ACC2024 Company Accounting: Accounting for Leases PDF

ACC2024 COMPANY ACCOUNTING Seminars 3 and 4: Accounting for Leases Learning Objectives 1. Understand the requirements of SFRS(I) 16 Leases 2. Account for leases in the financial statements of a lessee under the single lessee accounting model 3. Determine the classification of Leases (Finance...

ACC2024 COMPANY ACCOUNTING Seminars 3 and 4: Accounting for Leases Learning Objectives 1. Understand the requirements of SFRS(I) 16 Leases 2. Account for leases in the financial statements of a lessee under the single lessee accounting model 3. Determine the classification of Leases (Finance or Operating Lease) by a lessor 4. Account for leases in the financial statements of a lessor 2 What is a Lease? A Contractual Arrangement Lessor Lessee Right to control the (owner) use of an asset (user) Periodic cash payments 3 Why lease and not buy?  Economic Driven Reasons  A source of funding  Manage the need for asset & remain flexible able to upgrade their current model instead of sticking with older model  Tax benefits under some circumstances & in some countries  Accounting Driven Reasons  Off balance sheet debt if structured as operating lease (under IAS 17, which was heavily criticized for this reason)  May lower gearing ratios (debt-equity ratio), reduce the probability of debt covenants violation, improve performance ratios (e.g., ROA, interest coverage ratio) 4 Revised Lease Accounting from 2019 Background:  The lease accounting model in IAS 17 was criticised for failing to meet the needs of users of financial statements.  Because it did not always provide a faithful representation of leasing transactions, in particular, it did not require lessees to recognise assets and liabilities arising from operating leases.  Thus, the IASB and the Financial Accounting Standards Board (FASB) of the United States commenced a joint project in 2006 to develop a new approach to lease accounting that requires a lessee to recognise assets and liabilities for the rights and obligations created by leases.  The IASB decided to adopt a single lessee accounting model that significantly changes the lessee accounting requirements in IAS 17, that  requires a lessee to recognise assets and liabilities for all leases subject to exemptions, but LEESEE must record ROU asset on the date on inception in B/S  substantially carries forward the lessor accounting requirements in IAS 17. IFRS 16 issued in January 2016. Effective date: 1 January 2019. 5 Objective and Scope of SFRS(I) 16  The objective of SFRS(I) 16 is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents those transactions  An entity is required to apply SFRS(I) 16 to all leases, including leases of right-of- use assets in a sublease, except for: a. leases to explore for or use minerals, oil, natural gas and similar non- regenerative resources; b. leases of biological assets within the scope of IAS 41 held by a lessee; c. service concession arrangements within the scope of IFRIC 12; d. licences of intellectual property granted by a lessor within the scope of IFRS 16 15; and e. rights held by a lessee under licensing agreements within the scope of IAS 38 for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights. A lessee may, but is not required to, apply IFRS 16 to leases of intangible assets other than those described in this point 6 Identifying a Lease in SFRS(I) 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. 7 Identifying a Lease in SFRS(I) 16  The requirements imposed by SFRS(I) 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 (SFRS(I) 16.9).  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. 8 Identifying a Lease in SFRS(I) 16  To be accounted as a lease, 2 conditions must be met: IFRS (16) Customer An identified Asset Right to Control the Use 1) Physically distinct 1) The right to obtain 2) The supplier has no substantially all the economic substantive right to substitute benefits from the use of the the asset throughout the asset (e.g. having exclusive period of use. use of the asset), and A supplier’s right to substitute an asset 2) The right to direct the use of is substantive only if both of the the asset i.e. how and for what following conditions exist: purpose the asset is used (a) the supplier has the practical ability to substitute alternative assets throughout the period of use See para B26 and B27 for throughout the period of use; and examples of decision-making (b) the supplier would benefit rights economically from the exercise of its right to substitute the asset 9 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 10 changing circumstances. 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. 11 Is there a lease? Example 2 (cont’d) Customer has the right to control the use of the ship throughout the five-year 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 12 about how and for what purpose the ship is used. Identifying a Lease in SFRS(I) 16 No Is there an identified asset? 