CHAPTER 9: LEASE

Learning objectives
• Account for right of use assets and lease liabilities in the records of the lessee

• Explain the exemption from the recognition criteria for leases in the records of the lessee

• Account for sale and leaseback agreements

OVERVIEW
Lease: 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.
Co. A Co. B

RENTAL PAYMENTS
• Advance – start of the lease period
• Arrears – end of the lease period

Legally owns the assets Uses the assets

Lessor Lessee

• Right of use asset

• Lease liability
OVERVIEW
OVERVIEW
Terminologies
 Identify a lease?
An entity must identify whether a contract contains a lease, which is the case if the contract conveys
the right to control the use of an identified asset for a period of time in exchange for consideration.

RIGHT TO CONTROL IDENTIFIED ASSET PERIOD OF USE

Entity must have the right to: • Stated in the contract

• Obtain substantially all • May be a part of a larger asset
economic benefits from the • The lessor has no substitution
• Period of use in time
use of asset rights (a similar asset cannot
be used instead of the original
• Direct the use of the asset leased asset)
 Identify a lease?

Does the lessee

Does the lessee
obtain
Is there an have the right
YES substantially all YES YES
identified asset? to direct use of
the economic
the asset?
benefits?

Contract
contains a
NO NO NO lease

The contract does not contain a lease; apply other applicable IFRSs
 Identify a lease
Coketown Council has entered into a five-year contract with Carefleet Co, under which Carefleet Co supplies the council with ten
vehicles for the purposes of community transport. Carefleet Co owns the relevant vehicle, all ten of which are specified in the
contract. Coketown Council determines the routes taken for community transport and the charges and eligibility for discounts.
The council can choose to use the vehicles for purposes other than community transport. When the vehicles are not being used,
they are kept at the council's offices and cannot be retrieved by Carefleet Co unless Coketown Council defaults on payment. If a
vehicle needs to be serviced or repaired, Carefleet Co is obliged to provide a temporary replacement vehicle of the same type.

Identifiable asset - the ten vehicles specified in the contract

IDENTIFIED
Lessee: ASSET
Carefleet Co does not have the right to substitute any of
Coketown the vehicles unless they are being serviced or repaired
Recognise in its SOFP:
RIGHT TO council has a right to use the vehicles for the period of the 1. Right-of-use asset
CONTROL contract 2. Lease liability

PERIOD OF
five-year contract with Carefleet Co
USE
 Lessee accounting
Recognition & measurement

LEASE
RIGHT-OF-USE LIABILITY
ASSET (Present value
(AT COST) of lease
payments)

Under IFRS 16, There is no longer a distinction between finance lease and operating lease, as the lessee controls the
leased asset during the lease term, and is recognized an asset and a liability respectively. (recognized under the
previous standard's finance lease method)
Lessee accounting
Recognition & measurement

A lessee may elect to account for lease payments as an expense (like operating lease under IAS 17) on a straight-
line basis over the lease term or another systematic basis for the following 2 types of leases
Lessee accounting
Initial measurement

To calculate the initial value of the

liability and right-of-use asset, the
lessee must consider the length of
the lease term. The lease term
comprises:

• Non-cancellable periods

• Periods covered by an option to

extend the lease if reasonably
certain to be exercised

• Periods covered by an option to

terminate the lease if these are
reasonably certain not to be + Lessee’s incremental borrowing rate: represent what the lessee ‘would have to
exercised. pay to borrow over a similar term and with similar security, the funds necessary to
obtain an asset of similar value to the right-of-use asset in a similar economic
environment

tỷ suất ấn định ngầm

 Lessee accounting
At the beginning of the year 20X6, Tusco signed into a three-year contract to lease a lorry. The contract contains an
option to extend for one more year. Tusco believes that they will use this option. Lorries have a useful economic life of 8
years. Lease payments are $16,000 per year for the initial term and $20,000 per year for the option. All payments are
due at the end of the year. To obtain the lease, Tusco paid initial payment of $4,000. X’s incremental rate of borrowing is
5%.

Calculate the initial carrying amount of the lease liability and the right-of use asset of Tusco for this contract
 Lessee accounting
Step 1: Identify exactly lease term

Step 2: Calculate lease liability

Lease liability = Total value of annual payment (in each term of lease) × Discount rate

Discount rate = 1/(1+r)y

• r: implicitly rate
• y: time period from year 1 to the year-end of the lease term

Step 3: Calculate right of use asset (according to above theory).

Step 4: Record lease liability and right of use asset.

