would derecognise a portion of the underlying asset. if the lessee or lessor determines that renewal is more likely than not to occur, the lease term for the lessee or lessor is 15 years. In that case – the lessee would recognise a liability to make lease payments equal to the present value of 15 years of lease payments. if the lessor retains exposure to significant risks or benefits associated with the underlying asset, the lessor would recognise a receivable and a liability equal to the present value of 15 years of lease payments. The lessor would continue to recognise the underlying asset. if the lessor does not retain exposure to significant risks or benefits associated with the underlying asset, the lessor would recognise a receivable equal to the present value of 15 years of lease payments and would derecognise a portion of the underlying asset. At each reporting date, the lessee or lessor reassesses which outcome it considers to be most likely to occur on the basis of any new facts or circumstances that indicate that there would be a significant change in the recognised right to receive lease payments or liability to make lease payments since the previous reporting period. The lessee and lessor may have different information regarding the likelihood of an option being exercised; therefore, they may reach different decisions about what is the most likely outcome. Example 12 An entity enters in a lease for an equipment that includes a non-cancellable term of 4 years and 2 additional 4-year renewal options. If the entity finds no significant economic incentive to exercise the renewal options, the lease term would be 4 years. Now assume the lessee installed a significant amount of leasehold improvements at the commencement of the lease, which have a useful life of 10 years. The entity determines that a significant economic incentive exists through 10 years, which would otherwise be foregone if the lease were not extended. Therefore, the lease term would be for 10 years. an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) LEASES (EXPOSURE DRAFT) 19.8 19.8 CHAPTER NINETEEN Example 13 An entity enters into a 3-year lease for an equipment, which has a 5-year useful life and the expected fair value of the equipment at the end of 3 years is 10. The lease contract includes a purchase option under which the entity can purchase the equipment for 5 at the end of the contract. Since the entity can obtain the equipment at a price that is significantly lower than the expected fair value at the time of exercise of the option, the entity has a significant economic incentive to exercise the purchase option. Therefore, the lease term would be for 5 years. Lessee Recognition At the date of commencement of a lease, a lessee shall recognise in the Statement of Financial Position a right-of-use asset and a liability to make lease payments. Date of commencement of the lease The date on which the lessor makes the underlying asset available for use by the lessee. Right-of-use asset An asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Lease payments Payments arising under a lease including fixed rentals and rentals subject to uncertainty, including, but not limited to, contingent rentals and amounts payable by the lessee under residual value guarantees and term option penalties. Contingent rentals Lease payments that arise under the contractual terms of a lease because of changes in facts or circumstances occurring after the date of inception of the lease, other than the passage of time. Date of inception of the lease The earlier of the date of the lease agreement and the date of commitment by the parties to the lease agreement. A lessee shall recognise the following items in the Statement of Comprehensive Income, except to the extent that another IFRS requires or permits its inclusion in the cost of an asset – Interest expense on the liability to make lease payments Amortisation of the right-of-use asset If a lessee measures the right-of-use asset at amortised cost, it shall amortise the asset on a systematic basis from the date of commencement of the lease to the end of the lease term or over the useful life of the underlying asset if shorter. The lessee shall select the amortisation method and review the amortisation period and amortisation method in accordance with IAS 38. Revaluation gains and losses of a right-of-use asset A lessee may measure a right-of-use asset at its fair value at the date of revaluation less any amortisation and impairment losses arising after the date of revaluation if it revalues all owned assets in that class of property, plant and equipment, in accordance with IAS 16. For the purposes of this revaluation, fair value need not be determined by reference to an active market. If a lessee measures a right-of-use asset at a revalued amount, it shall revalue all right-of-use assets relating to the class of property, plant and equipment to which the underlying asset belongs. an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.9 FUNDAMENTALS OF IFRS 19.9 If the lessee revalues a right-of-use asset in accordance with the above, it shall recognise gains and losses on revaluation in the Statement of Comprehensive Income in accordance with IAS 38. Any changes in the liability to make lease payments resulting from reassessment of the expected amount of contingent rentals or expected payments under term option penalties and residual value guarantees relating to current or prior periods. Any impairment losses on a right-of-use asset A lessee shall apply IAS 36 at each reporting date to determine whether the right-of-use asset is impaired and shall recognise any impairment loss in accordance with IAS 36. Initial measurement At the end of inception of the lease, a lessee shall measure : the liability to make lease payments at the present value of the lease payments, discounted using the lessee’s incremental borrowing rate or, if it can be readily determined, the rate the lessor charges the lessee. Lessee’s incremental borrowing rate The rate of interest that, at the date of inception of the lease, the lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to purchase a similar underlying asset. Rate the lessor charges the lessee A discount rate that takes into account the nature of the transaction as well as the specific terms of the lease such as lease payments, lease term and contingent rentals. The discount rate used to determine the present value of lease payments for lessees is the lessee’s incremental borrowing rate or the rate the lessor charges the lessee if that rate can be reliably determined. The lessee’s incremental borrowing rate may be the same as the rate the lessor charges the lessee. Both the lessee’s incremental borrowing rate and the rate the lessor charges the lessee would reflect the nature of the transaction and the specific terms of the lease, such as lease payments, lease term, expected contingent rentals, expected payments under term option penalties and residual value guarantees, the expected value of the underlying asset at the end of the lease term and security attached to the underlying asset during and at the end of the lease term. Present value of lease payments A lessee shall determine the present value of lease payments payable during the lease term on the basis of expected outcome, determined using all relevant information. The expected outcome is the present value of the probability-weighted average of the cash flows for a reasonable number of outcomes. Estimating expected outcome involves – identifying each reasonably possible outcome. An entity need not assess every possible outcome to identify the reasonably possible outcomes included in the expected present value of the cash flows. estimating the amount and timing of the cash flows for each reasonably possible outcome. determining the present value of those cash flows. estimating the probability of each outcome. an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) If the lessee revalues a right-of-use asset in accordance with the above, it shall perform revaluations with such regularity that at the end of the reporting period the carrying amount of the asset does not differ materially from its fair value. LEASES (EXPOSURE DRAFT) 19.10 19.10 CHAPTER NINETEEN In determining the present value of lease payments payable, a lessee shall include an estimate of – contingent rentals payable. If the contingent rentals depend on an index or a rate, the lessee shall determine the expected lease payments using readily available forward rates or indices. If forward rates or indices are not readily available, the lessee shall use the prevailing rates or indices. amounts payable to the lessor under residual value guarantees. Residual value guarantees that are provided by an unrelated third party are not lease payments. expected payments to the lessor under term option penalties. The exercise price of a purchase option included in a lease is not a lease payment and the purchase option is not included in determining the present value of lease payments payable. the right-of-use asset at the amount of