What is a lease? What standard govern the accounting for leases?
IFRS 16
A lease is a contract or part of a contract that conveys a right to use an underlying asset for a period of time in exchange for consideration.
Underlying asset is the subject of the lease and it must be specifically identified
Lease identification
Recognition and Initial Measurement
How should a lessee recognize and initially measure a lease?
At commencement date, the lessee shall recognize a right of use asset and a lease liability.
The right of use asset is initially measured at cost, while the lease liability is initially measured at present value.
Recognition exemptions
What are the two instances in which a lessee is permitted to account for a lease as operating lease?
- The underlying asset is low value (when new)
- The lease is short term
This is a practical expedient. The entity is only permitted, not required. Hence, the entity may still account for it as a finance lease.
Recognition and Initial Measurement
What comprises the present value of lease liability?
- Fixed payments
- Variable payments
- Amount of residual value guarantee
- Exercise price of purchase option (reasonably certain to exercise)
- Termination penalties
Recognition and Initial Measurement
What comprises the cost of right of use asset?
- PV of lease liability
- Lease payments made at or before commencement date, less any lease incentive receivable
- Directly attributable costs
- PV of dismantling and restoration costs (with present obligation)
Recognition and Initial Measurement
How to compute for the present value of the lease liability?
The future payments or cash outflows should be discounted using the effective interest rate or incremental borrowing rate (if effective rate is not determinable)
What is a sale-and-leaseback transaction?
It is an arrangement whereby one party (i.e. seller-lessee) sells an asset to another party (i.e. buyer-lessor) and immediately leases it back.
Periodic fixed payments - PV of annuity
RV guarantee or Purchase option - PV of 1
Why does an original owner enter into a sale-and-leaseback transaction?
- cash flow or financing problems
- tax advantage (depending on the jurisdiction)
- avoid executory costs, e.g. repairs and maintenance
What is the important consideration in accounting for a sale-and-leaseback transaction?
Is it treated as one transaction?
Recognition of 2 separate transactions
- sale transaction
- lease transaction
What are the accounting procedures if the leaseback is an operating lease?
Lessee POV
- Initially - record the sale transaction
dr: cash
dr: accumulated depreciation
— cr: equipment
— cr: gain on right transferred - Subsequently - record the rental transaction
dr: rent expense
— cr: cash
- Subsequently - record the rental transaction
Gain on right transferred = “gain on sale”
Consideration received———————-xx
Carrying amount of the asset————(xx)
Gain on right transferred——————-XX
What is the accounting procedure if the sales price is at fair value?
Measurement of lease liability, RoUA
Gain or loss computation
Lease liability = at FV (i.e. PV of lease payments)
Right of use asset = CA (LL / SP)
Gain (loss) = SP - CA
Proportion of right transferred = SP - LL
Gain (loss) on RT = Gain (RT/SP)
The RoUA is the proportion of the carrying amount of the asset that relates to the right of use retained by the seller-lessee.
