Lecture 6
Leases
1
Overview
Assess a contract whether
it is a lease or contains a lease?
No
Yes
Determining lease term
Lessee accounting
Not within
IFRS 16
Lessor accounting
Reporting exemption is applicable
and elected?
No
Recognise
assets and liabilities
for all leases
Yes
Recognise
lease payments
as an expense
Sale and leaseback transactions
2
Identifying a Lease in IFRS 16
• Lease is defined as:
➢ A contract, or part of a contract, that conveys
the right to use an asset (the underlying asset)
for a period of time in exchange for
consideration.
• Underlying asset is defined as:
➢ An asset that is the subject of a lease, for
which the right to use that asset has been
provided by a lessor to a lessee.
3
Identifying a Lease in IFRS 16
• The requirements imposed by IFRS 16 implicitly
demands an entity to assess all the contracts and
consider them whether they are in substance a
lease.
➢ The assessment performed at inception of a
contract and, specifically, an entity is required to
assess whether the contract is a lease, or
contains a lease.
➢ After the inception, an entity is only required to
reassess, if the terms and conditions of the
contract are changed.
What is “inception of the lease”?
• The inception date of the lease is the earlier of
– the date of the lease agreement and
– the date of commitment by the parties to the principal terms
and conditions of the lease.
4
Identifying a Lease in IFRS 16
• To be accounted as a lease, 2 conditions must be
met:
An identified Asset
1) Physically distinct
2) The supplier has no substantive right
to substitute the asset throughout the
period of use.
A supplier’s right to substitute an asset is
substantive only if both of the following
conditions exist:
(a) the supplier has the practical ability
to substitute alternative assets
throughout the period of use; and
(b) the supplier would benefit
economically from the exercise of its
right to substitute the asset
Right to Control the Use
1) The right to obtain substantially all the
economic benefits from the use of the
asset (e.g. having exclusive use of the
asset), and
2) The right to direct the use of the asset
i.e. how and for what purpose the
asset is used throughout the period of
use
• See para B26 and B27 for examples
of decision-making rights
5
Is there a lease?
Example 1:
A fragrance company (Customer) enters into a contract with an
airport operator (Supplier) to use a space in the airport to sell its
goods for a three-year period. The contract states the amount of
space and that the space may be located at any one of several
boarding areas within the airport. Supplier has the right to
change the location of the space allocated to Customer at any
time during the period of use.
The contract does not contain a lease.
There is no identified asset. The contract is for space in the airport, and this space
can change at the discretion of Supplier. Supplier has the substantive right to
substitute the space Customer uses because:
(a) Supplier has the practical ability to change the space used by Customer
throughout the period of use.
(b) Supplier would benefit economically from substituting the space. There would be
minimal cost associated with changing the space used by Customer because the
kiosk can be moved easily. Supplier benefits from substituting the space in the
airport because substitution allows Supplier to make the most effective use of the
space at boarding areas in the airport to meet changing circumstances.
6
Is there a lease?
Example 2:
Customer enters into a contract with Supplier for the use of a specified ship for a
five-year period. Customer decides what cargo will be transported, and whether,
when and to which ports the ship will sail, throughout the five-year period of use,
subject to restrictions specified in the contract. Those restrictions prevent
Customer from sailing the ship into waters at a high risk of piracy or carrying
hazardous materials as cargo.
Supplier operates and maintains the ship and is responsible for the safe passage of
the cargo on board the ship. Customer is prohibited from hiring another operator
for the ship of the contract or operating the ship itself during the term of the
contract.
The contract contains a lease.
There is an identified asset i.e. a specified ship, and Supplier does not have the
right to substitute that specified ship.
7
Is there a lease?
Example 2 (cont’d)
Customer has the right to control the use of the ship throughout the fiveyear period of use because:
(a) Customer has the right to obtain substantially all of the economic
benefits from use of the ship over the five-year period of use. Customer has
exclusive use of the ship throughout the period of use.