the liability to make lease payments, plus any initial direct costs incurred by the lessee. Initial direct costs Recoverable costs that are directly attributable to negotiating and arranging a lease that would not have been incurred had the lease transaction not been made. They may include – commissions; legal fees; evaluation of the prospective lessee’s financial condition; evaluating and recording guarantees, collateral and other security arrangements; negotiating lease terms; preparing and processing lease documents; closing the transactions; other costs that are incremental and directly attributable to negotiating and arranging the lease. The following items are not initial direct costs – general overheads, such as rent, depreciation, occupancy and equipment costs, unsuccessful origination efforts and idle time; costs related to activities performed by the lessor for advertising, soliciting potential leases, servicing existing leases, or other ancillary activities. Subsequent measurement After the date of commencement of the lease, a lessee shall measure the : liability to make lease payments at amortised cost using the effective interest method. Effective interest method It is a method of calculating the amortised cost of a financial asset or a financial liability (or group of financial assets or financial liabilities) and of allocating the interest income or interest exposure over the relevant period. an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.11 FUNDAMENTALS OF IFRS 19.11 After the commencement of the lease, the lessee shall reassess the carrying amount of the liability to make lease payments arising from each lease if facts or circumstances indicate that there would be a significant change in the liability since the previous reporting period. When such indications exist, a lessee shall reassess the – length of the lease term and adjust the right-of-use asset to reflect any resulting change to the liability to make lease payments arising from changes to the lease term. expected amount of any contingent rentals and expected payments under term option penalties and residual value guarantees. A lessee shall recognise any resulting changes to the liability to make lease payments in accordance with the following paragraph. A lessee shall distinguish changes in contingent rentals and expected payments under term option penalties and residual value guarantees that relate to current or prior periods from those that relate to future periods. A lessee shall recognise changes in the expected amount of such payments – in profit or loss, to the extent that those changes relate to current or prior periods. as an adjustment to the right-of-use asset to the extent that those changes relate to future periods. Example 14 When lease payments depend on the amount of the lessee’s sales, changes relating to sales in the current or prior periods are recognised in profit or loss, whereas changes relating to expectations of future sales are recognised as an adjustment to the right-ofuse asset. A lessee shall not change the rate used to discount the lease payments except to reflect changes in reference interest rates when contingent rentals are based on those reference interest rates. When contingent rentals are based on reference interest rates, a lessee shall recognise any changes to the liability to make lease payments arising from changes in the discount rate in profit or loss. right-of-use asset at amortised cost, except for revaluation and impairment. Example 15 An entity enters into a 3-year lease of a machine. Annual lease payments are 1,000 in arrears. The lessee’s incremental borrowing rate is 10%. The present value of the lease payments using 10% discount rate is : Year-end Cash outflow Discount rate @ 10% 1 1,000 0.909 2 1,000 0.826 826 3 1,000 0.751 751 Present value of lease payments Present value 909 2,486 At the commencement of the lease, the lessee recognises the leased asset and corresponding liability at the present value of lease payments : Right-of-use asset 2,486 Liability to make lease payments 2,486 At the end of year 1, the lessee recognises – interest on the liability to make lease payments : Interest expense 248 (2,486 10%) Liability to make lease payments 248 lease payment : Liability to make lease payments Cash 1,000 1,000 an Amitabha Mukherjee endeavour www.ifrsdemystified.com continued ... LEASES (EXPOSURE DRAFT) Reassessment of the liability to make lease payments LEASES (EXPOSURE DRAFT) 19.12 19.12 CHAPTER NINETEEN ... continued and, amortisation of the right-of-use asset. Amortisation Accumulated amortisation At the end of year 2, the lessee recognises – interest on the liability to make lease payments : Interest expense Liability to make lease payments lease payment : Liability to make lease payments Cash and, amortisation of the right-of-use asset. Amortisation Accumulated amortisation At the end of year 3, the lessee recognises – interest on the liability to make lease payments : Interest expense Liability to make lease payments lease payment : Liability to make lease payments Cash and, amortisation of the right-of-use asset. Amortisation Accumulated amortisation * under SLM 829 (2,486 3)* 829 173 [(2,486 + 248 – 1,000) x 10%] 173 1,000 1,000 829 (2,486 3) 829 93 (1,000 – 907) 93 1,000 1,000 828 828 Example 16 An entity enters into a 3-year lease of a machine. Annual lease payments are 1,000 in arrears. The lessee’s incremental borrowing rate is 10%. The residual value guarantee at the end of 3 years is 500. The lease term can be renewed for an additional period of 2 years, when annual lease payments are 1,200 in arrears. The residual value guarantee at the end of 5 years is 300. At the commencement of the lease, it is more likely than not to occur that the lease term is 3 years. At the end of the 2nd year, the lessee determines to renew the lease for further 2 years. The lessee amortises the right-of-use asset on a straight-line basis. The present value of lease payments using 10% discount rate is : Year-end Cash outflow Discount rate @ 10% Present value 1 1,000 0.909 909 2 1,000 0.826 826 3 1,500* 0.751 1,127 Present value of lease payments 2,862 * including residual value guarantee. At the commencement of the lease, the lessee recognises the leased asset and corresponding liability at the present value of lease payments : Right-of-use asset 2,862 Liability to make lease payments 2,862 At the end of year 1, the lessee recognises – interest on the liability to make lease payments : Interest expense 286 (2,862 x 10%) Liability to make lease payments 286 an Amitabha Mukherjee endeavour www.ifrsdemystified.com continued ... 19.13 FUNDAMENTALS OF IFRS 19.13 lease payment : Liability to make lease payments 1,000 Cash 1,000 and, amortisation of the right-of-use asset. Amortisation 954 (2,862 3) Accumulated amortisation 954 Following these events, the carrying amount of the liability to make lease payments is 2,148 (2,862 + 286 – 1,000) and the carrying amount of right-of-use asset is 1,908 (2,862 – 954). At the end of year 2, the lessee recognises – interest on the liability to make lease payments : Interest expense 215 (2,148 x 10%) Liability to make lease payments 215 lease payment : Liability to make lease payments 1,000 Cash 1,000 and, amortisation of the right-of-use asset. Amortisation 954 (2,862 3) Accumulated amortisation 954 Following these events, the carrying amount of the liability to make lease payments is 1,363 (2,148 + 215 – 1,000) and the carrying amount of right-of-use asset is 954 (2,862 3). When the lessee determines to renew the lease, the present value of lease payments at the end of 2nd year is : Year-end Cash outflow Discount rate @ 10% Present value 3 1,000 0.909 909 4 1,200 0.826 991 5 1,500* 0.751 1,127 Present value of lease payments 3,027 * including residual value guarantee The lessee is to adjust the right-of-use asset to reflect the resulting change to the liability to make lease payments arising from changes to the lease term and residual value guarantee : Right-of-use asset 1,664 Liability to make lease payments 1,664 (3,027 – 1,363) Following these events, the carrying amount of the liability to make lease payments is 3,027 and the carrying amount of rightof-use asset is 2,618 (954 + 1,664). At the end of year 3, the lessee recognises – interest on the liability to make lease payments : Interest expense 303 (3,027 x 10%) Liability to make lease payments 303 lease payment : Liability to make lease payments 1,000 Cash 1,000 and, amortisation of the right-of-use asset. Amortisation 873 (2,618 3) Accumulated amortisation 873 Following these events, the carrying amount of the liability to make lease payments is 2,330 (3,027 + 303 – 1,000) and the carrying amount of right-of-use asset is 1,745 (2,618 – 873). At the end of year 4, the lessee recognises – interest on the liability to make lease payments : Interest expense 233 (2,330 x 10%) Liability to make lease payments 233 continued ... an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) ... continued LEASES (EXPOSURE DRAFT) 19.14 19.14 CHAPTER NINETEEN ... continued lease