Lessee accounting
 Lessee accounting
Subsequent measurement

Note 1: After initial recognition

• A right-of-use asset will normally be
measured on the cost model

• It can be measured on the revaluation

model if that belongs to an asset group
that should applies revaluation model
under IAS 16, or it is an investment
property under IAS 40.

Note 2: When using cost model to measure a right-of-use asset, we must calculate depreciation as follows:
• If ownership of the asset transfers to the lessee at the end of the lease term then depreciation should be charged over
the asset's useful life
• Otherwise, depreciation is charged over the shorter of the useful life and the lease term.
 Lessee accounting
Right-of-use asset Non-current assets
LESSEE
Current liabilities
Lease liability
Non-current liabilities
lessee: đi thuê
Interest charges Finance cost

SOFP SOPL SOCF

• ROU assets together • Depreciation of all • Principal within financing

with PPE or as own leased assets activities
line item
• Interest expense for • Interest within either
• Lease liability (IAS 1) all lease liabilities operating or financing
activities (IAS 7)
Lessee accounting
ALLOCATION OF FINANCE COST
LESSEE

RENTAL PAYMENT

A repayment of
Interest
part of the capital
portion
cost of the asset

Finance charge Debited to the lessor's

(SOPL) account to reduce the
outstanding liability
 Lessee accounting
ALLOCATION OF FINANCE COST

1. what proportion of each instalment paid by the lessee represents interest,

2. what proportion represents a repayment of the capital advanced by the lessor

RENTAL
PAYMENT

ACTUARIAL Finance charge To be allocated to periods during the lease term

METHOD using interest rate implicit in the lease

Repayment of the balance of the payment is the repayment of capital

capital
Lessee accounting
Subsequent measurement

Payment in advance is means Payment in arrears is

that rental made at means that rental made at
beginning of the lease year ending of the lease year
Lessee accounting
PAYMENT IN ADVANCE
 Lessee accounting
PAYMENT IN ADVANCE

Lion Co enters into a five-year lease of a building which has a remaining useful life of ten years. Lease payments are
$50,000 per annum, payable at the beginning of each year.

Lion Co incurs initial direct costs of $20,000 and receives lease incentives of $5,000. There is no transfer of the asset at
the end of the lease and no purchase option.

The interest rate implicit in the lease is not immediately determinable but the lessee’s incremental borrowing rate is
5%, with the value of $1 having a cumulative present value in four years' time of $3.546.

The value of $1 has a cumulative present value in five years' time of $4.329.

At the commencement date Lion Co pays the initial $50,000, incurs the direct costs and receives the lease incentives
 EXAMPLE – Payment in advance
Step 1 Calculate lease liability The lease liability is measured at the present value of the remaining four payments

Y1 Y2 Y3 Y4 Y5

0 1 2 3 4 5 6
$50,000 $50,000 $50,000 $50,000 $50,000

0 1 2 3 4 Total
$50,000 x $3.546 = $177,298 Payment 50,000 50,000 50,000 50,000 50,000 250,000
PV 50,000 47,619 45,351 43,192 41,135 227,298

$177,298
 EXAMPLE – Payment in advance

Step 2 Calculate value of Right-of-use asset Dr Cr

$ $
$

Right-to-use asset 242,298

Initial payment 50,000
Lease liability 177,298
Discounted liability 177,298
Cash (50 + 20 – 5) 65,000
Initial direct costs 20,000

Incentive received (5,000)

242,298
EXAMPLE – Payment in advance
Lease liability table

Opening Liability subject to Closing

Year Lease payment Interest (5%)
balance interest balance

1 227,298 (50,000) 177,298 8,865 186,162

2 186,162 (50,000) 136,162 6,808 142,971

3 142,971 (50,000) 92,971 4,649 97,619

4 97,619 (50,000) 47,619 2,381 50,000

5 50,000 (50,000) - - -
 EXAMPLE – Payment in advance
End of Y1 Start of Y2 End of Y2

0 1 2 2
Current liability

Opening bal 227,298

Principal 41,135 (= 50,000 – 8,865)

Lease payment 50,000 Y2:50,000

Interest 8,865
Liability subject
177,298
to interest

Interest payable 8,865 Current 41,135

Current

Closing bal 186,162 Principal Non-Current

Non-Current
177,298-41,135
 PAYMENT IN Y2
$50,000

Interest Y1 Principal in Y2

$177,298 at Y1
$8,865 $41,135 (bal)

Interest Short-term Y1
Short-term Long-term payable Y1

$41,135 $136,162 (bal) Current

liability Y1

Non-current
liability Y1
 EXAMPLE – Payment in advance

SFP extract
Non-current asset $
Fixed asset 242,298
Depreciation (48,460)

Carrying value 193,838

Current liability
$
Interest payable 8,865 Current liability 50,000

Non-current liability
Lease obligations 177,298 Non-current liability 136,163

Short-term lease obligation 41,135 186,163

Long-term lease obligation 136,163

SOPL extract
Depreciation 48,460
Interest charge 8,865
Lessee accounting
PAYMENT IN ARREARS
 EXAMPLE – Payment in arrear
Lion Co enters into a five-year lease of a building which has a remaining useful life of ten years. Lease payments are $50,000
per annum, payable at the end of each year.