(b) Customer has the right to direct the use of the ship. The contractual
restrictions about where the ship can sail and the cargo to be transported by
the ship define the scope of Customer’s right to use the ship. They are
protective rights that protect Supplier’s investment in the ship and Supplier’s
personnel. Within the scope of its right of use, Customer makes the relevant
decisions about how and for what purpose the ship is used throughout the
five-year period of use because it decides whether, where and when the
ship sails, as well as the cargo it will transport. Customer has the right to
change these decisions throughout the five-year period of use.
Although the operation and maintenance of the ship are essential to its
efficient use, Supplier’s decisions in this regard do not give it the right to
direct how and for what purpose the ship is used. Instead, Supplier’s
decisions are dependent upon Customer’s decisions about how and for
what purpose the ship is used.
8
Identifying a Lease in IFRS 16
Is there an identified asset?
No
Ye
Does the customer have the right
s to obtain substantially
No
all of the economic benefits from use of the asset
throughout the period of use?
Yes
Does
the
customer,
the
supplier
or
neither
party have the right to Supplier
Customer
direct how and for what purpose the asset is used throughout
the period of use?
Neither; how and for what purpose the
asset will be used is predetermined
Does the customer have the right to operate the asset
Yes
throughout the period of use, without the supplier having the
right to change those operating instructions?
No
Did the customer design the asset in a way that predetermines
Yes
No
how and for what purpose the asset will be used throughout the
period of use?
Contract contains a lease
Contract does not contain a lease
9
Lease Term in IFRS 16
• When there is a lease or a lease component in a contract, an
entity is required to determine the lease term as the noncancellable period of a lease, together with both:
a.
periods covered by an option to extend the lease if the
lessee is reasonably certain to exercise that option; and
b. periods covered by an option to terminate the lease if the
lessee is reasonably certain not to exercise that option.
Para B37-B40 provide a non-exhaustive list of facts and
circumstances that should be considered
• The lease term begins on the “commencement date” of the
lease. Commencement date: The date on which the lessor
makes an underlying asset available for use by the lessee
10
Determining the lease term
Examples
1. A lease with 2-year initial term
and another 2-year further
term. The lessor has an option
to cancel the further term.
2. A lease with 2-year initial term.
There is renewal option for
another 2 years at a bargain
rental (which is 70% below
market rate).
3. A lease with 2-year initial term,
with a renewal option for
another 1 year at market rate
and a purchase option to
acquire the asset at a bargain
price (10% of the market value
of the used asset) 1 year after
the initial term
• Lease term: 2 years
• The lessee has no discretionary
right to renew
• Lease term: 4 years
• It is reasonably certain that the
lessee will exercise the option
• Lease term: 3 years
• It is reasonably certain that the
lessee will exercise the
purchase option because of the
economic incentive
11
Lease Payments
Appendix A:
Payments made by a lessee to a lessor relating to the right to use an
underlying asset during the lease term, comprising the following:
(a) fixed payments (including in-substance fixed payments), less any lease
incentives;
(b) variable lease payments that depend on an index or a rate;
(c) the exercise price of a purchase option if the lessee is reasonably
certain to exercise that option; and
(d) payments of penalties for terminating the lease, if the lease term
reflects the lessee exercising an option to terminate the lease.
For the lessee, lease payments also include amounts expected to be
payable by the lessee under residual value guarantees.
For the lessor, lease payments also include any residual value guarantees
provided to the lessor by the lessee, a party related to the lessee or a third
party unrelated to the lessor that is financially capable of discharging the
obligations under the guarantee.
12
Lessee Accounting in IFRS 16
•
The single lessee accounting model in requires a lessee to
recognise assets and liabilities for all leases, unless a lease
with a term of less than 12 months, or the underlying asset of
a lease is of low value
•
Exemptions:
➢ Short-term leases (i.e. lease term of 12 months or less)
➢ Lease with low-value underlying asset (when new, are
individually of low value)
If exemptions are applied, the lessee shall recognise the lease
payments as an expense on either a straight-line basis over the
lease term or another systematic basis (if that basis is more
representative of the pattern of the lessee’s benefit). [Para 6]
•
General principle: at the commencement date, a lessee is
required to recognise
Right-of-Use Asset
➢ a right-of-use asset, and
➢ a lease liability.