payment : Liability to make lease payments Cash 1,200 1,200 and, amortisation of the right-of-use asset. Amortisation 873 (2,618 3) Accumulated amortisation 873 Following these events, the carrying amount of the liability to make lease payments is 1,363 (2,330 + 233 – 1,200) and the carrying amount of right-of-use asset is 872 (2,618 3). At the end of year 5, the lessee recognises – interest on the liability to make lease payments : Interest expense 137 (1,363 x 10%) Liability to make lease payments 137 lease payment : Liability to make lease payments 1,500 (1,363 + 137) Cash 1,500 and, amortisation of the right-of-use asset. Amortisation 872 Accumulated amortisation 872 Example 17 An entity enters into a lease of a machine that has a 3-year non-cancellable initial lease term with an additional 3-year renewal option. The lessee is required to pay 2,000 at the date of the commencement of the lease on 1 January 20x1 and annual lease payments of 1,000 at the beginning of each subsequent year. In case the renewal option is not exercised, the lessee is required to pay the lessor 1,500 as term option penalty, when the lessee returns the machine to the lessor at the end of 3 years. If the contract is renewed, the lessee is required to pay the lessor a residual value guarantee of 500 at the end of 5 years, when the lessee returns the machine to the lessor. The annual lease payments are increased by 200. The lessee’s incremental borrowing rate is 8%. The lessee amortises the right-of-use asset on a straight-line basis. At the commencement of the lease, it is more likely than not to occur that the lease term is 3 years. At the beginning of the 3rd year, the lessee installs significant leasehold improvements costing 1,000 that have a useful life of 4 years. As a result, the lessee determines that there is significant economic incentive to exercise the 3-year renewal option. The present value of lease payments using 8% discount rate is : Date Cash outflow Discount rate @ 8% Present value 1 January 20x1 2,000 1.000 2,000 1 January 20x2 1,000 0.926 926 1 January 20x3 1,000 0.857 857 31 December 20x3 1,500 0.794 1,191 Present value of lease payments 4,974 20x1 At the commencement of the lease, the lessee recognises – the leased asset and corresponding liability at the present value of lease payments : Right-of-use asset 4,974 Liability to make lease payments 4,974 and, lease payment. Liability to make lease payments Cash 2,000 2,000 continued ... an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.15 FUNDAMENTALS OF IFRS 19.15 At the end of the year, the lessee recognises – interest on the liability to make lease payments : Interest expense 238 (2,974 x 8%) Liability to make lease payments 238 and, amortisation of the right-of-use asset. Amortisation 1,658 (4,974 3) Accumulated amortisation 1,658 Following these events, the carrying amount of the liability to make lease payments is 3,212 (4,974 – 2,000 + 238) and the carrying amount of right-of-use asset is 3,316 (4,974 – 1,658). 20x2 At the beginning of the year, the lessee recognises – lease payment. Liability to make lease payments 1,000 Cash 1,000 At the end of the year, the lessee recognises – interest on the liability to make lease payments : Interest expense 177 [(3,212 – 1,000) x 8%] Liability to make lease payments 177 and, amortisation of the right-of-use asset. Amortisation 1,658 (4,974 3) Accumulated amortisation 1,658 Following these events, the carrying amount of the liability to make lease payments is 2,389 (3,212 – 1,000 + 177) and the carrying amount of right-of-use asset is 1,658. 20x3 At the beginning of the year, the lessee recognises – lease payment : Liability to make lease payments 1,000 Cash 1,000 and, leasehold improvements. Right-of-use asset 1,000 Cash 1,000 At the end of the year, the lessee recognises – the balance of the liability to make lease payments to adjust against right-of-use asset 1,191 [1,658 – (3,783 – 3,316)] and the remaining balance to profit or loss 198 (1,389 – 1,191). Liability to make lease payments Right-of-use asset Profit or loss 1,389 1,191 198 and, amortisation of the right-of-use asset. Amortisation 717 [(3,783 – 3,316) + (1,000 4)] Accumulated amortisation 717 Following these events, the carrying amount of the liability to make lease payments is Nil and the carrying amount of right-of-use asset is 750 (1,000 – 250). continued ... an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) ... continued LEASES (EXPOSURE DRAFT) 19.16 19.16 CHAPTER NINETEEN ... continued 20x4 After renewal, the present value of lease payments using 8% discount rate is : Date Cash outflow Discount rate @ 8% Present value 1 January 20x4 1,200 1.000 1,200 1 January 20x5 1,200 0.926 1,111 1 January 20x6 1,200 0.857 1,028 500 0.794 31 December 20x6 Present value of lease payments 397 3,736 At the beginning of the year, the lessee recognises – the leased asset and corresponding liability at the present value of lease payments : Right-of-use asset 3,736 Liability to make lease payments 3,736 and, lease payment. Liability to make lease payments 1,200 Cash 1,200 At the end of the year, the lessee recognises – interest on the liability to make lease payments : Interest expense 201 (2,536 x 8%) Liability to make lease payments 201 and, amortisation of the right-of-use asset. Amortisation 1,495 [(1,000 4) + (3,736 3)] Accumulated amortisation 1,495 Following these events, the carrying amount of the liability to make lease payments is 2,737 (3,736 – 1,200 + 201) and the carrying amount of right-of-use asset is 2,991 (750 + 3,736 – 1,495). 20x5 At the beginning of the year, the lessee recognises – lease payment. Liability to make lease payments 1,200 Cash 1,200 At the end of the year, the lessee recognises – interest on the liability to make lease payments : Interest expense 123 [(2,737 – 1,200) x 8%] Liability to make lease payments 123 and, amortisation of the right-of-use asset. Amortisation 1,495 [(1,000 4) + (3,736 3)] Accumulated amortisation 1,495 Following these events, the carrying amount of the liability to make lease payments is 1,660 (2,737 – 1,200 + 123) and the carrying amount of right-of-use asset is 1,496 (2,991 – 1,495). 20x6 At the beginning of the year, the lessee recognises – lease payment. Liability to make lease payments Cash 1,200 1,200 continued ... an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.17 FUNDAMENTALS OF IFRS 19.17 At the end of the year, the lessee recognises – interest on the liability to make lease payments : Interest expense 40 [500 – (1,660 – 1,200)] Liability to make lease payments 40 lease payment : Liability to make lease payments 500 Cash 500 and, amortisation of the right-of-use asset. Amortisation Accumulated amortisation 1,496 1,496 Presentation A lessee shall present the following items in the Statement of Financial Position – liabilities to make lease payments, separately from other financial liabilities. right-of-use assets as if they were tangible assets within property, plant and equipment or investment property as appropriate, separately from assets that the lessee does not lease. A lessee shall present amortisation of the right-of-use asset and interest expense on the liability to make lease payments separately from other amortisation and interest expense, either in profit or loss or in the notes. A lessee shall classify cash payments for leases as financing activities in the Statement of Cash Flows and present them separately from other financial cash flows. Lessor At the date of inception of the lease, a lessor shall assess whether a lease is accounted for in accordance with the – performance obligation approach If a lessor retains exposure to significant risks or benefits associated with an underlying asset, the lessor shall apply the performance obligation approach to the lease. or, derecognition approach If a lessor does not retain exposure to significant risks or benefits associated with an underlying asset, the lessor shall apply the derecognition approach to the lease. On the basis of whether the lessor retains exposure to significant risks or benefits associated with the underlying asset either – during the expected term of the lease; or after the expected term of the lease by having the expectation or ability to generate significant returns by re-leasing or selling the underlying asset. A lessor shall not change the lessor accounting approach after the date of inception of the lease. A lessor shall consider the following factors in assessing whether it retains exposure to significant risks or benefits associated with the underlying asset during the expected term of the current lease – an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) ... continued LEASES (EXPOSURE DRAFT) 19.18 19.18 CHAPTER NINETEEN significant contingent rentals during the lease term that are based on the use or performance of the underlying asset; options to extend or terminate the lease; material non-distinct services provided under the current lease. Example 18 The existence of material non-distinct services may expose the lessor to a significant risk that the lessee will