SMU Classification: Restricted
ACCT 657 – Financial Reporting in
the IFRS World (I)
Leases Part 1I
- Spiceland et al. Chapter 11
- IAS 17; IFRS 16
SMU Classification: Restricted
Lease accounting model
IAS 17
Finance
lease
Operating
lease
IFRS 16 (Lessee
accounting)
Right-ofuse model
A lessee may elect not to
apply ROU accounting for:
(1) Short term leases (by
class of asset) and
(2) Low value underlying
asset (lease-by-lease)
Apply straight-line expensing
or other representative basis
IFRS 16 (Lessor
accounting)
Finance
lease
Operating
lease
2
SMU Classification: Restricted
Lessor Accounting
a. Lease Classification
Lessor classifies each lease as either an operating lease or a
finance lease. Finance lease is one that transfers substantially all
the risks and rewards incidental to ownership of an underlying
asset from lessor to lessee; otherwise, it is an operating lease.
Five indicators of a finance lease:
1) Transfer of ownership at end of lease
2) Bargain purchase option
3) Lease term is a major part of underlying asset’s economic
life (75% or more)
4) Present value of lease payments is substantially all of
underlying asset’s fair value (90% or more)
5) Underlying asset is of a specialized nature and only lessee
can use without major modifications
SMU Classification: Restricted
Lessor Accounting
Lease classification is done at inception
date and reassessed only if there is a lease
modification.
 What if,

◦ There is a bargain renewal option?
◦ Lessee bears losses on lease cancellation by
lessee?
◦ Gains or losses from fluctuation in fair value
of the residual value accrue to the lessee?
IFRS
SMU Classification: Restricted
US GAAP
Situations (individually or in
combination) that normally
would lead to classification as a
finance lease are:
Situations that require
classification as a finance lease if
any one (or more) is met are:
The agreement specifies that
ownership of the asset transfers to
the lessee
Same as IFRS
The agreement contains a bargain
purchase option
Same as IFRS
The non-cancelable lease term is for
“a major part” of the economic life
of the asset
“75% or more” of the economic life
of the asset. (If lease term arises
within the remaining 25% of the
asset life then not a finance lease)
Present value of the minimum lease
payments is equal to or greater than
“substantially all” of the fair value of
the asset
“90% or more” of the fair value of
the asset
The lease asset is of a specialized
nature such that only the lessee can
use it without major modifications
being made
No similar situation specified
IFRS
SMU Classification: Restricted
US GAAP
Other situations (individually or
in combination) that might also
lead to classification as a finance
lease are:
The lessor’s losses are borne by the
lessee upon cancellation
No similar situation specified
Gains or losses from changes in the
fair value of the residual value go to
the lessee
No similar situation specified
The lease contains a bargain renewal
option whereby the lessee can
continue the lease for substantially
less than market rent
No similar situation specified
SMU Classification: Restricted
Lessor Accounting
b. Recognition
At commencement date in statement of financial
position
Finance Lease
- Derecognize the
underlying asset and
- Recognize a finance
lease receivable
Operating Lease
- Continue to recognize the
underlying asset and
- Add any initial direct costs
incurred to obtain the lease
to the carrying amount of
the underlying asset
SMU Classification: Restricted
Lessor Accounting
c. Initial Measurement
At commencement date, lessor measures the finance lease
receivable at the present value of (a) future lease
payments and (b) unguaranteed residual value accruing to
lessor.
Future lease payments include:
(a) Fixed payments (including in-substance fixed payments) less any
lease incentives payable,
(b) Variable payments that depend on an index or a rate,
(c) Guaranteed residual value or bargain purchase option, and
(d) Penalty payment of termination, which is reflected in the lease
term.
SMU Classification: Restricted
Lessor Accounting
d. Subsequent Measurement
Finance Lease
Statement of Financial
Position
- Adjust finance lease
receivable by lease
payments
Statement of Profit or Loss
- Recognize finance income on
finance lease receivable on
the effective interest
method
Operating Lease
Statement of Profit or Loss
- Recognize lease payments
as income
- Recognize depreciation
charges on underlying
asset
9
9
SMU Classification: Restricted
Sales-type Leases
If the lessor is a manufacturer or dealer, the
fair value of the leased asset generally is
higher than the cost of the asset.
At inception of the lease, the lessor will
record the Cost of Goods Sold as well as
the Sales Revenue (PV of minimum lease
payments).
In addition to interest revenue earned over
the lease term, the lessor receives a
manufacturer’s or dealer’s profit on the “sale”
of the asset.
SMU Classification: Restricted
Sales-type Leases with Selling Profit
• Occurs when the fair value of the asset exceeds the cost or
carrying value.
• Lessor recognizes a selling profit at the beginning of the lease
term (as sales revenue and cost of goods sold).
• Lessor also recognizes interest revenue over the lease term.
Key Point
Selling profit is the difference between sales revenue
and cost of goods sold.
• Does sales revenue always equal lease receivable?
•
When RV is unguaranteed, then must be subtracted from sales
revenue and cost of goods sold.
SMU Classification: Restricted