Lease Liability
13
Short-term Lease Exemption
• A lease that contains a purchase option cannot be classified as a
short-term lease, irrespective of the probability that the option will be
exercised.
• The election to take the exemption for short-term leases is required
to be made by class of underlying asset (i.e. grouping of underlying
assets of a similar nature and use in an entity’s operations)
• Example: items of office equipment are considered to be of the
same class, if the entity wishes to use the exemption, it must apply
that exemption for all of the leases with terms of 12 months or less.
14
Low-value Asset Exemption
• “Low value” – when it is new, regardless of the age of the
asset
• No explicit definition for what is meant by “low-value”
assets
• US$5,000 or less [per Basis of Conclusions]
• Assessment as to whether an underlying asset is of low
value is performed on an absolute basis, i.e. the
assessment is not affected by the size, nature or
circumstances of the lessee. Accordingly, different lessees
are expected to reach the same conclusions about
whether a particular underlying asset is of low value.
• Examples: tablet and personal computers, small items of
office furniture, telephones etc.
• Exemption is available on a lease-by-lease basis.
• Assets highly dependent on, or highly interrelated with
other assets do not qualify as low-value assets.
15
Accounting for Low-value assets
Co. A leases office equipment for 5 years. The total value of
the equipment when new is $5,000. Co. A elects to apply
the low-value asset exemption.
Lease payments are payable:
Year 1: Rent-free period
Years 2 and 3: $1,750 per year
Years 4 and 5: $1,500 per year
What is the accounting treatment of this lease?
16
Accounting for Low-value assets
The lessee’s benefit under the lease is accounted for on a
straight-line basis over the lease term.
Total lease payments = ($1,750 x 2) + ($1,500 x 2) =
$6,500
Yearly lease expense = $6,500 / 5 years = $1,300
Year 1:
Dr. Rent expense $1,300
Cr. Rent payable $1,300
Year 2:
Dr. Rent expense $1,300
Dr. Rent payable $450
Cr. Cash
$1,750
17
Lessee Accounting in IFRS 16
Initial Measurement
•
In general, assets and liabilities arising from a lease for a lessee are
initially measured on a present value basis.
• Specifically, IFRS 16 requires, at the commencement date, a lessee to
measure the right-of-use asset at cost.
• IFRS 16 specifically requires the cost of the right-of-use asset to
comprise:
a. the amount of the initial measurement of
Right-of-Use Asset
the lease liability in IFRS 16;
b. any lease payments made at or before the commencement date, less
any lease incentives received;
c. any initial direct costs incurred by the lessee; and
d. an estimate of costs to be incurred by the lessee in dismantling and
removing the underlying asset, restoring the site on which it is located or
restoring the underlying asset to the condition required by the terms and
conditions of the lease, unless those costs are incurred to produce
inventories
18
Initial Direct Costs
Appendix A: Incremental costs of obtaining a lease
that would not have been incurred if the lease had
not been obtained, except for such costs incurred by
a manufacturer or dealer lessor in connection with a
finance lease.
Example: costs incurred in negotiating and securing
lease arrangements (commissions, legal fees)
19
Lessee Accounting: Initial Lease Measurement
C Ltd. leases 1000 square feet of office space for 3 years at $120,000 per year with option
to extend for another 3 years at $140,000 per year, payable at start of year. C incurs initial
direct costs of $15,000 to compensate former tenant of office.
C does not know implicit rate of lease, and its incremental borrowing rate is 5%.
Lease starts on 2 January 2023. PV of 2 annual payments $120,000 at 5% is $223,129.
