LEASES
CHAPTER 9
Learning Objectives
Define the terms "lease", "inception date", "commencement date" and
"lease term"
Account
for a lease in the financial statements of the lessee in
accordance with the requirements of IFRS16 Leases
Measure a lessee's right-of-use asset and lease liability, both at the
commencement date of a lease and in subsequent periods
Distinguish between a finance lease and an operating lease
Account
for finance leases and operating leases in the financial
statements of the lessor in accordance with the requirements of IFRS16
Outline the requirements of IFRS16 with regard to sale and leaseback
transactions
IFRS16 defines a lease 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".
Two further definitions given in IFRS16 are as follows:
(a) The inception date of a lease is "the earlier of the date of a lease agreement
and the date of commitment by the parties to the principal terms and conditions of
the lease".
An inception date refers to the specific moment when something officially
begins or is created
(b) The commencement date of a lease is "the date on which a lessor makes an underlying
asset available for use by a lessee“
A commencement date is defined as the date that a contract or legal agreement becomes
effective
In other words, a commencement date marks the point at which a contract officially begins
and binds the parties involved. This is also known as the contract’s effective date.
Throughout the "period of use" specified in the contract, the customer must have both of the
following:
(a) the right to obtain substantially all of the economic benefits from use of the underlying
asset, and
(b) the right to direct the use of that asset.
Lease term IFRS16 defines the length of a lease (the "lease term") as "... the
non-cancellable period for which a lessee has the right to use an underlying
asset, 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."
Important to determine the lease term so that the liability to the lessor and
the right-of use asset may be measured correctly at the commencement date of
a lease
Lease Accounting By Lessees
IFRS16 requires that, at the commencement of a lease, the lessee should
recognize a right-of-use asset and a corresponding lease liability.
A right-of-use asset is defined as "an asset that represents a lessee's right to use
an underlying asset for the lease term".
Requirement to recognize a right-of-use asset and a lease liability generally
applies to all leases.
An entity may elect not to apply this accounting treatment to: (a) short-term
leases (i.e. leases of 12 months or less), and
(b) leases for which the underlying asset is of low value
If such an election is made, the lease payments for the leases concerned are
recognized as an expense and spread over the lease term (usually on a straight-line
basis).
There is no right-of-use asset or lease liability.
Election for short-term leases should be made by class of underlying asset, where a
"class" is a grouping of assets of a similar nature and use.
Election for leases of low-value assets should be made on a lease-by-lease basis
"low value" is not defined in IFRS16, but the application guidance which forms
part of the standard makes it clear that the assessment of whether an asset is of low
value should be carried out on an absolute basis, not a materiality basis
Initial Measurement of The Right-of-use Asset and The Lease
Liability
Right-of-use asset which is recognized at the commencement of a lease is
measured initially at cost.
Cost of the right-of-use asset is obtained by adding together the following
elements:
(a) the amount of the initial measurement of the lease liability
(b) any lease payments made at or before the commencement date (e.g. deposits)
(c) any initial direct costs incurred by the lessee
(d) an estimate of any costs to be incurred by the lessee in dismantling or removing
the underlying asset at the end of the lease term, restoring the site on which it is
located or restoring the asset as required by the terms of the lease
Subsequent Measurement
Right -of-use asset established at the commencement of a lease
should be measured subsequently at cost less any accumulated
depreciation and accumulated impairment losses (the "cost model")
Asset should be depreciated in accordance with IAS16 Property,
Plant and Equipment and impairment losses should be accounted for in
accordance with IAS36 Impairment of Assets
Note that: (a) If the lease transfers ownership of the underlying asset to the
lessee by the end of the lease term the right-of-use asset should be depreciated up
to the end of the useful life of the underlying asset.
(b) Otherwise, the right-of-use asset should be depreciated up to the earlier of
the end of the lease term and the end of the useful life of the right-to-use asset.
Presentation and Disclosure Requirements for Lessees
IFRS16 disclosure requirements for lessees are very extensive.
Lessee should disclose the following amounts for the reporting period:
(a) the depreciation charge for right-of-use assets, analyzed by class of
underlying asset
(b) the interest expense on lease liabilities
(c) the expenses relating to leases of short term assets and leases of low-
value items for which the lessee has elected not to recognize a right-of-use
asset and a lease liability
(d) the carrying amount of right-of-use assets at the end of the reporting
period, analyzed by class of underlying asset.