Finance Lease
Lease Receivable FV
Asset

FV
Sales-type Lease (one type of finance lease)
Lease Receivable FV
Cost of Goods Sold Cost- PV of URV
Inventory
Cost
Sales Revenue
FV- PV of URV
SMU Classification: Restricted
Comprehensive Example
Rhone-Metro Industries manufactures equipment that is sold or leased. On
December 31, 2021, Rhone-Metro leased equipment to Western Soya Co. for a
non-cancelable stated lease term of four years ending December 31, 2025, at
which time possession of the leased asset will revert back to Rhone-Metro. The
equipment cost $300,000 to manufacture and has an expected useful life of six
years. Its normal sales price is $365,760. The expected residual value of
$25,000 at December 31, 2025 is not guaranteed. Western Soya Co. can
exercise a bargain purchase option (i.e., Western is reasonably certain to
exercise) on December 30, 2024, at an option price of $10,000. Equal
payments under the lease are $134,960 (including $4,000 annual executory
costs) and are due on December 31 of each year. The first payment was made
on December 31, 2021. Western Soya’s incremental borrowing rate is 12%.
Western Soya knows the interest rate implicit in the lease payments is 10%.
Both companies use straight-line depreciation.
SMU Classification: Restricted
Western-Soya (Lessee Accounting)
December 31, 2021
(ROU Asset is the PV of three payments of 130,960 plus 10,000 (BPO)
discounted at 10%)
ROU Asset
365,760
Lease Liability
Lease Liability
365,760
130,960
Prepaid maintenance exp. (2022 executory costs) 4,000
Cash
134,960
SMU Classification: Restricted
Lease Amortization Schedule
Dec. 31
Annual
Payments
(excluding
executory
costs)
Effective
Interest (10% of
Beg. LL)
Decrease in
Balance
2021
Outstanding
Balance
365,760
2021
130,960
130,960
234,800
2022
130,960
23,480
107,480
127,320
2023
130,960
12,732
118,228
9092
2024
10,000 (BPO)
908
9,092
0
SMU Classification: Restricted
Western-Soya (Lessee Accounting)
December 31, 2022
Depreciation Expense
60,960
Accumulated Depreciation
Maintenance expense (2022 executory costs)
Prepaid maintenance expense
60,960
4,000
4,000
Interest expense
23,480
Lease liability
107,480
Prepaid maintenance exp. (2023 executory costs) 4,000
Cash
134,960
SMU Classification: Restricted
Western-Soya (Lessee Accounting)
December 31, 2024
Depreciation Expense
60,960
Accumulated Depreciation
Maintenance expense (2024 executory costs)
Prepaid maintenance expense
60,960
4,000
Interest expense
Lease liability
Cash
9,092
Equipment
365,760
4,000
908
10,000
ROU-Asset
365,760
*This assumes the Accumulated Depreciation stays on the books so the net Equipment is still 182,880
Prepaid maintenance exp. (2025 executory costs) 4,000
Cash