Lion Co incurs initial direct costs of $20,000 and receives lease incentives of $5,000. There is no transfer of the asset at the
end of the lease and no purchase option.

The interest rate implicit in the lease is not immediately determinable but the lessee’s incremental borrowing rate is 5%,
with the value of $1 having a cumulative present value in four years' time of $3.546.

The value of $1 has a cumulative present value in five years' time of $4.329.

At the commencement date Lion Co pays the initial $50,000, incurs the direct costs and receives the lease incentives
 EXAMPLE – Payment in arrear

Step 1 Calculate lease liability The lease liability is measured at the present value of the remaining five payments

Y1 Y2 Y3 Y4 Y5

0 1 2 3 4 5 6
$50,000 $50,000 $50,000 $50,000 $50,000

0 1 2 3 4 5 Total
$50,000 x $4.329 = $216,474 Payment 50,000 50,000 50,000 50,000 50,000 250,000
PV - 47,619 45,351 43,192 41,135 39,176 216,474
 EXAMPLE – Payment in arrear

Step 2 Calculate value of Right-of-use asset Dr Cr

$ $
$

Right-to-use asset 231,474

Initial payment 0
Lease liability 216,474
Discounted liability 216,474
Cash (20 – 5) 15,000
Initial direct costs 20,000

Incentive received (5,000)

231,474
Example – Payment
in arrear Year Opening Interest (5%) Payment Closing

1 10,824 177,298
• Lease liability table 216,474 (50,000)

2 136,162
177,298 8,865 (50,000)

3 92,971
136,162 6,808 (50,000)

4 47,619
92,971 4,649 (50,000)

5 -
47,619 2,381 (50,000)
 EXAMPLE – Payment in arrear
End of Y1 Start of Y2 End of Y2

0 1 2 2

Opening bal 216,474

Interest 10,824
Interest Y2
Interest Y1

Payment 50,000 50,000

Principal Y2

Closing bal 177,298

Current liabilitiy
EXAMPLE – Payment in arrear
PAYMENT IN Y1
$50,000

Paid Interest Y1 Principal

payable in Y1

$177,298 at Y1

Short-term Long-term
(Current liability) (Non-current liability
$41,135 $136,163 (bal)
= 50,000 – 8,865
 EXAMPLE – Payment in arrear
SFP extract
Non-current asset $
Fixed asset 231,474
Depreciation (46,295)

Carrying value 185,179

Current liability

Interest payable 0

Non-current liability
Lease obligations 177,298 $

Short-term lease obligation 41,135 Current liability 41,135

Long-term lease obligation 136,163 Non-current liability 136,163

SOPL extract 177,298

Depreciation 46,295
Interest charge 10,824
 Lessor accounting

Note:
Examples of single or combined situations that often lead to leasing of property that are classified as finance leases are as
follows:
• The lease transfers ownership of the asset to the lessee by the end of the lease term.
• The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at
the date of the option exercisability.
• The lease term is for the major part of the economic life of the asset even if the title is not transferred.
• At the inception of the lease the present value of the lease payments amounts to at least substantially all of the fair value
of the leased asset.
• The leased assets are of such a specialized nature that only the lessee can use them without major modifications
Lessor accounting
 Sales & Lease back
A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset

The seller-lessee must assess whether the transfer should be accounted for as a sale or not. For this purpose, the seller must
apply IFRS 15 Revenue from Contracts with Customers. This normally occurs when the buyer obtains control of the asset (the
ability to obtain substantially all of the remaining benefits)
 Sales & Lease back
Transfer is NOT a SALE Transfer is a SALE

continues to recognize still controls the asset for amount of time when it
Seller
the transferred asset lease back the asset

Proceeds Financial liability (Loan)

realized profit from selling transaction must be

Profit calculate rely on the time when buyer (lessor)
actually holds the assets
 Sales & Lease back
Transfer
Transfer NOTis a sale
SALE

RIGHTS RIGHT
Sales proceeds FV of asset
TRANSFERRED RETAINED

% of the right to % of the right to

difference = LOAN provided by the buyer-lessor to the seller-
use the property lessee
use the property
have been remains in the
transferred to lessee Sales proceeds FV of asset
lessor

the difference = a prepayment of lease payments

 Sales & Lease back
Transfer NOT SALE

Step 1: Calculate total gain from sale of asset = Fair value of assets – Carrying amount

