Leases

IFRS 16
Buying vs Lease Vs Rent

► Key considerations?
► Duration of use
► Maintenance and servicing responsibilities
► Cost factor
► Willingness to take risk and responsibilities
► And so on…

► Buying

► Capital Lease

► Rent
Lessee Vs Lessor
Agenda

Objectives and Applicability

Scope and Key Definitions

Classification

Measurement

Disclosures

Sale and Leaseback Transactions

Key Differences
Objectives and scope

Objective of IFRS 16 is to prescribe, for lessees and lessors, the appropriate accounting
policies and disclosure to apply in relation to leases.

Applicability:
 This standard will be effective from 1 January, 2019;
 A company can choose to apply IFRS 16 before that date but only if it also applies IFRS 15
“Revenue from contracts with Customer”

This standard is applicable to all lease transactions except for the following:

► Leases of non-regenerative resources

► Leases of biological assets
► Licenses of intellectual property granted by lessor
► Rights held by a lessee under certain licensing agreements such items as motion picture
films, video recordings, plays, manuscripts, patents and copyrights
1. Definitions

► A lease is a contract that conveys to the customer (‘lessee’) the rights to control the use of
an identified asset for a period of time in exchange for consideration.

Identified Asset : Rights to control the use :

• No substantive rights to substitute • Rights to obtain substantially all

• No benefits from substitution economic benefits
• Right to direct the use

Consideration includes Fixed payments, Purchase options (exercise price), Residual

value guarantee, Termination option penalties, Variable lease payments that depends
on an index or rate.

E.g. A occupies certain Cu Mtr in a warehouse and owner can change the
space allocated
2. Accounting Model: Lease

Lessee point of view Lessor point of view

► Lessee have a single accounting model for ► A finance lease is a lease that transfers
all leases. substantially all the risks and rewards
incidental to ownership of an asset. Title
► Lessee is required to recognize: may or may not eventually be transferred.
(a) assets and liabilities for all leases. ► An operating lease is a lease other than a
(b) depreciation of lease assets separately finance lease.
from interest on lease liabilities in the
income statement.
► Two Exemptions:
(a) Short-term leases up to 12 months.
(b) Underlying asset is of low value (e.g.
lease of a personal computer)
3. Lessee Accounting: Recognition and measurement

Initial recognition and measurement Measure right of use (ROU) asset and lease
liability at present value of lease payments

ROU Asset: Depreciate the asset based on IAS

16, or use alternative measurement basis under
IAS 16 and IAS 40.
Subsequent Measurement

Liability: Accrete liability based on the interest

method, using a discount rate determined at lease
commencement. Reduce the liability by payments
made.

Statement of profit & loss Interest and depreciation expenses are separated.

IFRS 16 requires lessees to recognize most leases on their balance sheets, regardless of the
Industry that the entity operates in.
3. Lessee – Journal entries

ROU asset Dr (PV of leases payments applied at implicit rate/

borrowing rate)
To ROU Liability

Interest expense Dr (Interest for respective years)

To ROU Liability

ROU Liability (Annual payment of lease)

To Bank

Depreciation Dr
To ROU asset
4. Lessor Accounting: Recognition and measurement

Operating Lease Finance Lease

Lessor continue recognizing an asset. Lessor derecognizes the asset

► Lessor will book lease income on straight ► Lessor will book interest income on the
line basis. financed portion
► Provides depreciation on leased assts. ► Recognizes lease receivables at present
value of future lease payments.
► Payments receipts in subsequent years

Bank Dr would be bifurcated into two parts: Interest

income and repayment of lease obligations.
To Lease Income

Lease receivables Dr (PV)

Depreciation Dr
To Asset
To Asset

Bank Dr
To Lease receivables
To Interest income
Lessor derecognizes the asset
Lessor Accounting: Indicators of finance or operating lease

Following indicators individually or in combination would normally lead to a lease being classified
as finance lease, else it would be an operating lease:

Finance Lease
Lease for
Ownership Bargain Minimum
majority of Specialised
transfers at Purchase lease
economic nature
end of lease option payments
life
Lessor Accounting: Additional indicators of finance lease

Following are additional indicators which individually or in combination could lead to a lease
being classified as finance lease, else it could be an operating lease:

Lessor’s cancellation losses borne by lessee

Changes in fair value of residual

borne by lessee Bargain lease renewal option
Economic versus useful life

Lease for majority of economic life?

Economic life
Period over which the asset is
expected to be usable by any user(s)

Useful life
Remaining period over
which the economic benefits
of the asset are expected to
be used by the lessee
Minimum lease payments

► Include
► Non-cancellable lease payments
► Lease payments under bargain renewal option
► Purchase option if reasonable certainty of exercise
► Guaranteed residual value

► Exclude
► Cost for services
► Taxes if paid by and reimbursed to the lessor
► Contingent rent
Guaranteed residual value

► Lessee ► Lessor
► Lessee (or related party) guarantees value ► Amount of residual value guaranteed by
of asset at the end of the lease term lessee (or party related to lessee or
► Lessee is at risk for residual value unrelated third party)
► Include amount of residual value ► Means lessor is not at risk for residual value
guaranteed in the minimum lease payments ► Include amount of residual value guarantee
in minimum lease payments
Discount rates for PV calculations

► Lessor ► Lessee
► Interest rate implicit in the lease ► Interest rate implicit in the lease
► If not possible to determine: incremental
borrowing rate of interest
An example – classification of lease

► ABC Ltd. entered into a finance lease on July 1, 2015. The terms of the lease
were six payments of $200 payable annually in arrears. The cash price of the
asset was $870.
► The interest rate implicit in the lease is 10%.
► Show the interest allocation

► Show how the lease would be carried in the financial statements of ABC
Ltd. As at June 30, 2016.