Alternatively, you can remove the Accumulated Depr as well
Equipment 182,880
Accumulated Depreciation 182,880
ROU – Asset
365,760
4,000
SMU Classification: Restricted
Rhone-Metro (Lessor Accounting)
December 31, 2021
1. Identify lease type
Because the lease contains a BPO and PV of minimum lease payments is greater
than 90% of the fair value of the asset, it is considered a finance lease. Moreover,
since the fair value exceeds the carrying value, it is also a sales-type lease.
2. Recognition of lease receivable and profit
(Lease receivable equals PV of three payments of 130,960 and PV of BPO.)
Lease Receivable
365,760
Cost of Goods Sold
300,000
Inventory of Equipment
300,000
Sales Revenue
365,760
Cash
134,960
Maintenance Payable (for 2022)
4,000
Lease Receivable
130,960
SMU Classification: Restricted
Rhone-Metro (Lessor Accounting)
December 31, 2022
Maintenance Payable
4,000
Cash
Cash
4,000
134,960
Interest Revenue
23,480
Maintenance Payable (for 2023)
4,000
Lease Receivable
107,480
SMU Classification: Restricted
Rhone-Metro (Lessor Accounting)
December 31, 2024
Cash
10,000
Interest Revenue
908
Lease Receivable
9,092
Cash
4,000
Maintenance Payable (for 2025)
4,000
SMU Classification: Restricted
Exercise Time
On December 31, 2021, Yard Art Landscaping leased a delivery truck from Branch Motors. Branch paid
$40,000 for the truck. Its retail value is $45,114.
The lease agreement specified annual payments of $11,000 beginning December 31, 2021, the inception of
the lease, and each December 31 through 2024. Branch Motors’ interest rate for determining payments was
10%. At the end of the four-year lease term (December 31, 2025), the truck is expected to be worth
$15,000. The estimated useful life of the truck is five years with no salvage value. Both companies use
straight-line depreciation.
Yard Art guaranteed a residual value of $6,000, which is the amount that Yard Art expects to pay at the end
of the lease. Guarantor Assurance Corporation was engaged to guarantee a residual value of $11,000, but
with a deductible equal to any amount paid by the lessee ($11,000 reduced by any amount paid by the
lessee). Yard Art’s incremental borrowing rate is 9%. A $1,000 per year maintenance agreement was
arranged for the truck with an outside service firm. As an expediency, Branch Motors agree to pay this fee.
It is, however, reflected in the 11,000 lease payments.
Required:

Prepare the appropriate journal entries for Yard Art and Branch Motors on December 31, 2021.

Prepare the lease amortization schedule reflecting interest expense and revenue for Yard Art and
Branch Motors, respectively.

Prepare the appropriate journal entries for Yard Art and Branch Motors on December 31, 2022.