terminate the lease early because of the non-provision of those services. When the risk that the lessee will terminate the lease early is significant, the lessor is likely to be exposed to significant risks or benefits associated with the underlying asset during the term of the lease. A lessor shall consider the following facts when determining whether it retains exposure to significant risks or benefits associated with the underlying asset after the expected term of the current lease : whether the duration of the lease term is not significant in relation to the remaining useful life of the underlying asset. whether a significant change in the value of the underlying asset at the end of the lease term is expected. In making that assessment, the lessor shall consider the – present value of the underlying asset at the end of the lease term, and effect that any residual value guarantees (including those provided by an unrelated third party) may have on the lessor’s exposure to risks or benefits. Example 19 In general, a residual value guarantee will reduce a lessor’s exposure to downside risk but may give the lessor the potential to benefit from increases in the expected value of the underlying asset at the end of the lease. The existence of one or more indicators is not conclusive in determining whether the lessor retains exposure to significant risks or benefits associated with the underlying asset. A lessor shall not consider the risks associated with the counterparty credit risk of the lessee when determining whether it retains exposure to significant risks or benefits associated with the underlying leased asset during the expected term of the current lease. Performance obligation approach Recognition At the date of commencement of a lease, a lessor shall recognise in the Statement of Financial Position a right to receive lease payments and a lease liability. The lessor shall not derecognise the underlying asset. Lease liability The lessor’s obligation to permit the lessee to use the underlying asset over the lease term. A lessor shall recognise the following items in profit or loss – Interest income on the right to receive lease payments. Lease income as the lease liability is satisfied. Any changes in the lease liability resulting from reassessment of the expected amount of contingent rentals and expected payments under term option penalties and residual value guarantees when the lessor satisfies that liability. an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.19 FUNDAMENTALS OF IFRS 19.19 length of the lease term and adjust the lease liability to reflect any change to the right to receive lease payments arising from changes to the lease term. expected amount of any contingent rentals and any expected payments under residual value guarantees that the lessor can measure reliably and any expected payments under term option penalties. A lessor shall recognise any resulting changes to the right to receive lease payments – in profit or loss to the extent that the lessor has satisfied the related lease liability. as an adjustment to the lease liability to the extent that the lessor has not satisfied, the related lease liability. However, the lessor shall recognise any changes that would reduce that liability below zero in profit or loss. A lessor shall not change the rate used to discount the lease payments except to reflect changes in reference interest rates when contingent rentals are based on those reference interest rates. When contingent rentals are based on reference interest rates, a lessor shall recognise any changes to the right to receive lease payments arising from changes in the discount rate in profit or loss. Any impairment losses on the right to receive lease payments A lessor shall apply IAS 39 at each reporting date to determine whether the right to receive lease payments is impaired and shall recognise any impairment loss in profit or loss. Initial measurement At the date of inception of the lease, a lessor shall measure the : right to receive lease payments at the sum of the present value of the lease payments, discounted using the rate the lessor charges the lessee, and any initial direct costs incurred by the lessor. Present value of lease payments A lessor shall determine the present value of the lease payments receivable during the lease term on the basis of expected outcome, determined using all relevant information. The expected outcome is the present value of the probability-weighted average of the cash flows for a reasonable number of outcomes. In determining the present value of lease payments receivable, a lessor shall include an estimate of – contingent rentals receivable that the lessor can measure reliably. If the contingent rentals depend on an index or a rate, the lessor shall determine the expected lease payments using readily available forward rates or indices. If forward rates or indices are not available, the lessor shall use the prevailing rates or indices. amounts receivable from the lessee under residual value guarantees that the lessor can measure reliably, residual value guarantees that are provided by an unrelated third party are not lease payments. expected payments from the lessee under term option penalties. The exercise price of a purchase option included in a lease is not a lease payment and the purchase option is not included in determining the present value of lease payments receivable. an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) After the date of commencement of the lease, the lessor shall reassess the carrying amount of the right to receive lease payment arising from each lease if the facts or circumstances indicate that there would be a significant change in the right to receive lease payments since the previous reporting period. When such indications exist, a lessor shall reassess the : LEASES (EXPOSURE DRAFT) 19.20 19.20 CHAPTER NINETEEN The discount rate used to determine the present value of lease payments for lessor is the rate that the lessor charges the lessee. The rate the lessor charges the lessee could be, eg, the lessee’s incremental borrowing rate, the rate implicit in the lease (ie, the rate that causes the sum of the present value of cash flows and the present value of the residual value of the underlying asset at the end of the lease to equal the fair value of the underlying asset) or, for property leases, the yield on the property. lease liability at the amount of the right to receive lease payments. Subsequent measurement After the date of commencement of the lease, a lessor shall measure the : right to receive lease payments at amortised cost using the effective interest method. remaining lease liability determined on the basis of the pattern of use of the underlying asset by the lessee. If the lessor cannot determine reliably the remaining lease liability in a systematic and rational manner on the basis of the pattern of use of the underlying asset by the lessee, it shall use the straight-line method. Systematic and rational methods of determining the lessor’s remaining liability, other than straight-line method, include – output methods in which the pattern of use of the underlying asset is based on the number of units produced by the lessee (eg, units delivered, contract milestones, or estimates of goods or services transferred to date relative to the total goods or services to be transferred). input methods in which the pattern of use of the underlying asset is based on the efforts expended to date by the lessee (eg, machine hours used), relating to total efforts expected to be expended over the lease term. Example 20 An entity enters into a lease of a machine (carrying amount 5,000; useful life 5 years). The lessor amortises the lease liability and depreciates the machine on a straight-line basis. The present value of lease payments is : Year Cash inflow Discount rate @ 10% Present value 1 1,000 0.909 909 2 1,000 0.826 826 3 1,000 0.751 751 Present value of lease payments 2,486 At the commencement of the lease, the lessor recognises a lease receivable and a lease liability at the present value of lease payments : Lease receivable 2,486 Lease liability 2,486 At the end of year 1, the lessor recognises – interest on the lease receivable : Lease receivable Interest income receipt of the lease payment : Cash Lease receivable lease income from satisfaction of the lease liability : Lease liability Lease income 248 (2,486 x 10%) 248 1,000 1,000 829 (2,486 3) 829 and, depreciation of the underlying asset. Depreciation Accumulated depreciation 1,000 (5,000 5) 1,000 an Amitabha Mukherjee endeavour www.ifrsdemystified.com continued ... 