Journal entries on lease commencement:
Dr ROU asset
Cr Lease payable
Cr Cash
Dr ROU asset
Cr Cash
$343,129
$223,129
$120,000
$15,000
$15,000
20
Lessee Accounting in IFRS 16
• The cost of right-of-use asset of a lease to a lessee
depends on the initial measurement of the lease liability.
• For the initial measurement of the lease liability, IFRS 16
requires that, at the commencement date, a lessee
measures the lease liability at the present value of the
lease payments that are not paid at that date.
• To determine the present value of the lease payments,
IFRS 16 requires the lease payments to be discounted by
using
Lease Liability
➢ the interest rate implicit in the lease,
if that rate can be readily determined; and
➢ then, the lessee’s incremental borrowing rate,
if the interest rate implicit in the lease cannot be readily
determined
21
Lessee Accounting in IFRS 16
Subsequent Measurement
• After the commencement date, a
lessee subsequently measures the
right-of-use asset and the lease
liability.
• In subsequent measurement of the
right-of-use asset, an entity is
required to measure the right-ofuse asset by
➢ applying a cost model,
➢ unless it applies one of
the other measurement models
Right-of-Use Asset
Cost
Model
Measurement
Models
22
Lessee Accounting in IFRS 16
• To apply a cost model, a
lessee is required to
measure the right-of-use
asset at cost:
➢ less any accumulated
depreciation;
➢ less any accumulated
impairment losses; and
➢ adjusted for any
remeasurement of the
lease liability when
there is any
reassessment or
lease modification.
Right-of-Use Asset
Cost
Model
23
Depreciation for ROU Assets
A lessee shall apply the depreciation requirements in
IFRS 16 Property, Plant and Equipment in depreciating
the right-of-use asset, subject to the following:
If the lease transfers ownership of the underlying asset to
the lessee by the end of the lease term or if the cost of the
right-of-use asset reflects that the lessee will exercise a
purchase option, the lessee shall depreciate the right-ofuse asset from the commencement date to the end of the
useful life of the underlying asset.
Otherwise, the lessee shall depreciate the right-of-use
asset from the commencement date to the earlier of the
end of the useful life of the right-of-use asset or the end of
the lease term.
24
Lessee Accounting
• In addition to measure the right-of-use asset by applying a cost
model after the commencement date, a lessee is required to
subsequently measure or may subsequently measure the rightof-use asset by applying one of the following other
measurement models:
Right-of-Use Asset
➢ Revaluation model
When right-of-use assets relate to a class of property, plant
and equipment to which the lessee applies the revaluation
model in IFRS 16, a lessee may elect to apply that
revaluation model to all of the right-of-use assets that relate
to that class of property, plant and equipment.
Measurement
Models
➢ Fair value model
➢ When a lessee applies the fair value model in IAS 40 to its
investment property
25
LO11-3
Lessee Accounting
c. Subsequent Measurement—Lease Liability
After commencement date, lessee
• measures the lease liability at amortized cost using the
effective interest method and
• remeasures the lease arising from changes to lease
payments because of changes in terms and conditions
that are
A. part of the original lease agreement or
B. outside the original lease agreement (labeled in IFRS
16 as “lease modifications”).
Lessee Accounting: Subsequent Lease
Measurement
Using same example of C Ltd, C depreciates ROU asset over lease term 3 years
at $119,376 per year and recognizes interest on lease payments using
amortization:
Year
Lease payment
Starting
balance after
payment
Interest
expense (5%)
Ending balance
2023
120,000
223,129
11,156
234,285
2024
120,000
114,285
5,715
120,000
2025
120,000
-
-
-
Total
360,000
31 Dec 2023
Dr Depreciation expense
Cr Accumulated depreciation
Dr Interest expense
Cr Lease payable
16,871
$119,376
$119,376
$11,156
$11,156
Lessee Accounting: Subsequent Lease
Measurement
1 Jan 2024
Dr Lease payable
Cr Cash
31 Dec 2024
Dr Depreciation expense
Cr Accumulated depreciation
Dr Interest expense
Cr Lease payable
$120,000
$120,000
$119,376
$119,376
$5,715
$5,715
Lessee Accounting
(A) Lease liability remeasurement for lease changes in terms and
conditions of original lease agreement involving:
(i) Lease term or purchase option
➢Remeasure lease liability based on revised lease payments
discounted by a revised discount rate
(ii) Residual value guarantee or variable lease payments dependent on
an index or a rate for the future
➢Remeasure lease liability based on revised lease payments
discounted by the original discount rate
(iii) Variable lease payments (a) dependent on an index or a rate for
current period or (b) not dependent on an index or a rate
➢ No lease liability remeasurement, changes in variable lease
payments for current period are recognized in P/L as a gain/loss
Lessee Accounting: Subsequent Change in
Lease term
Using earlier example on C Ltd., on December 2023, C Ltd.
