Comprehensive exercise for IFRS 16 – Lease
On 1st January 20X0, Open Co (the lessee) signed a 7-year lease noncancellable contract for a floor of a building, with an option
(cancellable) to extend the lease for a further 8 years. Annual payment
for the lease is $100,000 per annum during the initial term and
$115,000 per annum during the optional period, all payable by cash at
the beginning of each year. To obtain the lease, Open Co incurs initial
direct costs of $25,000 ($15,000 to the former tenant occupying the
floor and $10,000 for real estate commissions). The lessor agrees to
reimburse the lessee the real estate commission of $5,000. Fair value
of lease asset on 1st January 20X0 is estimated at $1,850,000. At the
inception date, Open Co determines that it is not reasonably certain to
exercise the option to extend the lease. The rate implicit in the lease is
not readily determinable. Open Co’s incremental borrowing rate is
9.5% per annum and they are using straight-line depreciation policy
for all non-current asset.
Requirement:
1. Is this a finance lease or operating lease from lessor point of
view? Explain.
2. Determine the initial value of lease asset at inception date. How
would the value of lease asset change, given that annual payment
for the lease is payable at the end of each year?
3. Determine all possible accounting entries for the first year
(20X0) in relation to this lease contract from both lessee and
lessor perspective.
4. Determine all possible accounting entries for the second year
(20X1) in relation to this lease from both lessee and lessor
perspective.