19.21 FUNDAMENTALS OF IFRS 19.21 LEASES (EXPOSURE DRAFT) ... continued Following these events, the carrying amount of the lease receivable is 1,734 (2,486 + 248 – 1,000), At the end of year 2, the lessor recognises – interest on the lease receivable : Lease receivable 173 (1,734 10%) Interest income 173 receipt of the lease payment : Cash 1,000 Lease receivable 1,000 lease income from satisfaction of the lease liability : Lease liability 829 (2,486 3) Lease income 829 and, depreciation of the underlying asset. Depreciation 1,000 (5,000 5) Accumulated depreciation 1,000 Following these events, the carrying amount of the lease receivable is 907 (1,734 + 173 – 1,000), At the end of year 3, the lessor recognises – interest on the lease receivable : Lease receivable 93 (1,000 – 907) Interest income 93 receipt of the lease payment : Cash 1,000 Lease receivable 1,000 lease income from satisfaction of the lease liability : Lease liability 828 Lease income 828 and, depreciation of the underlying asset. Depreciation 1,000 (5,000 5) Accumulated depreciation 1,000 Example 21 An entity (lessor) enters into a lease of a machine (carrying amount 5,000, useful life 5 years) with another entity (lessee). Annual lease payments are 1,000 in arrear. The lessee’s incremental borrowing rate is 8%, whereas the rate the lessor charges the lessee is 9%. The lessee amortises the right-of-use asset on a straight-line basis. The lessor amortises the lease liability and depreciates the machine also on a straight-line basis. The lease contract includes a guarantee by the lessee that the lessor will realise 500 from selling the asset at the expiration of the lease. At the commencement of the lease, the lessee estimates that the underlying asset will have a fair value of 300 at the expiration of the lease. Lessee Year-end Cash outflow Discount rate @ 8% 1 1,000 0.926 Present value 926 2 1,000 0.857 857 3 1,200 0.794 953 Present value of lease payments 2,736 At the commencement of the lease, the lessee recognises the leased asset and corresponding liability at the present value of lease payments : Right-of-use asset 2,736 Liability to make lease payments 2,736 At the end of year 1, the lessee recognises – interest on the liability to make lease payments : Interest expense Liability to make lease payments 219 (2,736 x 8%) 219 continued ... an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.22 CHAPTER NINETEEN LEASES (EXPOSURE DRAFT) 19.22 ... continued lease payment : Liability to make lease payments Cash 1,000 1,000 and, amortisation of the right-of-use asset. Amortisation 912 (2,736 3) Accumulated amortisation 912 Following these events, the carrying amount of the liability to make lease payments is 1,955 (2,736 + 219 – 1,000). At the end of year 2, the lessee recognises – interest on the liability to make lease payments : Interest expense Liability to make lease payments lease payment : Liability to make lease payments Cash 156 (1,955 x 8%) 156 1,000 1,000 and, amortisation of the right-of-use asset. Amortisation 912 (2,736 3) Accumulated amortisation 912 Following these events, the carrying amount of the liability to make lease payments is 1,111 (1,955 + 156 – 1,000). At the end of year 3, the lessee recognises – interest on the liability to make lease payments : Interest expense Liability to make lease payments lease payment : Liability to make lease payments Cash 89 (1,200 – 1,111) 89 1,200 1,200 and, amortisation of the right-of-use asset. Amortisation Accumulated amortisation 912 (2,736 3) 912 Lessor Year-end Cash inflow Discount rate @ 9% 1 1,000 0.917 Present value 917 2 1,000 0.842 842 3 1,500 0.772 1,158 Present value of lease payments 2,917 At the commencement of the lease, the lessor recognises a lease receivable and a lease liability at the present value of lease payments : Lease receivable 2,917 Lease liability 2,917 At the end of year 1, the lessor recognises – interest on the lease receivable : Lease receivable Interest income receipt of the lease payment : Cash Lease receivable lease income from satisfaction of the lease liability : Lease liability Lease income 263 (2,917 x 9%) 263 1,000 1,000 972 (2,917 3) 972 continued ... an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.23 FUNDAMENTALS OF IFRS 19.23 LEASES (EXPOSURE DRAFT) ... continued and, depreciation of the underlying asset. Depreciation 1,000 (5,000 5) Accumulated depreciation 1,000 Following these events, the carrying amount of the lease receivable is 2,180 (2,917 + 263 – 1,000). At the end of year 2, the lessor recognises – interest on the lease receivable : Lease receivable Interest income receipt of the lease payment : Cash Lease receivable lease income from satisfaction of the lease liability : Lease liability Lease income 196 (2,180 x 9%) 196 1,000 1,000 972 (2,917 3) 972 and, depreciation of the underlying asset. Depreciation 1,000 (5,000 5) Accumulated depreciation 1,000 Following these events, the carrying amount of the lease receivable is 1,376 (2,180 + 196 – 1,000). At the end of year 3, the lessor recognises – interest on the lease receivable : Lease receivable Interest income receipt of the lease payment : Cash Lease receivable lease income from satisfaction of the lease liability : Lease liability Lease income depreciation of the underlying asset : Depreciation Accumulated depreciation and, changes to the right to receive lease payments. Profit or loss Lease receivable 124 (1,500 – 1,376) 124 1,200 1,200 973 973 1,000 (5,000 5) 1,000 300 300 Example 22 An entity enters into a 5-year lease of a machine with an expected useful life of 15 years. The lease includes an option to terminate after 3 years. Annual lease payments are 1,000 in arrears. The rate the lessor charges in the lease is 8%. The carrying amount of the machine at the commencement of the lease is 15,000. The lessor initially estimates that it retains exposure to significant risks or benefits associated with the underlying asset after the expected lease term and accounts for the lease using the performance obligation approach. The present value of 5 years of lease payments is 3,993. The lessor amortises the lease liability on a straight-line basis. At the end of year 1, the lessor reassesses the lease term and determines that the option will be exercised and the lease will terminate at the end of 3 years. The present value of remaining 2 years of lease payment is 1,783. At the commencement of the lease, the lessor recognises a right to receive lease payments (lease receivable) and a lease liability : Lease receivable 3,993 Lease liability 3,993 continued ... an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) 19.24 19.24 CHAPTER NINETEEN ... continued At the end of year 1, the lessor recognises – receipt of the lease payment : Cash Lease receivable interest on the lease receivable : Lease receivable Interest income lease income from satisfaction of the lease liability : Lease liability Lease income 1,000 1,000 319 (3,993 8%) 319 799 (3,993 5) 799 and, depreciation of the underlying asset. Depreciation 1,000 (15,000 15) Accumulated depreciation 1,000 Following these events, the carrying amount of the lease receivable is 3,312 (3,993 – 1,000 + 319), the carrying amount of lease liability is 3,194 (3,993 – 799) and the net amount recognised in profit or loss is income of 118 (799 + 319 – 1,000). At the end of year 1, the lessor reassess the lease term and decreases its lease receivable to reflect the new expected payments (2 years remaining). The lessor makes a corresponding decrease in the lease liability to reflect the shorter term of the lease : Lease liability 1,529 Lease receivable 1,529 (3,312 – 1,783) After making this adjustment the carrying amount of the lease receivable is 1,783 representing the present value of the 2 remaining 1,000 lease payments and the carrying amount of the lease liability is 1,665 representing the lease liability of 3,194 adjusted for the decrease in the lease receivable of 1,529. At the end of year 2, the lessor recognises – receipt of the lease payment : Cash 1,000 Lease receivable 1,000 interest on the lease receivable : Lease receivable 143 (1,783 8%) Interest income 143 lease income from satisfaction of the lease liability : Lease liability 832 (1,665 2) Lease income 832 and, depreciation of the underlying asset. Depreciation 1,000 (15,000 15) Accumulated depreciation 1,000 Following these events, the carrying amount of the lease receivable is 926 (1,783 – 1,000 + 143), the carrying amount of the lease liability is 833 (1,665 – 832) and the net amount recognised in profit or loss is a loss of 25 (832 + 143 – 1,000). Example 23 The facts are the same as in the previous example except that the lessor initially estimates that the lease term is 3 years. The lessor further determines that it retains exposure to significant risks or benefits associated with the underlying asset after expected lease term and accounts for the lease using the performance obligation approach. The present value of 3 years of lease payments is 2,577. At the end of year 1, the lessor reassesses the lease term and determines that the lease term is 5 years. The present value of 4 years of lease payments is 3,312. At the date of commencement of the lease, the lessor recognises a right to receive lease payments (lease receivable) and a lease liability : Lease receivable Lease liability 2,577 2,577 an Amitabha Mukherjee endeavour www.ifrsdemystified.com continued ... 