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 Customer Does the customer, the supplier or neither party have the right to Supplier 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 Yes Does the customer have the right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions? No Yes Did the customer design the asset in a way that predetermines how No and for what purpose the asset will be used throughout the period of use? 13 Contract contains a lease Contract does not contain a lease Lease Term in SFRS(I) 16  When there is a lease or a lease component in a contract, an entity is required to determine the lease term as the non-cancellable 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 Both Lessee or Lessor can do assessment can be 5y or 7yrs they don need to be in sync for the lease contract 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 14 Determining the lease term Examples 1. A lease with 2-year initial term and Lease term: 2 years another 2-year further term. The The lessee has no discretionary lessor has an option to cancel the right to renew further term. 2. A lease with 2-year initial term. There Lease term: 4 years is renewal option for another 2 years at It is reasonably certain that the a bargain rental (which is 70% below lessee will exercise the option market rate). 3. A lease with 2-year initial term, with a Lease term: 3 years renewal option for another 1 year at It is reasonably certain that the market rate and a purchase option to lessee will exercise the purchase acquire the asset at a bargain price option because of the economic (10% of the market value of the used incentive asset) 1 year after the initial term 15 Lessee Accounting in SFRS(I) 16  The single lessee accounting model in SFRS(I) 16 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  a right-of-use asset, and  a lease liability. Right-of-Use Asset Lease Liability 16 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. 17 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. 18 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? 19 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: Year 2: Dr. Rent expense $1,300 Dr. Rent expense $1,300 Cr. Rent payable $1,300 Dr. Rent payable $450 Cr. Cash $1,750 20  Implications when exemptions are applied  Treated as period expense  Implication: Off Balance Sheet for the lessee  No asset is recognized.  No liability is recognized.  Instead, lease payments for each period are charged as operating expenses for that period. Accounted for as executory contracts. 21 Lessee Accounting in SFRS(I) 16 Initial Measurement  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.  Refer to next slide for components of lease payments  To determine the present value of the lease payments, SFRS(I) 16 requires the lease payments to be discounted by using  the interest rate implicit in the lease, use implict rate for lease liability if that rate can be readily determined; and but for dismantling and ROU use discount rate  then, the lessee’s incremental borrowing rate, if the interest rate implicit in the lease cannot be readily determined Lease Liability 22 Lease Payments This slide is crucial for Mock Paper Need to include in our lease payment. 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 receivable; (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. guarantees by Lessee 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. Lessee parent Co Insurance Co. Exclude:  Variable payment not based on an index or rate (e.g. based on sale)  Payment for non-lease component, e.g. payment for services such as security or maintenance services 23 Lessee Accounting in SFRS(I) 16 Initial Measurement  In general, assets and liabilities arising from a lease for a lessee are initially measured on a present value basis.  Specifically, SFRS(I) 16 requires, at the commencement date, a lessee to measure the right-of-use asset at cost.  The cost of the right-of-use asset comprises: a. the amount of the initial measurement of the lease liability in SFRS(I) 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 Right-of-Use Asset 24 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) 25 Lessee Accounting in SFRS(I) 16 Subsequent Measurement Right-of-Use Asset  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- of-use asset by  applying a cost model, Cost Model  unless it applies one of the other measurement models Measurement Models 26 Lessee Accounting in SFRS(I) 16 Right-of-Use Asset  To apply a cost model, a lessee is required to measure the right-of-use asset at cost:  less any accumulated depreciation; Cost  less any accumulated impairment losses; and Model  adjusted for any remeasurement of the lease liability when there is any reassessment or lease modification. 27 Depreciation for ROU Assets A lessee shall apply the depreciation requirements in SFRS(I) 1-16 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-of-use 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. 28 Lessee Accounting in SFRS(I) 16 Right-of-Use Asset  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 right-of- use asset by applying one of the following other measurement models: Measurement  Revaluation model in SFRS(I) 1- 16 Models When right-of-use assets relate to a class of property, plant and equipment to which the lessee applies the revaluation model in SFRS(I) 1- 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.  Fair value model in SFRS(I) 1-40  When a lessee applies the fair value model in SFRS(I) 1-40 to its investment property 29 Example for Lessee Accounting Refer to Lecture Illustration 30 Example for Lessee Accounting: Extension  Using the lecture illustration and assume there is variable lease payment (a.k.a. contingent rent)  Without variable lease payment, On 31 December 20X1 Dr Lease Payable $8,104 Dr Interest Expense $1,896 Cr Cash $10,000 (To record the yearly lease payment)  With variable lease payment (let’s say $500) which is dependent of some future events e.g. sales On 31 December 20X1 Dr Lease Payable $8,104 Dr Interest Expense $1,896 Dr Variable Lease Expense $500 Cr Cash $10,500 (To record the yearly lease payment) 31 Recap components of ROU asset & Lease Liability At commencement ROU Asset Lease Liability PV (LP) + Lessee’s IDC + lease prepayment made - lease incentive received PV (LP) + dismantling restoration cost if already recognized as provision 32 Lessor Accounting in SFRS(I) 16  SFRS(I) 16 significantly changes the lessee accounting requirements in SFRS(I) 1-17, but it substantially carries forward the lessor accounting requirements in SFRS(I) 1-17 and a lessor continues the existing practices in SFRS(I) 1-17.  