Lease Accounting IFRS 16

Corporate Accounting

Shahid Ilyas

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Lease IFRS - 16

Lease Asset Identification Criteria

To identify a lease under IFRS 16, the following conditions must be satisfied:

1.Identified Asset: The asset must be specified, and the supplier should not have a substantive right to
substitute it.

2.Right to Control: The lessee must have both:

1. The right to obtain substantially all of the economic benefits from the use of the asset.
2. The right to direct the use of the asset during the lease term.

If these conditions are met, the arrangement contains a lease, and the lessee should recognize a right-of-use
asset and a lease liability on its balance sheet.

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Lease IFRS - 16

Practical Examples of Lease Identification

1.Example of a Lease (Identified Asset):

1. A company leases a specific car identified by its license plate number for three years. The lessee has
the right to decide where and when to use the car, and how to operate it, without the lessor having any
right to substitute it. This contract contains a lease because it involves an identified asset and gives the
lessee control over its use.

2.Example of No Lease (Substitution Right):

1. A data center contract allows a company to use a specific server. However, the supplier can replace the
server at any time with another server of similar specifications. If this substitution right is substantive,
the arrangement would not qualify as a lease.

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Lease IFRS - 16

Key Components of Lessee Accounting:

•Right-of-Use (ROU) Asset: Represents the lessee's right to use the leased asset over the lease term. It is
initially measured at cost and subsequently depreciated over the lease term.

•Lease Liability: Represents the lessee's obligation to make lease payments. It is initially measured at the
present value of future lease payments and subsequently measured at amortized cost.

Lease Term and Discount Rate:

•Lease Term: Includes the non-cancellable period of the lease plus any extension options that the lessee is
reasonably certain to exercise.

•Discount Rate: The rate used to discount the future lease payments is typically the interest rate implicit in the
lease, if readily determinable. Otherwise, the lessee’s incremental borrowing rate should be used.

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Lease IFRS - 16

Exemptions:

•Short-term Leases: Leases with a term of 12 months or less.

•Low-value Assets: Leases of assets like laptops, small office equipment, etc.

•Balance Sheet: Recognition of both ROU assets and lease liabilities.

•Income Statement: Depreciation of the ROU asset and interest expense on the lease liability, replacing the
straight-line lease expense under IAS 17.

•Cash Flow Statement: Lease payments are split into interest (operating activities) and principal repayments
(financing activities).

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Lease IFRS - 16

Initial Measurement of the Right-of-Use (ROU) Asset

At the commencement date of the lease, the ROU asset is measured at cost, which includes the following
components:

1.Initial Lease Liability: The initial measurement of the lease liability, which is the present value of future
lease payments.

2.Lease Payments Made Before or at Commencement: Any lease payments made to the lessor before or at
the commencement date, less any lease incentives received.

3.Initial Direct Costs: Costs that are directly attributable to negotiating and arranging the lease, such as legal
fees or brokerage fees.

4.Dismantling or Restoration Costs: An estimate of the costs required to dismantle or restore the leased
asset or the site on which it is located, if applicable. This is similar to a provision for future expenses that must
be recognized when a leased asset is returned or decommissioned.

Initial Recognition Formula for ROU Asset:

ROU Asset=Lease Liability+Lease Payments Made+Initial Direct Costs+Dismantling/Restoration Costs

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Lease IFRS - 16

Subsequent Measurement of the Right-of-Use (ROU) Asset

After initial recognition, the ROU asset is subsequently measured using the cost model, unless the asset is
required to be measured using another model under a specific IFRS standard (e.g., revaluation model under
IAS 16 for property, plant, and equipment).

Cost Model Measurement

•Depreciation: The ROU asset is depreciated on a straight-line basis over the shorter of the lease term or the
useful life of the asset.

•Impairment: The ROU asset is tested for impairment under IAS 36, just like other non-financial assets. If
there are indications of impairment, the asset should be written down to its recoverable amount.

•Adjustments for Reassessment or Modifications: Adjustments may be required if there are changes to the
lease terms, such as lease modifications, changes in lease payments, or the exercise of extension or
termination options.