19.25 FUNDAMENTALS OF IFRS 19.25 At the end of year 1, the lessor recognises – receipt of the lease payment : Cash 1,000 Lease receivable 1,000 interest on the lease receivable : Lease receivable 206 (2,557 8%) Interest income 206 lease income from satisfaction of the lease liability : Lease liability 859 (2,557 3) Lease income 859 and, depreciation of the underlying asset. Depreciation 1,000 (15,000 15) Accumulated depreciation 1,000 Following these events, the carrying amount of the lease receivable is 1,783 (2,577 – 1,000 + 206), the carrying amount of the lease liability is 1,718 (2,577 – 859) and the net amount recognised in profit or loss is income of 65 (859 + 206 – 1,000). At the end of year 1, the lessor reassesses the lease term and increases the lease receivable to the newly expected payments (remaining 4 years) with a corresponding increase in the lease liability to reflect the longer term of the lease : Lease receivable 1,529 (3,312 – 1,783) Lease liability 1,529 After making this adjustment the carrying amount of the lease receivable is 3,312 representing the present value of the 4 remaining ,1,000 lease payments and the carrying amount of the lease liability is 3,247 representing the lease liability of 1,718 adjusted for the increase in the lease receivable of 1,529. At the end of year 2, the lessor recognises – receipt of the lease payment : Cash 1,000 Lease receivable interest on the lease receivable : Lease receivable 265 (3,312 8%) Interest income 1,000 265 lease income from satisfaction of the lease liability : Lease liability 812 (3,247 4) Lease income 812 and, depreciation of the underlying asset. Depreciation 1,000 (15,000 15) Accumulated depreciation 1,000 Following these events, the carrying amount of the lease receivable is 2,577 (3,312 – 1,000 + 265), the carrying amount of the lease liability is 2,435 (3,247 – 812) and the net amount recognised in profit or loss is income of 77 (812 + 265 – 1,000). Presentation A lessor shall present the following items together in the Statement of Financial Position – (a) underlying assets; (b) rights to receive lease payments; (c) lease liabilities; (d) the total of (a) – (c) as a net lease asset or a net lease liability. An intermediate lessor shall present the liability to make lease payments under a head lease separately from other assets and liabilities arising from the sublease and shall present the following items together in the Statement of Financial Position – an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) ... continued LEASES (EXPOSURE DRAFT) 19.26 19.26 CHAPTER NINETEEN (a) right-of-use assets (which are the underlying assets in subleases); (b) rights to receive lease payments under subleases; (c) lease liabilities (d) the total of (a) – (c) as a net lease asset or a net lease liability. Example 24 Presentation of information from a sublease Property, patent and equipment X Cash X Right-of-use asset X Lease receivables X Lease liability (X) Net sublease asset X Total assets X Trade and other payables X Liability to make lease payments Total liabilities X (X) A lessor shall present in profit or loss interest income on a right to receive lease payments, lease income resulting from satisfaction of a lease liability and depreciation expense on an underlying asset separately from other interest income, income and depreciation expense. A lessor shall classify the cash receipts from lease payments as operating activities in the Statement of Cash Flows. If the lessor applies the – direct method, it shall present those cash receipts separately from other cash flows from operating activities. indirect method, it shall present changes in the right to receive lease payments separately from the changes in other operating receivables. Derecognition approach Recognition At the commencement of a lease, a lessor shall – recognise a right to receive lease payments in the Statement of Financial Position. derecognise from the Statement of Financial Position the portion of the carrying amount of the underlying asset that represents the lessee’s right-to-use the underlying asset during the term of the lease. reclassify as a residual asset the remaining portion of the carrying amount of the underlying asset that represents the rights in the underlying asset that the lessor retains. Residual asset An asset representing the rights to the underlying asset retained by the lessor under the derecognition approach for lessor accounting. A lessor shall determine the amount derecognised and the initial carrying amount of the residual asset by allocating the carrying amount of the underlying asset at the date of inception of the lease in proportion to the fair value of the rights that have been transferred and the fair value of the rights that have been retained by the lessor. Therefore, the amount of the an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.27 FUNDAMENTALS OF IFRS 19.27 A lessor shall recognise the following items in profit or loss – Lease income representing the present value of the lease payments and lease expense representing the cost of the portion of the underlying asset that is derecognised at the date of commencement of the lease. A lessor shall determine the present value of lease payments receivable during the lease term on the basis of expected outcome, determined using all relevant information. The expected outcome is the present value of the probability-weighted average of the cash flows for a reasonable number of outcomes. In determining the present value of lease payments receivable, a lessor shall include an estimate of – contingent rentals receivable that the lessor can measure reliably. If the contingent rentals depend on an index or a rate, the lessor shall determine the expected lease payments using readily available forward rates or indices. If forward rates or indices are not readily available, the lessor shall use the prevailing rates or indices. the amounts receivable from the lessee under residual value guarantees that the lessor can measure reliably. Residual value guarantees that are provided by an unrelated third party are not lease payments. expected payments from the lessee under term option penalties. The exercise price of a purchase option included in a lease is not a lease payment, and the purchase option is not included in determining the present value of lease payments receivable. Interest income on the right to receive lease payments Lease income and lease expense upon any reassessment of the lease term. Any changes in the right to receive lease payments resulting from reassessment of the expected amount of contingent rentals and expected payments under term option penalties and residual value guarantees After the date of commencement of the lease, the lessor shall reassess the carrying amount of the right to receive lease payments arising from each lease if facts or circumstances indicate that there would be a significant change in the right to receive lease payments since the previous reporting period. When such indications exist, a lessor shall reassess the – length of the lease term. When that reassessment results in a change to the residual asset, the lessor shall allocate those changes to the rights derecognised and the residual asset and adjust the carrying amount of the residual asset accordingly. expected amount of any contingent rentals and any expected payments under residual value guarantees that the lessor can measure reliably and any expected payments under term option penalties. A lessor shall recognise any resulting changes in the expected amount of the right to receive lease payments in profit or loss. A lessor shall not change the rate used to discount lease payments except to reflect changes in reference interest rates when contingent rentals depend on those reference interest rates. When contingent rentals are based on reference interest rates, a lessor shall recognise any changes to the right to receive lease payments arising from changes in the discount rate in profit or loss. an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) underlying asset multiplied by the fair value of the right to receive lease payments divided by the fair value of the underlying asset (all determined at the date of inception of the lease). LEASES (EXPOSURE DRAFT) 19.28 19.28 CHAPTER NINETEEN Any impairment losses on the right to receive lease payments or the residual value At each reporting date, lessor shall apply – IAS 39 to determine whether the right to receive lease payments is impaired. A lessor shall recognise any impairment loss in profit or loss. IAS 36 to determine whether the residual asset is impaired. A lessor shall recognise any impairment loss in profit or loss. Initial measurement At the date of inception of the lease, a lessor shall measure the – right to receive lease payments at the sum of the present value of the lease payments, discounted using the rate the lessor charges the lessee, and any initial direct costs incurred by the lessor. residual asset at an allocated amount of the carrying amount of the underlying asset. Subsequent measurement After the date of commencement of the lease, a lessor shall measure the right to receive lease payments at amortised cost using the effective interest method, unless the reassessment or impairment applies. A lessor shall not measure the residual asset unless reassessment or impairment applies. Example 25 An entity enters into a lease of a machine (carrying amount 2,500; fair value 3,000). The present value of lease payments is : Year-end Cash inflow Discount rate @ 8% Present value 1 1,000 0.909 909 2 1,000 0.826 826 3 1,000 0.751 751 Present value of lease payments 2,486 At the commencement of the lease, the lessor derecognises the portion of the asset transferred to the lessee, recognises lease receivable, revenue and cost of sales : Lease receivable 2,486 Cost of sales 2,070 Machinery 2,070 (2,500 x 2,486 3,000) Revenue 2,486 In effect, the lessor recognises a profit from the lease of 416 (2,486 – 2,070). At the end of year 1, the lessor recognises – interest on the lease receivable : Lease receivable 248 (2,486 x 10%) Interest income 248 and, receipt of the lease payment. Cash 1,000 Lease receivable 1,000 Following these events, the carrying amount of the residual asset is 430 (2,500 – 2,070) and the carrying amount of the lease receivable is 1,734 (2,486 + 248 – 1,000). At the end of year 2, the lessor recognises – interest on the lease receivable : Lease receivable Interest income 173 (1,734 x 10%) 173 an Amitabha Mukherjee endeavour www.ifrsdemystified.com continued ... 