Accordingly, SFRS(I) 16 continues to require a lessor to classify each of its leases as either an operating lease or a finance lease (SFRS(I) 16.61) and to account for those two types of leases differently. Finance Lease Operating Lease Direct Finance Sales-type Lease Lease 33 Classification of Leases by Lessor Lease classification is made at the inception of the lease. Reassessed only if there is a lease modification What is “inception of the 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. Finance Lease As at this date: a) a lease is classified as either or a finance or an operating lease; and Operating b) in the case of a finance lease, Lease the amounts to be recognised at the commencement of the lease term are determined. 34 Classification Criteria by Lessor Operating Finance Lease 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; 35 Classification Criteria by Lessor Operating Finance Lease Lease “transfers substantially all the risks and rewards of ownership of an asset to the lessee”: 3. the lease term is for the major part of the economic life of the underlying asset even if title is not transferred; 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. 36  IFRS versus U.S. GAAP Lease accounting under IFRS and U.S. GAAP provides a good general comparison of “principles-based accounting” as IFRS often is described and “rules-based accounting” which often is the description assigned to U.S.GAAP. Situations that normally would lead to Lease classification rules. classification as a finance lease are: 1. Transfer of title. 1. Transfer of title. 2. Contains a BPO. 2. Contains a BPO. 3. 75% or more of 3. Term is “major portion” of asset’s life. asset’s life. 4. PV of lease payments greater than 4. 90% or more of fair “substantially all” of the fair value of value. the asset. 5. Specialized asset. 37 Professional Judgment Required Three suggestive indicators of a finance lease: 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 5 examples and 3 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. 38 Operating Leases Lease Criteria for a agreement finance lease exists. not met. Record lease as an Operating Lease. Finance Lease 39 Lessor Accounting Initial Measurement At commencement date in statement of financial position Finance Lease Operating Lease - Derecognize the - Continue to recognize the underlying asset and underlying asset and - Recognize a finance lease - Add any initial direct costs receivable incurred to obtain the lease to the carrying amount of the underlying asset 40 Lessor Accounting – Finance Lease Receivable 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. *Calculated using the interest rate implicit in the lease Refer to slide 23 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. 41 Lessor Accounting Subsequent Measurement Finance Lease Operating Lease Statement of Financial Position Statement of Profit or Loss - Adjust finance lease receivable - Recognize lease payments as by lease payments income on either a straight-line basis or another systematic basis if it is more representative of the Statement of Profit or Loss pattern in which benefit from the - Recognize finance income on use of the asset is diminished. finance lease receivable on the - Recognize depreciation charges effective interest methodz on underlying asset 42 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 have been 10%. At each of the Four Payment Dates CompuDec Corporation (Lessor) Cash 100,000 Unearned rent revenue 100,000 43 Example: Accounting for Operating Leases by Lessor At the End of each Year CompuDec Corporation (Lessor) Unearned rent revenue 100,000 Rent revenue 100,000 Depreciation expense xxx Accumulated depreciation xxx The lessor retains the asset on its books and accordingly records depreciation on the asset. 44 Example: Accounting for Finance Leases by Lessor Refer to Lecture Illustration 45 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. The manufacturer or dealer lessor earns 2 distinct types of income: (1) Gross profit on sales, and (2) Interest income on financing Direct finance only earn interest income Any initial direct costs are expensed at the inception of the lease. Gross Cost Fair Value Investment Gross Interest Profit Income recognize over the lease period recognize it on inception or P.V. of Lease Payments (if 46 lower) Example of Sales-Type Lease On January 1, 2011, Sans Serif Publishers, leased a copier from CompuDec Corp. at a price of $479,079 (i.e. P.V. of the lease payments). The lease agreement specifies annual payments of $100,000 beginning January 1, 2011 (the inception of the lease), and at each December 31 thereafter through 2015. The six-year lease term ending December 31, 2016, is equal to the estimated useful life of the copier. CompuDec manufactured the copier at a cost of $300,000. CompuDec’s interest rate for financing the transaction is 10%. 47 Example of Sales-Type Lease finance lease - direct finance - sale type lease Lease Classification 1. The lease term (6-years) is equal to 100% of the useful life of the copier, and 2. Fair market value is different from the cost of the leased asset. SO The lease agreement is classified as a Sales-Type lease from the viewpoint of CompuDec (lessor). 