Lease Accounting by Lessors
IFRS16 requires that lessors should classify each of their leases (at the
inception date) as either a "finance lease" or an "operating lease".
These terms are defined as follows:
(a) A finance lease is "A lease that transfers substantially all the risks and
rewards incidental to ownership of an underlying asset".
(b) An operating lease is "A lease that does not transfer substantially all
the risks and rewards incidental to ownership of an underlying asset".
As these definitions make clear, the classification of a lease concentrates
on the extent to which the "risks and rewards" normally associated with
ownership of the underlying asset lie with the lessor or the lessee.
Risks
include the possibility of losses from idle capacity or
technological obsolescence.
Rewards include the expectation of profitable operation over the asset's
useful life and gain from any appreciation in its value
Situations which would normally lead to a lease being classified as a finance
lease include:
(a) the lease transfers ownership of the asset to the lessee by the end of the
lease term
(b) the lessee has the option to purchase the asset at a price expected to be
sufficiently lower than the asset's fair value on the date that the option is
exercisable, so as to make it reasonably certain that this option will be exercised
(c) the lease term is for the major part of the economic life of the asset
(d) 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
(e) the underlying asset is of such a specialized nature that only the lessee
could use it without major modifications.
Leases of Land and Buildings
For a lease of both land and buildings, the land element and the
buildings element should be considered separately for the purposes of
lease classification
Leases of land are classified as either finance leases or operating
leases in the same way as other assets.
land normally has an indefinite economic life and so a lease of land
cannot be for "the major part of the economic life of the asset"
Recognition and Measurement for Finance Leases
At the commencement date of a finance lease, the lessor is required to
recognize the asset held under the lease as a receivable equal to the "net
investment" in the lease.
Amount is initially measured at the present value of:
(a) the lease payments receivable by the lessor after the commencement date,
plus
(b) the estimated residual value of the underlying asset for the lessor (if any) at
the end of the lease term.
Recognition And Measurement For Operating Leases
If a lease is classified as an operating lease, the underlying asset should be
shown in the lessor's financial statements and then depreciated as usual.
lease payments made by the lessee are recognized as income, generally on a
straight-line basis over the lease term.
Any direct costs incurred by the lessor on arranging an operating lease should
be added to the carrying amount of the asset concerned and written off over the
lease term.
Presentation and disclosure requirements for lessors
The main disclosure requirements of IFRS16 for lessors are as follows:
(a) Finance leases: – the amount of finance income for the reporting period
– a maturity analysis of lease payments receivable, showing undiscounted
amounts to be received in each of the following five years and the total to be
received in remaining years (reconciled to the net investment in finance leases)
(b) Operating leases: – the amount of lease income for the reporting period
– a maturity analysis of lease payments receivable, showing undiscounted
amounts to be received in each of the following five years and the total to be
received in remaining years
Should also be additional qualitative and quantitative information with regard
to the nature of the lessor's leasing activities and
Way in which the lessor manages the risks associated with any rights that it
retains in underlying assets.
Sale and leaseback transactions
A "sale and leaseback" transaction occurs when an entity (the "seller-lessee")
sells an asset to another entity (the "buyer-lessor") and then immediately leases the
asset back from that other entity
Outcome of such a transaction is that the seller-lessee continues to use the asset
concerned for a period of time, even though it has been sold to the buyer-lessor.
Requirements
of IFRS16 with regard to sale and leaseback transactions are
broadly† as follows:
(a) Transfer of the asset is a sale.
If the transfer qualifies as a sale (i.e. the buyer-lessor has obtained control), the
seller-lessee should derecognize the transferred asset and recognize a right-of-use
asset instead.
(b) Transfer of the asset is not a sale.
If the transfer of the asset does not qualify as a sale (and so the buyer-lessor
has not obtained control), the seller-lessee must continue to recognize the
transferred asset.
Buyer -lessor should not recognize this asset.
Transfer
proceeds are treated as a loan and are recognized as a financial
liability for the seller-lessee and a financial asset for the buyer-lessor
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