extends lease for another 3 years at end of 2025 i.e. from 31
Dec 2023 C pays $120,000 for 2 years and $140,000 for next 3
years. C’s incremental borrowing rate is 6%.
On 31 Dec 2023, before adjusting for lease term, lease liability =
$223,129 + $11,156 = $234,285; ROU asset = $238,753.
PV of revised lease payments at 6% = $586,247 (1 $120,000 + 3
payments of $140,000 + $120,000 due on 1 January 2024)
1 January 2024
Dr ROU asset (586,247 – 234,285)
Cr Lease liability
Dr Lease liability
Cr Cash
$351,962
$351,962
$120,000
$120,000
Lessee Accounting: Subsequent Change in
Lease term
New ROU asset after remeasurement = $238,753 + $351,962 =
$590,715, depreciated over revised lease term of 5 years.
2 January 2024
Dr Depreciation expense (590,715 / 5) $118,143
Cr Accumulated depreciation
$118,143
Dr Interest expense
$27,975
Cr Lease payable (234,285 + 351,962 – 120,000) x 6% $27,975
1 January 2025
Dr Lease payable
Cr Cash
$120,000
$120,000
Lessee Accounting
(B) Lease liability remeasurement for lease modifications
in terms and conditions outside the original lease
agreement
➢ Lease modification definition . . . 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
Lessee Accounting
(B) (Continuation) Lease liability remeasurement for
lease modifications involving:
(i) Decrease in scope of the lease
➢ Restate lease liability and ROU asset to reflect
partial/full termination of lease and recognize
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.
Lessee Accounting: Reduction in Lease scope
Using earlier example on C Ltd. (without extension of lease term) on 1
January 2024, C reduces floor area by half with reduction in lease payments
to $70,000 per year for remaining 2 years. Lease liability is reduced by
$234,285 / 2 = $117,143, and ROU asset reduced by $238,753 / 2 =$119,377.
2 January 2024
Dr Lease payable
$117,143
Dr Gain (P/L)
$2,234
Cr ROU asset
$119,377
Restate lease liability to $136,038 (PV 2 payments of $70,000 at start of year,
at 6% discount rate). Increase in lease liability =$136,038 - $117,142= $18,896
Dr ROU asset
Cr Lease payable
Dr Lease payable
Cr Cash
$18,896
$18,896
$70,000
$70,000
Lessee Accounting
(B) (Continuation) 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
LO11-3
Lessee Accounting
d. Presentation
In the statement of financial position:
a) ROU assets
• Present separately from other assets or disclose in the
notes
• Except for ROU asset that meets investment property
definition, present as investment property
b) Lease liabilities
• Present separately from other liabilities or disclose in the
notes
LO11-3
Lessee Accounting
In the statement of profit or loss and other
comprehensive income:
a) Interest expense on lease liability
• Present separately from depreciation charge of ROU
asset
• Present as a component of finance costs
b) Depreciation charge of ROU asset
LO11-2
Lessee Accounting
In the statement of cash flows:
a) Operating activities
• Short-term lease payments (for elected exemption)
• Low-value assets’ lease payments (for elected exemption)
• Variable lease payments excluded from lease liability
measurement
b) Financing activities
• Cash payments for the principal portion of lease liability
*Cash payments for the interest portion of lease liability follow
presentation of other interest expense
Lessor Accounting in IFRS 16
•
IFRS 16 significantly changes the lessee accounting
requirements in IAS 17, but it substantially carries forward the
lessor accounting requirements in IAS 17 and a lessor continues
the existing practices in IAS 17.