19.29 FUNDAMENTALS OF IFRS 19.29 LEASES (EXPOSURE DRAFT) ... continued and, receipt of the lease payment : Cash 1,000 Lease receivable 1,000 Following these events, the carrying amount of the lease receivable is 907 (1,734 + 173 – 1,000). At the end of year 3, the lessor recognises – interest on the lease receivable : Lease receivable Interest income and, receipt of the lease payment. Cash Lease receivable 93 (1,000 – 907) 93 1,000 1,000 Example 26 An entity (lessor) enters into a 4-year lease of a machine (carrying amount 4,000; fair value 5,000; useful life 5 years) with another entity (lessee). The lessor determines that it does not retain exposure to significant risks or benefits associated with the underlying asset during or after the expected lease term and accounts for the lease using the derecognition approach. The rate the lessor charges the lessee is 9%, whereas the lessee’s incremental borrowing rate is 8%. The lessee amortises the right-of-use asset on a straightline basis. Annual lease payments are 1,200 in arrears and a residual value guarantee of 800. Lessee Year-end Cash outflow Discount rate @ 8% Present value 1 1,200 0.926 1,111 2 1,200 0.875 1,050 3 1,200 0.794 953 4 2,000 0.735 1,470 Present value of lease payments 4,584 At the commencement of the lease, the lessee recognises the leased asset and corresponding liability at the present value of lease payments : Right-of-use asset 4,584 Liability to make lease payments 4,584 At the end of year 1, the lessee recognises – interest on the liability to make lease payments : Interest expense Liability to make lease payments lease payment : Liability to make lease payments Cash 367 (4,584 x 8%) 367 1,200 1,200 and, amortisation of the right-of-use asset. Amortisation 1,146 (4,584 4) Accumulated amortisation 1,146 Following these events, the carrying amount of the liability to make lease payments is 3,751 (4,584 + 367 – 1,200). At the end of year 2, the lessee recognises – interest on the liability to make lease payments : Interest expense Liability to make lease payments lease payment : Liability to make lease payments Cash 300 (3,751 x 8%) 300 1,200 1,200 continued ... and, an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) 19.30 19.30 CHAPTER NINETEEN ... continued amortisation of the right-of-use asset. Amortisation 1,146 (4,584 4) Accumulated amortisation 1,146 Following these events, the carrying amount of the liability to make lease payments is 2,851 (3,751 + 300 – 1,200). At the end of year 3, the lessee recognises – interest on the liability to make lease payments : Interest expense Liability to make lease payments lease payment : Liability to make lease payments Cash 228 (2,851 x 8%) 228 1,200 1,200 and, amortisation of the right-of-use asset. Amortisation 1,146 (4,584 4) Accumulated amortisation 1,146 Following these events, the carrying amount of the liability to make lease payments is 1,879 (2,851 + 228 – 1,200). At the end of year 4, the lessee recognises – interest on the liability to make lease payments : Interest expense Liability to make lease payments lease payment : Liability to make lease payments Cash 121 (2,000 – 1,879) 121 2,000 2,000 and, amortisation of the right-of-use asset. Amortisation Accumulated amortisation 1,146 (4,584 4) 1,146 Lessor Year-end Cash inflow Discount rate @ 9% Present value 1 1,200 0.917 1,100 2 1,200 0.842 1,010 3 1,200 0.772 926 4 2,000 0.708 1,416 Present value of lease payments 4,452 At the commencement of the lease, the lessor derecognises the portion of the asset transferred to the lessee, recognises lease receivable, revenue and cost of sales : Lease receivable 4,452 Cost of sales 3,562 (4,000 x 4,452 5,000) Machinery 3,562 Revenue 4,452 In effect, the lessor recognises a profit from the lease of 890 (4,452 – 3,562). At the end of year 1, the lessor recognises – interest on the lease receivable : Lease receivable 401 (4,452 x 9%) Interest income 401 and receipt of the lease payment. Cash 1,200 Lease receivable 1,200 Following these events, the carrying amount of the residual asset is 438 (4,000 – 3,562) and the carrying amount of the lease receivable is 3,653 (4,452 + 401 – 1,200). continued ... an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.31 FUNDAMENTALS OF IFRS 19.31 LEASES (EXPOSURE DRAFT) ... continued At the end of year 2, the lessor recognises – interest on the lease receivable : Lease receivable 329 (3,653 x 9%) Interest income 329 and receipt of the lease payment. Cash 1,200 Lease receivable 1,200 Following these events, the carrying amount of the lease receivable is 2,782 (3,653 + 329 – 1,200). At the end of year 3, the lessor recognises – interest on the lease receivable : Lease receivable 250 (2,782 x 9%) Interest income 250 and, receipt of the lease payment. Cash 1,200 Lease receivable 1,200 Following these events, the carrying amount of the lease receivable is 1,832 (2,782 + 250 – 1,200). At the end of year 4, the lessor recognises – interest on the lease receivable : Lease receivable Interest income and, receipt of the lease payment. Cash Lease receivable 168 (2,000 – 1,832) 168 2,000 2,000 Example 27 An entity enters into a 10-year lease of a machine. The lease includes an option to terminate after 8 years. Annual lease payments are 1,000 in arrears. The rate the lessor charges in the lease is 8%. The fair value of the machine at the commencement of the lease is 7,000 and its carrying amount is 5,000. The useful life of the machine is 10 years. The lessor initially estimates the lease term is 10 years. The lessor further determines that it does not retain exposure to significant risks or benefits associated with the underlying asset either during or after the expected lease term and accounts for the lease using the derecognition approach. The present value of 10 years of lease payments is 6,710. At the end of year 1, the lessor reassesses the lease term and determines that the option will be exercised and the lease will terminate at the end of 8 years. The fair value of the machine at the end of year 1 is 6,250. The present value of 7 years of lease payments is 5,206. At the date of commencement of the lease, the lessor derecognises the portion of the asset transferred to the lessee, recognises lease receivable, revenue and cost of sales : Lease receivable 6,710 Cost of sales 4,793 Asset 4,793 (5,000 6,710 7,000) Revenue 6,710 At the date of commencement of the lease, the lessor recognises a profit from the lease of 1,917 (6,710 – 4,793). At the end of year 1, the lessor recognises – receipt of the lease payment : Cash 1,000 Lease receivable 1,000 and, continued ... an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) 19.32 19.32 CHAPTER NINETEEN ... continued interest on the lease receivable. Lease receivable 537 (6,710 8%) Interest income 537 Following these events, the carrying amount of the residual asset is 207 (5,000 – 4,793) and the carrying amount of the lease receivable is 6,247 (6,710 – 1,000 + 537). At the end of year 1, the lessor reassesses the lease term and reinstates a portion of the asset, recognises an adjustment to lease receivable, revenue and cost of sales : Revenue Residual asset Cost of sales Lease receivable 1,041 34 (207 1,041 6,250) 34 1,041 (6,247 – 5,206) The net result of the reassessment of the lease term is a loss of 1,007 (34 – 1,041). After making this adjustment the carrying amount of the lease receivable is 5,206 representing the present value of the 7 remaining 1,000 lease payments and the carrying amount of the residual asset is 241 (207 + 34). At the end of year 1, the net amount recognised in profit or loss is income of 1,447 (1,917 + 537 – 1,007). Example 28 The facts are the same as in the previous example except that the lessor initially estimates that the lease term is 8 