Step 2: Calculate gain relates to right retained = Total gain × Lease payment at present value/Fair value

Step 3: Calculate gain relates to right transferred = Total gain – Gain relates to right retained

Step 4: Record gain relates to right transferred Dr Cash – proceeds from sale of asset
Dr ROU asset - CA x Discounted lease pmt/FV

Cr PPE – Carrying amount

Cr Lease liability – PV of annual lease payment
Cr P&L – Gain relates to right transferred
 Sales & Lease back
Transfer NOT SALE
Example 5:
On 1 April 20X8, Tusco Co bought a machine for $1,000,000. The carrying amount of the machine as at 31
March 20X9 was $900,000. On 1 April 20X8, Tusco sold it to NCC for fair value of $1,300,000. An immediately
leased the machine back for 5 years, the remainder of its useful life at $280,000 per annum payable in arrears.
The present value of the annual lease payments is $1,200,000 and the transaction satisfies the IFRS 15 criteria
to be recognized as a sale.

What gain should Tusco recognize for the year ended 31 Mar 20Y0 as a result of the sale and leaseback?
 Sales & Lease back
Step 1: Calculate total gain from sell of asset
Total gain = $1,300,000 – $900,000 = $400,000

Step 2: Calculate gain relates to right retained

Gain relates to right retained = $400,000 × $1,200,000/$1,300,000 = $369,231

Step 3: Calculate gain relates to right transferred

Gain relates to right transferred = $400,000 – $369,231 = $30,769

Step 4: Debit Cash $1,300,000

Debit Right of use asset $ 830,769 (0.9m x 1.2m/1.3)
Credit PPE $900,000 (scenario)
Credit Lease Liability $1,200,000 (scenario)
Credit P&L $30,769 (Step 3)
Summary
 Question 1
1 An entity leases a computer with legal title of the asset passing after two years. The entity usually
depreciates computers over three years. The entity also leases a machine for seven years but legal title does
not pass to the entity at the end of the agreement. The entity usually depreciates machinery over ten years.

Over what period of time should the computer and machine be depreciated?

Computer Machine
A 2 years 7 years
B 2 years 10 years
C 3 years 7 years
D 3 years 10 years
 Question 2
An entity leases a motor vehicle. The present value of the minimum lease payments is $27,355 and the rate
implicit in the lease is 10%.
The terms of the lease require three annual rentals to be paid of $10,000 each at the start of each year.

At the end of the first year of the lease what amount will be shown for the lease liability in the company’s
statement of financial position under the headings of current liabilities and non-current liabilities?

Current liabilities Non-current liabilities

A $9,091 $10,000
B $10,000 $10,900
C $10,900 $10,000
D $10,000 $9,091
 Question 3
On 1 April 20X7 Chan sells an item of plant to a finance company and leases it back for a period of five years, at
the end of which the fair value of the plant is estimated to be nil.

Which of the following represents the correct accounting treatment for this transaction?

A Recognise the profit on disposal in the current year, capitalize the new lease at the present value of the lease
payments

B Spread the profit on disposal over five years, capitalise the new lease at the present value of the lease
payments

C Ignore the disposal, treat the sale proceeds as a financial liability

D Revalue the plant to the value of the sale proceeds, treat the sale proceeds as a financial liability
Test your understanding
The following trial balance relates to Fryatt at 31 May 20X7:
The following notes are relevant:
1 Owned plant and equipment is to be depreciated on the
reducing balance basis at a rate of 20% per annum. The property
cost includes land at a cost of $60,000. The building is
depreciated over 30 years on a straight line basis. All depreciation
is charged to cost
of sales.

2 On 1 June 20X6 Fryatt commenced using an item of plant and

machinery under a lease agreement, with three annual payments
of $29,000. The first payment was made on 31 May 20X7 and has
been charged to cost of sales. The present value of the lease
payments at 1 June 20X6 was $72,000. Under the terms of the
lease Fryatt has the option to extend the lease indefinitely at a
reduced rental at the end of the 3 years. The plant has an
estimated useful life of six years, with a negligible value at the end
of this period. The rate of interest implicit in the lease is 10%.

3 The directors have estimated the provision for income tax for
the year to 31 May 20X7 at $7,200

Required:
Prepare the SOPL for Fryatt for the year to 31 May 20X7 and a SOFP at that date, in a form suitable
for presentation to the shareholders and in accordance with the requirements of IFRS Standards