•
Accordingly, IAS 16 continues to require a lessor to classify
each of its leases as either an operating lease or a finance lease
and to account for those two types of leases differently.
Finance Lease
Direct
Finance
Lease
Operating Lease
Sales-type
Lease
39
Classification of Leases by Lessor
Lease classification is made at the inception of the lease.
What is “inception of the lease”?
Finance
Lease
Operating
Lease
• The inception of the lease is the earlier of
– the date of the lease agreement and
– the date of commitment by the parties to the principal
terms and conditions of the lease.
• As at this date:
a) a lease is classified as either or a finance or an
operating lease; and
b) in the case of a finance lease,
• the amounts to be recognised at the
commencement of the lease term are determined.
40
Classification Criteria by Lessor
Operating
Lease
Finance Lease
“transfers substantially all the risks and rewards of
ownership of an asset to the lessee”:
Examples of situations that normally lead to a lease being classified as a finance lease:
1. the lease transfers ownership of the underlying asset to the lessee by the end of the
lease term;
2. the lessee has the option to purchase the underlying asset at a price that is
expected to be sufficiently lower than the fair value at the date the option becomes
exercisable for it to be reasonably certain, at the inception date, that the option will
be exercised;
3. the lease term is for the major part of the economic life of the underlying asset even
if title is not transferred;
41
Classification Criteria by Lessor
Operating
Lease
Finance Lease
“transfers substantially all the risks and rewards of
ownership of an asset to the lessee”:
4. at the inception date, the present value of the lease
payments amounts to at least substantially all of the fair
value of the underlying asset; and
5. the underlying asset is of such a specialised nature that
only the lessee can use it without major modifications.
42
Professional Judgment Required
Indicators of situations that individually or in combination could
also lead to a lease being classified as a finance lease are:
1. if the lessee can cancel the lease, the lessor’s losses
associated with the cancellation are borne by the lessee;
2. gains or losses from the fluctuation in the fair value of the
residual accrue to the lessee; and
3. the lessee has the ability to continue the lease for a secondary
period at a rent that is substantially lower than market rent.
These examples and indicators are not always conclusive. If it is
clear from other features that the lease does not transfer
substantially all the risks and rewards incidental to ownership of
an underlying asset, the lease is classified as an operating lease.
43
Operating Leases
Lease
agreement
exists.
Record lease as
an Operating
Lease.
Criteria for a
finance lease
not met.
Finance
Lease
44
Accounting for Operating
Lease by Lessor
Recognition and measurement
➢ Lease payments are recognized as income on either a straight-line
basis or another systematic basis if it is more representative of the
pattern in which benefit from the use of the asset is diminished.
➢ The underlying asset is still in the lessor’s books, subject to the lessor’s
normal depreciation policy for similar assets.
➢ Any initial direct costs incurred by the lessor should be added to the
carrying amount of the underlying asset and recognized as an expense
over the lease term on the same basis as the lease income.
➢ A manufacturer or dealer lessor does not recognise any selling profit
on entering into an operating lease because it is not the equivalent of a
sale.
45
Example: Accounting for
Operating Leases by Lessor
On January 1, 2011, Sans Serif Publishers, a computer services
and printing firm, leased a color copier from CompuDec
Corporation.
The lease agreement specifies four annual payments of $100,000
beginning January 1, 2011, the inception of the lease, and at each
January 1 thereafter through 2014.The useful life of the copier is
estimated to be six years. Before deciding to lease, Sans Serif
considered purchasing the copier for its cash price of $479,079. If
funds were borrowed to buy the copier, the interest rate would
At each of the Four Payment Dates
have been 10%.