48 Example of Sales-Type Lease At inception of the Lease – January 1, 2011 CompDec Corp. (Lessor) Lease receivable 479,079 Cost of goods sold 300,000 Sales revenue 479,079 Gross profit = $179,079 Inventory of equipment 300,000 Receipt of the First Lease Payment – January 1, 2011 CompDec Corp.(Lessor) Cash 100,000 Lease receivable 100,000 49 One Major issue with Sales-type Lease Seller-Lessor charges artificially low interest rate for the lease financing to attract sale Should the reduction in total income be deducted from the gross profit or interest income? If artificially low rates of interest are quoted, a manufacturer or dealer lessor shall restrict selling profit to that which would apply if a market rate of interest were charged [para 73]. 50 Summary Lessee (“renter”) Right-of-Use Lessor (“owner”) Transfer of Risk/Rewards to Lessee So for the same lease, lessee and lessor may account differently. 51 Lessee Accounting Recognize ROU asset E.g. and lease liability at Dr ROU asset commencement date Cr Lease liability unless exemptions Cr Provision for dismantling elected Cr. Cash Depreciate ROU asset over the Reduce Lease liability balance and lease term or useful life* recognize interest expense when *if assume ownership transfers or cash is paid throughout the lease purchase option exercised term Dr Depreciation expense Dr Interest expense Cr AD – ROU asset Dr Lease liability Cr Cash 52 Lessor Accounting Transfer of Risk/Rewards to Lessee? Use the 5 examples to assess Yes No Finance Lease Operating Lease Reduce Lease Receivable Asset remains in Lessor’s Derecognize books, subject to and recognize interest asset, instead depreciation income when cash is recognize Lease received throughout the receivable lease term Recognize rental income throughout the lease term Direct Finance vs. Sales- Type Lease 53 Other Technicalities Annuity due Identifying All conditions to be met to vs Ordinary a Lease be accounted as a lease annuity Use of Determining implicit a Lease term interest rate in the lease Lease Payments = Fixed / Variable payments* – Lease Cost of ROU Asset = P.V. Lease incentive receivable Composition Composition Payments + Initial direct costs + Purchase Option* of Lease of ROU (Lessee) + P.V. estimated + Termination dismantling/restoration costs – Option* + Payments Assets Lease incentive received Guaranteed residual value * 54 *Refer to lecture slide 23 for details Appendix 55 Practical Expedient – Applying to a portfolio of Leases  SFRS(I) 16 specifies the accounting for an individual lease but as a practical expedient, an entity may apply it to a portfolio of leases with similar characteristics  Example: an entity enters into a single contract to lease a number of identical assets (e.g. 20 commercial printers)  The practical expedient allows the entity to account for the leases as one portfolio, rather than recognizing and accounting for 20 leases separately. 56  Combining Contracts  2 or more contracts that are interdependent should be combined and accounted for as a single contract. This requirement applies when:  The contract are entered into at or near the same time, and  The contracts are with the same counterparty (or related parties of the counterparty), and  One or more of the following criteria are met:  The contracts are negotiated as a package with an overall commercial objective that cannot be understood without considering the contracts together; or  The amount of consideration to be paid in one contract depends on the price or performance of the other contract; or  The rights to use underlying assets conveyed in the contracts (or some rights to use underlying assets conveyed in each of the contracts) form a single lease component 57 Separating components of a contract – Lessee’s perspective  If a contract is, or contains, a lease, an entity is required to account for each lease component within the contract as a lease separately from non-lease components of the contract, unless the entity applies the practical expedient (a lessee may elect not to separate non-lease components from lease components and hence, account as a single lease component)  Examples: a contract for a car may combine a lease with maintenance services or a single contract may include leases of land, building and equipment 58 Separating components of a contract – Lessor’s perspective  A lessor needs to separate lease and non-lease components  No practical expedient allowed, unlike lessee as IASB believes that a lessor should be able to separate payments for lease and non-lease components. This is because the lessor would need to have information about the value of each component or a reasonable estimate of it when pricing the contract.  A lessor should allocate the consideration in the contract by applying paragraphs 73 to 90 of SFRS(I) 15 Revenue from Contracts with Customers 59 Disclosure Requirements The objective of the disclosures is for lessees / lessors to disclose information in the notes that, together with the information provided in the statement of financial position, statement of profit or loss and statement of cash flows, gives a basis for users of financial statements to assess the effect that leases have on the financial position, financial performance and cash flows of the lessee / lessor. Paragraphs 52–60 specify lessee’s requirements on how to meet this objective. Paragraphs 90–97 specify lessor’s requirements on how to meet this objective. 60