► INTEREST ALLOCATION
Total Finance Charge:
Rentals (6*$200) $1,200
Cash price of the asset $ (870)
$ 330
An example – classification of lease

Allocation of Interest
Period Amount owed at Interest Rental Amount
the start of the @10% owed at the
period end of the
period
1 870 87 (200) 757
2 757 76 (200) 633
3 633 63 (200) 496
4 496 50 (200) 346
5 346 35 (200) 181
6 181 19 (200) 0
330
Example

Ivy leased an asset to Holly under a finance lease arrangement on 1 July 2015.
The terms of the lease were six payments of $200 payable annually in arrears.
The cash price of the asset was $870.

The interest rate implicit in the lease is 10%.

Required:

Show how the transaction would be accounted for in Ivy’s financial statements for
the year ended 30 June 2016.
Solution

Sale of asset
As the transaction is a finance lease the physical asset should be derecognized
through a sale transaction, with any profit or loss on sale included in profit or loss
for the period.
A receivable asset should be recognized instead of the physical asset sold; the
receivable recognized at lease inception would be based on the cash price of the
asset, $870.

Annual rent
The $200 rent needs to be split into the interest element and the repayment of
capital. In this example the interest income for year ended 30 June 2016 would
be $87 (see previous example) and the receivable would be reduced to $757.
Important considerations:

► Lessee:
► Initially records leased asset and corresponding liability at lower of:

► PV of minimum lease payments, and

► Fair value

► Depreciates asset over the shorter of:

► Lease term, or

► Useful life

► Unless reasonable certainty that lessee will obtain ownership by the end of the lease
term
► Lessee / Lessor:
► Finance income or expense is calculated using effective interest rate method (using rate
implicit in lease)
An example – lease classification and measurement

► Entity A transferred a machinery on lease for a period of 3 years (useful life 4 years)
► The fair value of the asset at the date of contract inception is INR 100,000 and the present
value of minimum lease payments is INR 90,000. The MLPs are payable (at year end) as
INR 37,500 p.a. for 3 yrs.
► The interest rate implicit in the lease is 10%
► Post lease period the asset will be transferred to the lessee
► How would the lease be classified and accounted?
An example – lease classification and measurement (cont.)

► The PV of minimum lease payments amount to more than 90% of the fair value of the asset.
Also, ownership of the asset will be transferred to the lessee by the end of the lease term.
Hence, the lease shall be classified as a finance lease.
► On the date of commencement of the lease term, the asset would be derecognized and
lease receivable would be recorded at the PV of MLPs at the date of inception of the lease
(contract date) i.e., at INR 90,000.
Balance sheet impact – summary

Operating Lease (lessor)/

Finance Lease
Exempted Lease (lessee)
Leased asset
Off balance sheet Lease liability
Lessee
(PV of minimum lease payments)

Leased asset Lease receivable

Lessor (PV of gross investment)
Disclosures

By lessees- finance lease

► For each class of asset, the net carrying amount at the end of the reporting period
► Reconciliation between the total of future minimum lease payments at the end of the
reporting period, and their present value (≤ 1 year, > 1 year and ≤ 5 years, > 5 years)
► Contingent rents recognised as an expense in the period

By lessees- exempted lease

► Future minimum lease payments (≤ 1 year, > 1 year and ≤ 5 years, > 5 years)
► Lease and sublease payments recognised as an expense in the period, with separate
amounts for minimum lease payments, contingent rents, and sublease payments
Disclosures

By lessees- general
► Description of significant leasing arrangements
► The total of future minimum sublease payments expected to be received under non-
cancellable subleases at the end of the reporting period
► Facts of short-term leases or leases of low-value assets.
► Information relating to extension options or termination options.
► Information relating to residual value guarantees.
► Information relating to sale and leaseback transactions.
Disclosures

By Lessors- finance lease

► Reconciliation between the gross investment in the lease at the end of the reporting period,
and the present value of MLPs (≤ 1 year, > 1 year and ≤ 5 years, > 5 years)
► Unearned finance income
► The unguaranteed residual values accruing to the benefit of the lessor
► The accumulated allowance for uncollectible minimum lease payments receivable

By Lessors- operating leases

► Future minimum lease payments (≤ 1 year, > 1 year and ≤ 5 years, > 5 years)
Disclosures

By Lessors- general
► Contingent rents recognised as income in the period.

► A general description of the lessor's material leasing arrangements.

Key differences

Issue IFRS 16 Ind AS 17

Lease rentals in line Straight-lining of lease rentals will No straight-lining of lease
with expected general apply. rentals if the payments to the
inflation lessor are structured to
increase in line with
expected general inflation to
compensate for the lessor’s
expected inflationary cost
increases.
Key differences

Issue IFRS 16 Indian GAAP

Finance Leases- Initial For other than manufacturer/ For other than manufacturer/
direct costs for lessors dealer lessors, initial direct costs dealer lessors, initial direct
are included in measurement of costs are either recognised as
finance lese receivable and expense immediately in the
reduce the amount of income statement of profit and loss or
recognized over lease term. allocated against finance
income over the lease term.
Key differences

Issue IFRS 16 Indian GAAP

Operating leases- Added to carrying amount Either deferred or allocated to
Initial direct costs of leased asset and income over the lease term in
for lessors recognised as expense proportion to the recognition of
over the lease term on the lease income or recognised as
same basis as lease expense in the statement of
income profit and loss in the period in
which incurred
Operating leases- Recognized as a reduction No specific guidance
incentives of lease income and
expense by the lessors and
lessees, respectively, over
the lease term on a straight-
line basis unless another
basis is more appropriate
Thank You