years. The lessor determines that it does not retain exposure to significant risks or benefits associated with the underlying asset either during or after the expected lease term and accounts for the lease using the derecognition approach. The present value of 8 years of lease payments is 5,747. At the end of year 1, the lessor reassesses the lease term and determines that the lease term is 10 years. The present value of 9 years of lease payments is 6,247. At the date of commencement of the lease, the lessor derecognises the portion of the asset transferred to the lessee, recognises lease receivable, revenue and cost of sales : Lease receivable 5,747 Cost of sales 4,105 Asset 4,105 (5,000 5,747 7,000) Revenue 5,747 At the date of commencement of the lease, the lessor recognises profit from the lease of 1,642 (5,747 – 4,105). At the end of year 1, the lessor recognises – receipt of the lease payment : Cash 1,000 Lease receivable 1,000 and, interest on the lease receivable. Lease receivable 460 (5,747 8%) Interest income 460 Following these events, the carrying amount of the residual asset is 895 (5,000 – 4,105) and the carrying amount of the receivable is 5,207 (5,747 – 1,000 + 460). Upon reassessing the lease term, the lessor derecognises an additional portion of the asset transferred to the lessee, recognises additional lease receivable, revenue and cost of sales : Lease receivable 1,040 (6,247 – 5,207) Cost of sales 149 Residual asset 149 (895 1,040 6,250) Revenue 1,040 In profit or loss, the net result of the reassessment of the lease term is income of 891 (1,040 – 149). After making this adjustment the carrying amount of the lease receivable is 6,247 representing the present value of the 9 remaining 1,000 lease payments, and the carrying amount of the residual asset is 746 (895 – 149). At the end of year 1, the net amount recognised in profit or loss is income of 2,993 (1,642 + 460 + 891). an Amitabha Mukherjee endeavour www.ifrsdemystified.com 19.33 FUNDAMENTALS OF IFRS 19.33 A lessor shall present the following items in the Statement of Financial Position – rights to receive lease payments, separately from other financial assets, distinguishing those that arise under a sublease. residual assets, separately within property, plant and equipment, distinguishing those that arise under a sublease. A lessor shall present lease income and lease expense in profit or loss either in separate line items or net in a single line item so that the lessor provides information that reflects the lessor’s business model. Example 29 If a lessor’s business model uses leases – as an alternative means of realising value from the goods it would otherwise sell, the lessor shall present lease income and lease expense in separate line items. Many manufacturers and dealers regard the lease of an asset as equivalent to selling the asset. Those lessor would present revenue and cost of sales so that income and expenses from sold and leased items are presented consistently. for the purposes of providing finance, the lessor would present lease income and lease expense net in a single line item. A lessor shall present in profit or loss interest income from rights to receive lease payments separately from other interest income. A lessor shall classify cash receipts from lease payments as operating activities in the Statement of Cash Flows. If a lessor applies the — direct method, it shall present the cash receipts from lease payments separately from other cash flows from operating activities. indirect method, it shall present the changes in the right to receive lease payments separately from changes in other operating receivables. Short-term leases A short-term lease is a lease that, at the date of commencement of the lease, has a maximum possible lease term including options to renew or extend, of 12 months or less. At the date of inception of a lease, a : lessee that has a short-term lease may elect on a lease-by-lease basis to measure, both at initial measurement and subsequently, – the liability to make lease payments at the undiscounted amount of the lease payments; and the right-of-use asset at the undiscounted amount of lease payments plus initial direct costs. Such leases shall recognise lease payments in profit or loss over the lease term. lessor that has a short-term lease may elect on a lease-by-lease basis not to recognise assets or liabilities arising from a short-term lease in the Statement of Financial Position, nor derecognise any portion of the underlying asset. Such lessor shall continue to recognise the underlying asset in accordance with other IFRSs and shall recognise lease payments in profit or loss over the lease term. an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) Presentation LEASES (EXPOSURE DRAFT) 19.34 19.34 CHAPTER NINETEEN Sale and leaseback transactions If the transferor transfers an asset to another party and leases that asset back from that other party, both the transferor and the transferee shall account for the transfer contract and the lease contract if the contracts are – entered into at or near the same time; negotiated as a package with a single commercial objective; or performed either concurrently or consecutively. The transferor shall account for transactions as follows – If the transfer meets the condition for a sale, the transferor shall account for the sale in accordance with applicable IFRSs and for the lease in accordance with this Exposure Draft (ie, as a lessee). If the transfer does not meet the conditions for a sale, the transferor shall account for the contract as a financing. The transferor shall not derecognise the transferred asset and shall recognise any amounts received as a financial liability. The transferee shall account for transactions as follows : If the transfer meets the condition for a purchase, the transferee shall account for the purchase in accordance with applicable IFRSs and for the lease using the performance obligation approach. If the transfer does not meet the conditions for a purchase, the transferee shall not recognise the transferred asset. The transferee shall recognise the amount paid as a receivable in accordance with applicable of IFRSs. If the consideration for a purchase or sale or the lease payments specified by the leaseback are not at fair value : a transferor shall adjust the – measurement of the right-of-use asset to reflect current market rates for lease payments for that asset. gain or loss on the disposal of the underlying asset by any difference between the present value of lease payments based on the terms specified in the lease and the present value of the lease payments based on current market rates. a transferee shall adjust the carrying amount of the underlying asset and the lease liability it recognises under the performance obligation approach to reflect current market rates for the lease payments for that lease. An entity considers the effect of the transfer contract and the lease contract together to assess whether the transferred asset has been purchased or sold. Additionally, such sale and leaseback contracts may have conditions that generally do not arise in other transactions and may result in the transfer not meeting the conditions for a purchase or sale. Example 30 The following conditions normally preclude the seller / lessee from transferring more than a trivial amount of the risks and benefits associated with the transferred asset at the end of the contract and do not result in a purchase or sale – The seller / lessee has an obligation or an option to repurchase the asset at an amount that is not fair value at the time of purchase, or the buyer / lessor can compel the seller / lessee to repurchase the asset. The seller / lessee guarantees the buyer / lessor’s investment or a return on that investment. The seller / lessee provides the buyer / lessor with a residual value guarantee. an Amitabha Mukherjee endeavour www.ifrsdemystified.com continued ... 19.35 FUNDAMENTALS OF IFRS 19.35 The seller / lessee provides non-recourse financing to the buyer / lessor. The seller / lessee retains an obligation to service any existing debt related to the asset. The seller / lessee provides collateral on behalf of the buyer / seller (other than the transferred asset) or guarantees the buyer / lessor’s debt. The seller / lessee’s rental payment is contingent on some predetermined or determinable level of future operations of the buyer / lessor. The seller / lessee enters into a sale and leaseback transaction involving asset enhancements without leasing the transferred asset from the buyer / lessor,. The buyer / lessor is obliged to share a significant portion of the appreciation of the asset with the seller / lessee. Any other provisions or circumstances exist that allow the seller / lessee to participate in any future profits of the buyer / lessor or the appreciation of the transferred asset, eg, a situation in which the seller / lessee owns or has an option to acquire a significant interest in the buyer / lessor. an Amitabha Mukherjee endeavour www.ifrsdemystified.com LEASES (EXPOSURE DRAFT) ... continued