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 Lease Vs Bank Loan

Aspect Assets Acquired Through Bank Loan Assets Acquired Through Lease
Lessee does not own the asset but has the right to use it
Ownership Full ownership from the outset
for the lease term
Asset and a corresponding liability on the Right-of-use (ROU) asset and a corresponding lease
Recognition
balance sheet liability on the balance sheet at the commencement date
Present value of future lease payments, discounted using
Asset's initial cost, including purchase price,
Initial Measurement the interest rate implicit in the lease or incremental
transaction costs, and borrowing costs
borrowing rate
Depreciation of asset's cost over its useful
Depreciation of the right-of-use asset over the shorter of
Depreciation life, with depreciation or amortization
the lease term or the asset's useful life
expenses
Interest expense on the income statement
Interest expense on the lease liability recognized
Interest Expense based on the bank loan's interest rate and
separately from the right-of-use asset depreciation
outstanding balance
Interest expense on the lease liability is typically
Interest in Expenses Separately identified as interest expenses combined with amortization (depreciation) of the ROU
asset
Payments consist of both principal and interest portions,
Lease Payments N/A (no lease payments)
with interest recognized as an expense
If options are reasonably certain to be exercised, they
Bargain Purchase Option N/A (not applicable)
may impact the lease term and asset measurement 8
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Practice Questions

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Practice Question 1

Corteva signed a lease agreement on May 1, 2022 for four years. Annual rentals payable at the beginning
of year were agreed at Rs. 27,926.97. Useful life of equipment was 10 years and interest rate implicit in
the lease was 13%. Fair value of equipment was Rs. 100,000. The lease contains a bargain purchase
option of Rs. 10,000.

Year-end of lessee is December 31.

Requirement

1. Prepare lease amortization schedule

2. Prepare journal entries in the books of Lessee for 2022 and 2023
3. Present the extracts in the balance sheet and Income Statement for the first year only.
4. Prepare reconciliation b/w lease payments and present value for the first-year end only.

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Practice Question 2

Corteva signed a lease agreement on May 1, 2022 for four years. Annual rentals payable at the beginning
of year were agreed at Rs. 31,557.48. Useful life of equipment was 10 years and interest rate implicit in
the lease was 13%. Fair value of equipment was Rs. 100,000. The lease contains a bargain purchase
option of Rs. 10,000.

Year-end of lessee is December 31.

Requirement

1. Prepare lease amortization schedule

2. Prepare journal entries in the books of Lessee for 2022 and 2023
3. Present the extracts in the balance sheet and Income Statement for the first year only.
4. Prepare reconciliation b/w lease payments and present value for the first-year end only.
Note: in case the lease rentals are being paid at the end of the period, the BPO is paid at the end of the
4th year, unlike In the case of rentals being paid at the start of the year where BPO is paid in the next
year after completing the lease term.

While calculating the total present value of the cash outvlows (present value test), the BPO will be16
multiplied by the present value factor of 4 year, unlike in the case of rentals being paid at the start of the
Practice Question 3

On January 1, 2020, Rajbi Textile entered into a lease of an equipment for 4 years at an annual rental of Rs. 4.222.57 payable
at the beginning of year. Execution costs payable by Rajbi Textile, in additions to annual rentals were Rs. 600 per year. The fair
value of an asset at the inception of lease term was Rs. 15,000 and the estimated economic life of equipment was 6 years.

The Lessor’s implicit rate known to Rajbi Textile was 12% per annum. The lease contained a bargain purchase option
amounting to Rs. 1000 whereby Rajbi Textile were entitled to obtain legal title to the property at the end of lease term.

Year end is Dec

Requirement

1. Prepare lease amortization schedule

2. Prepare journal entries in the books of Lessee for 4 years
3. Present the extracts in the balance sheet and Income Statement for the first year only.
4. Prepare reconciliation b/w lease payments and present value for the first year end only.

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Practice Question 4

On January 1, 2020, Rajbi Textile entered into a lease of an equipment for 4 years at an annual rental of Rs. 4.729.28 payable
at the beginning of year. Execution costs payable by Rajbi Textile, in additions to annual rentals were Rs. 600 per year. The fair
value of an asset at the inception of lease term was Rs. 15,000 and the estimated economic life of equipment was 6 years.

The Lessor’s implicit rate known to Rajbi Textile was 12% per annum. The lease contained a bargain purchase option
amounting to Rs. 1000 whereby Rajbi Textile were entitled to obtain legal title to the property at the end of lease term.

Year end is Dec

Requirement

1. Prepare lease amortization schedule

2. Prepare journal entries in the books of Lessee for 4 years
3. Present the extracts in the balance sheet and Income Statement for the first year only.
4. Prepare reconciliation b/w lease payments and present value for the first year end only.

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Practice Question 5

Corteva signed a lease agreement on Jul 1, 2015 for four years. Annual rentals payable at the beginning of year were agreed
at Rs. 22,342.58. Useful life of equipment was 10 years and interest rate implicit in the lease was 13%. Fair value of
equipment was Rs. 80,000. The lease contains a bargain purchase option of Rs. 8,000.

Year-end of lessee is December 31.

Requirement

1. Prepare lease amortization schedule

2. Prepare journal entries in the books of Lessee for 2015 and 2016
3. Present the extracts in the balance sheet and Income Statement for the first year only.
4. Prepare reconciliation b/w lease payments and present value for the first-year end only.

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