Prepare the appropriate journal entries for Yard Art and Branch Motors on December 31, 2025 (the
end of the lease term), assuming that the truck is returned to the lessor and the actual residual value of
the truck was $4,000 on that date.
SMU Classification: Restricted
Lease Modifications
Subsequent Measurement—Lease Liability
After commencement date, lessee
• Remeasures the lease arising from changes in terms and
conditions that are outside the original lease agreement
(labeled in IFRS 16 as “lease modifications”).
• A change in the scope of, or the consideration for, a lease
that was NOT part of the original terms and conditions of
the lease
 Examples of change in lease scope:
• Adding/terminating the right to use one or more
underlying assets
• Extending/shortening the contractual lease term
SMU Classification: Restricted
Lessee Accounting
Lease liability remeasurement for lease
modifications involving:
(i)
Decrease in scope of the lease
 Restate lease liability and ROU asset to reflect the
partial/full termination of the lease and recognize the
restatement difference in P/L as a gain/loss and
 Remeasure lease liability based on revised lease
payments discounted using a revised discount rate and
adjust ROU asset correspondingly.
SMU Classification: Restricted
Lessee Accounting
LO11-3
Lease liability remeasurement for lease modifications involving:
(ii) Increase in scope of the lease with commensurate increase in
lease payments
 Recognize lease modification as a separate lease and no
change in the original lease accounting
(iii) All other lease modifications
 Examples: Change in lease payment, a scope increase
without commensurate increase in lease payment
 Remeasure lease liability based on revised lease payments
discounted by a revised discount rate and adjust ROU asset
correspondingly
SMU Classification: Restricted
Comprehensive Example
On January 1, 2021 Natural Textiles leased an entire warehouse from Secure
Storage. The lease is for five years. The lease calls for Natural to assume all costs
of ownership and to make annual payments of $25,000 due at the beginning of
each year. Natural uses the straight-line method of depreciation and pays 10%
interest on borrowed money. Secure’s implicit interest rate is unknown.
Determine the ROU Asset and Lease Liability for Natural Textiles on January 1,
2021 and January 1, 2022.
January 1, 2021
PV(10%, 5, -25000, 0, 1) = 104.247
ROU Asset
104,247
Lease Liability
Lease Liability
Cash
104,247
25,000
25,000
SMU Classification: Restricted
December 31, 2021
Depreciation Expense
20,849 (104,247/5)
Acc. Depreciation - ROU Asset
Interest Expense
20,849
7,925
Lease Liability
7,925
January 1, 2022
Lease Liability
25,000
Cash
25,000
December 31, 2022
Depreciation Expense
20,849
Acc. Depreciation - ROU Asset
Interest Expense
20,849
6,217
Lease Liability
6,217
Balance before lease modification
ROU – Asset
Lease Liability
62,549
68,388
SMU Classification: Restricted
Assume that toward the end of 2022, Natural successfully negotiates with
Secure to reduce the leased warehouse area to 50% of its original scope with
effect from January 1, 2023. The lease payments for the remaining three years
will be reduced to $15,000 due at the beginning of each year. Natural’s
incremental borrowing rate at the end of 2022 is 12%. How should Natural
record this lease modification?
1) First recognize gain/loss from restating lease liability and asset to reflect
partial termination of the lease
ROU – Asset 62,549 x 50% = 31,275
Lease Liability 68,388 x 50% = 34,194
Lease Liability
34,194
Gain on Lease
2,919
ROU – Asset
31,275
2) Remeasure lease liability and adjust ROU asset correspondingly
Lease Liability based on PV(12%, 3, -15000, 0, 1) = 40,351
40,351 – 34,194 = 6,157
ROU – Asset
Lease Liability
6,157
6,157
SMU Classification: Restricted
Assume that toward the end of 2022, Natural successfully negotiates with
Secure to lease another warehouse of the same area as its current leased
warehouse with effect from January 1, 2023, till December 31, 2025. The lease
payments for the remaining three years will be increased by $15,000 due at
the beginning of each year. Natural is aware the additional annual lease
payment does not commensurate with the increase in the leased warehouse
area. Natural’s incremental borrowing rate at the end of 2022 is 12%. Provide
the appropriate journal entries.
Since the additional payment does not commensurate with the increase,
restate the lease liability and adjust ROU asset correspondingly.
Lease Liability based on PV(12%, 3, -40000, 0, 1) = 107,602
107,602 – 68,388 = 39,214
ROU – Asset
Lease Liability
39,214
39,214
SMU Classification: Restricted
How will the new IFRS affect
lessees?
Equity (Profit) lower in earlier years
 Assets higher ROA
 Liability higher  debt covenants
 Cash outflow  financing, not operating