CompuDec Corporation (Lessor)
Cash
100,000
Unearned rent revenue
100,000
46
Example: Accounting for
Operating Leases by Lessor
At the End of each Year
CompuDec Corporation (Lessor)
Unearned rent revenue
Rent revenue
100,000
100,000
Depreciation expense
xxx
Accumulated depreciation
xxx
The lessor retains the asset on its
books and accordingly records
47
depreciation on the asset.
Accounting for Finance Lease by Lessor
Recognition and measurement
➢ At the commencement date, a lessor shall recognise assets held
under a finance lease in its SFP and present them as a receivable at
an amount equal to the net investment in the lease.
➢ The lessor shall use the interest rate implicit in the lease to measure
the net investment in the lease.
➢ Initial direct costs for Direct Finance Lease are included in the initial
measurement of the net investment in the lease. The interest rate
implicit in the lease is defined in such a way that the initial direct costs
are included automatically in the net investment in the lease; there is
no need to add them separately.
➢ Initial measurement of the lease payments included in the net
investment in the lease – refer to earlier slide on what lease payments
comprise
48
Accounting for Finance Lease by Lessor
On January 1 2021, SSP leased a copier from Leasecorp. Leasecorp purchased
equipment at cost of $479,079.
Lease agreement specifies annual payments beginning January 1 2021, inception of
lease and December 31 thereafter through 2025. 6-year lease term ending December 31
2026 is equal to estimated useful life of copier. Interest rate in financing is 10%.
PV of minimum lease payment is equal to FV of copier and lease term is equal to
expected useful life of copier, hence this is a finance lease.
Lease payments = $479,079 / 4.79079 (PV annuity $1, n=6, i=10%) = $100,000.
1 Jan 2021
Dr Lease receivable
$479,079
Cr Inventory
$479,079
Dr Cash
$100,000
Cr Lease receivable
$100,000
31 Dec 2021
Dr Cash
$100,000
Cr Lease receivable
$62,092
Cr Interest revenue
$37,908 (10% x ($479,079 – 100,000))
49
LO11-9
Lessor Accounting
e. Presentation
Finance Lease
Operating Lease
Statement of Financial Position
Statement of Financial Position
- Present finance lease receivable
as finance asset (IFRS 9)
- Present underlying asset
according to its nature
LO11-6
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.
LO11-6
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.
Sales-type Leases with Selling Profit
On 1 Jan 2021, SSP leased copier from CD at price of $479,079.
Lease payments are $100,000 beginning 1 Jan 2021, and 31 Dec
thereafter. 6 year lease term is same as estimated useful life.
Manufacturing cost is $300,000. Interest rate for financing is 10%.
1 Jan 2021
Dr Lease receivable (PV of lease payments)
Dr Cost of goods sold
Cr Sales revenue
Cr Inventory
$479,079
$300,000
$479,079
$300,000
Dr Cash
Cr Lease receivable
$100,000
$100,000
LO11-7
Bargain Purchase Options
and Residual Value
A bargain purchase option (BPO) is a provision of some
lease contracts that gives the lessee the option of
purchasing the leased property at a bargain price. The
expectation that the option price will be paid effectively
adds an additional cash flow to the lease for both the
lessee and the lessor. As a result,
LESSEE adds the present value of the BPO price to the present value of
periodic rental payments when computing the amount to be recorded a ROU
asset and a lease liability.
LESSOR, when computing periodic rental payments, subtracts the present
value of the BPO price from the amount to be recovered (fair value) to
determine the amount that must be recovered from the lessee through the
periodic rental payments.
Bargain Purchase Options
On January 1 2021, SSP leased a copier from Leasecorp at price of
$479,079.
Manufacturing cost is $300,000. Interest rate for financing is 10%.
Lease agreement specifies annual payments beginning January 1
2021, inception of lease and December 31 thereafter through 2025.
6-year lease term. End of useful life 7 years expected residual value is
zero. SSP has option to buy copier for $60,000.
