Applying financial reporting standards to lease accounting for lessors

• Lease Accounting for Lessors — IFRS 16

IFRS 16

IFRS 16, Leases, establishes the principles for the recognition, measurement, presentation, and disclosure of leases for
both lessees and lessors. The accounting considerations for leases are very different depending on which side of a lease
contract the parties sit — as the lessee or the lessor.

leases

• finance lease • Operating lease

Substantially all of the risks and rewards If substantially all of the risks and rewards do
transfer, the commercial substance of the not transfer, the transaction is more like a rental
transaction is that it is a sale, and the buyer agreement, and the lease is accounted for as an
is effectively purchasing the asset by taking operating lease by the lessor.
out a loan with the seller. These
circumstances require the lease to be
accounted for as a finance lease by the
lessor.
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

Lessee
An entity that obtains the right to use an underlying asset for a period of time in exchange for consideration

Lessor
An entity that provides the right to use an underlying asset for a period of time in exchange for consideration

Gross Investment in the lease

The sum of
• The lease payments receivable by a lessor under a finance lease; and
• Any unguaranteed residual value accruing to the lessor

Net Investment in the lease

The gross investment in the lease discounted at the interest rate implicit in the lease

Unguaranteed residual value

That portion of the residual value of the underlying asset, the realisation of which by a lessor is not assured or is guaranteed solely by a party related to
the lessor
 Leases not subject to IFRS 16

The following leases (or agreements) are scoped out of IFRS 16 due to coverage by another standard in IFRS:

•Leases to explore for or use minerals, oil, natural gas, and similar nonregenerative resources.

•Leases of biological assets within the scope of IAS 41, Agriculture, held by a lessee.

•Service concession arrangements within the scope of IFRIC 12, Service Concession Arrangements.

•Licenses of intellectual property granted by a lessor within the scope of IFRS 15, Revenue from Contracts with Customers.

•Rights held by a lessee under licensing agreements within the scope of IAS 38, Intangible Assets, for such items as motion picture
films, video recordings, plays, manuscripts, patents, and copyrights
Lease Accounting for Lessors

Identify whether a contract contains a lease

• A contract contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in
exchange for consideration.

• A contract conveys the right to control the use of an identified asset for a period of time if the customer has both

1. The right to obtain substantially all of the economic benefits from use of the identified asset and
2. The right to direct the use of the identified asset.

Identify the lease term. An entity should determine the lease term as the non-cancellable period of a lease, together with both.

1. Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option
2. Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that
option.
 Operating lease
From the lessor’s perspective, a lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to
ownership of an underlying asset.

Accounting treatment for an Operating lease

• Lease receipts are shown as income in the statement of profit or loss on a straight-line basis over the term of the lease, unless
another systematic basis is more appropriate.

• Any difference between amounts charged and amounts paid will be recognised as accrued income or deferred income in the
statement of financial position.

• Any initial direct costs incurred by the lessor with regards to an operating lease at the lease commencement date should be
deferred and recognised over the lease term on the same basis as lease income.
Example
Mosala Ltd entered into a four-year operating lease on 1 January 2019 to rent a combine harvester to Manure. Mosala
provided an initial rent free
period of 12 months followed by three annual payments of $2,000 in arrears on 31 December each year. The annual
payments commence on
31 December 2020.

Prepare extracts from the financial statements of Mosala Ltd for the year ended 31 December 2022.
 Scenario
You are a finance manager working for Swedholm Company, a global seller and manufacturer of computer equipment. Swedholm
Company prepares financial statements in accordance with IFRS as issued by the International Accounting Standards Board. The
business has a history of leasing the manufacturing equipment that it uses, and it leases some of its computer equipment to other
businesses.

Swedholm leases a computer system to Vajxholm Company under an operating lease with the following details:

•Two-year lease
•Lease rentals are US$300 per month
•Operating lease commenced on 1 June 2018
•First receipt on 1 July 2018
•All subsequent receipts received on the first day of the month
•Computer system cost US$6,000 and with an average economic life of three years

Swedholm company has a financial year of 31 December.

Apply IFRS 16 to the above scenario helping Swedholm account for the operating lease.
 Finance leases
A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying
asset.
That determination is made based on the substance of the transaction rather than the form of the contract.

Indications of a finance lease ;

• The lease transfers ownership of the underlying asset to the lessee by the end of the lease term;

• 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, therefore making it reasonably certain at the inception date that the option will be exercised;

• The lease term is for the major part of the economic life of the underlying asset even if title is not transferred;

• 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

• The underlying asset is of such a specialised nature that only the lessee can use it without major modifications.
Accounting treatment — Initial recognition

At the inception of a lease, lessors present assets held under a finance lease as a receivable Because the lessor has transferred the risks and
rewards associated with ownership to the lessee

Net Investment of the lease

The finance lease receivable is equal to the net investment of the lease. This is calculated as the present value of all unreceived:

• Fixed rental payments

• Variable rental payments
• Residual value guarantees (amounts the lessee guarantees that the leased asset will be worth at the end of the lease)
• Unguaranteed residual values
• Termination penalties

• The payments mentioned above are discounted at the rate implicit in the lease to arrive at the net investment of the finance lease.

For lessors other than manufacturers and dealers, initial direct costs are included in the initial measurement of the net investment in the
lease and factor into the interest rate implicit in the lease.
Example

On 31 December 2019, Rain leases a machine to Snow on a three-year finance lease and will receive $10,000 per year in
arrears. Snow has guaranteed that the machine will have a market value at the end of the
lease term of $2,000.

The interest rate implicit in the lease is 10%.

Required
Calculate Rain’s net investment in the lease as at 31 December 2019.
Subsequent treatment

The carrying amount of the lease receivable is:

• increased by the finance income earned

• decreased by the cash receipts.

• Separately recognise income from variable lease payments that are not included in the net investment in the lease (for
example, performance- or usage-based variable payments) in the period in which that income is earned.

• Recognise any impairment of the net investment in the lease in accordance with IFRS 9, Financial Instruments.

Year Balance* plus (less) equals

brought Finance Lease Balance*
forward income payments carried
received forward

X X (X) X
* ‘balance’ refers to the balance of the net investment in the lease.
Scenario

Amber Company leases a computer system under a finance lease to Granite Company on 1 January 20X9. It is a four-year lease with lease
payments of US$4,000 per year due from Granite Company annually at the end of each year.

The interest rate implicit in the lease is 15%. The fair value of the system is US$11,420, and the economic life of the system is four years.
The fair value of the computer system is equal to the present value of the lease payments to be received. There is no unguaranteed residual.

Apply the accounting treatment for a finance lease, as per IFRS 16 to the mentioned scenario above