Rental payment = [FV $479,079 – BPO (60,000 x 0.56447)] / 4.79079
= $445,211 / 4.79079 = $92,931.
SSP journal entries
31 December 2026
Dr Depreciation expense (479,079 / 7 years)
Cr Accumulated depreciation
$68,440
$68,440
Bargain Purchase Options
SSP journal entries
31 December 2026
Dr Interest expense (10% x 54,542) $5,458
Dr Lease payable
$54,542
Cr Cash
$60,000
Leasecorp journal entries
Dr Cash
Cr Lease receivable
Cr Interest revenue
$60,000
$54,582
$5,458
LO11-8
Effect on the Lessee of a Residual Value
Guaranteed Residual Value
Sometimes, the lease agreement includes a guarantee by the lessee
that the lessor will recover a specified residual value when custody of
the asset reverts back to the lessor at the end of the lease term. This
not only reduces the lessor’s risk but also provides incentive for the
lessee to exercise a higher degree of care in maintaining the leased
asset to preserve the residual value.
Unguaranteed Residual Value
A lease agreement may be silent as to the question of residual value.
This is referred to as an unguaranteed residual value. In the case of
unguaranteed residual value, the lessee is not obligated to make any
payments other than the periodic rental payments. The same is true
when the residual value is guaranteed by a third-party guarantor such
as an insurance company.
LO11-8
Effect on the Lessor of a Residual Value
When the residual value is guaranteed, the lessor views it as a
component of minimum lease payments. In fact, even if it is not
guaranteed, the lessor still expects to receive it in the form of
property or cash or both.
Special Leasing Arrangements—
Sale-leaseback Arrangements
• The owner of an asset sells it and immediately
leases it back from the new owner
• In a sale-leaseback transaction:
– Seller-lessee receives cash from the sale of the
asset
– Seller-lessee pays periodic rent payments to the
buyer-lessor to retain the use of the asset
• Common reasons that motivates sale-leaseback:
– Effectively refinance at a lower rate
– To generate cash
Sale and Leaseback Transactions
1. If transfer of asset satisfies IFRS 15, the transfer is
accounted for as sale of asset.
➢ Seller-lessee measures ROU asset from
leaseback at the proportion of previous carrying
amount of asset relating to the retained right of
use and recognizes any gain or loss relating to the
transferred right.
Gain/loss on
rights transferred
=
(fair value − book value) ×
ROU asset = book value ×
(fair value − lease liability)
fair value
A
lease liability
fair value
B
➢ Buyer-lessor accounts for the transfer as
purchase and the lease per IFRS 16
60
Sale and Leaseback: SP=FV; lease term <
useful life
TD sells its warehouses at fair value $900,000, and lease back
warehouses on 31 Dec 2021. Warehouse carrying amount $600,00
(cost $950,000).
Non-cancelable lease term is 5 years. Remaining useful life is 10 years.
Lease payment is $133,155 beginning 31 December 2021.
PV of lease payments is $133,155 x 4.16986 (n=5, i=10%) = $555,238
Using formula A, gain on disposal = (900,000 – 600,000) x (900,000 –
555,238) /900,000 = $114,921
Using formula B, ROU asset = 600,000 x 555,238/900,000 = $370,159.
61
Sale and Leaseback: SP=FV; lease term <
useful life
31 Dec 2021 (Buyer Lessor) $
Dr Warehouse
Cr Cash
31 Dec 2021 (TD) $
Dr Cash
Dr ROU asset
Dr Accumulated depreciation
Cr Warehouse
Cr Gain on disposal
Cr Lese payable
900,000
900,000
900,000
370,159
350,000
950,000
114,921
555,238
62
Sale and Leaseback Transactions
2. If transfer of asset does not satisfy IFRS 15:
➢ Seller-lessee continues to recognize the
transferred asset and recognizes a financial
liability per IFRS 9 for the transfer proceeds.
➢ Buyer-lessor does not recognize the
transferred asset and recognizes a financial
asset per IFRS 9 for the transfer proceeds.
63