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IFRS 16 LEASE.ppt
Here is an example of the accounting entries by the lessor APIN for the finance lease: 1 Jan 20X1 (inception of lease) Dr Receivable $5,710 Cr Machinery $5,710 To record the net investment in the finance lease as a receivable, equal to the present value of lease payments. 31 Dec 20X1 Dr Cash $2,000 Dr Interest income $570 Cr Receivable $2,570 To record receipt of the annual lease payment, and unwind interest on the receivable balance. The balance sheet will show the receivable of $3,180 as a non-current asset. The income statement will include interest
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IFRS 16 LEASE.ppt
- 1.
- 2. Training Outline Introduction Definition ofterms Identifying a lease Lessee Accounting Lessor Accounting Sales and lease back
- 3. Introduction • IFRS 16was issued in January 2016 and applies to annual reporting periods beginning on or after 1 January 2019. • This is to address concept of assets and labilities in line with conceptual framework.
- 4. Definition of Terms? Alease is a contract, or part of a contract, that conveys the right to use an underlying asset for a period of time in exchange for consideration. The lessor is the entity that provides the right-of-use asset and, in exchange, receives consideration. The lessee is the entity that obtains use of the right-of-use asset and, in exchange, transfers consideration. A right-of-use asset is the lessee's right to use an underlying asset over the lease term
- 5. Identifying a lease Acontract contains a lease if it conveys 'the right to control the use of an identified asset for a period of time in exchange for consideration. For this to be the case, IFRS 16 says that the contract must give the customer: • the right to substantially all the identified asset's economic benefits, and • the right to direct the identified asset's use The right to direct the use of the asset can still exist if the lessor puts restrictions on its use within a contract (such as by capping the maximum mileage of a vehicle or limiting which countries an asset can be used in). These restrictions define the scope of a lessee's right of use, rather than preventing them from directing use. IFRS 16 says that a customer does not have the right to use an identified asset if the supplier has the practical ability to substitute the asset for an alternative and if it would be economically beneficial for them to do so.
- 6. Illustration on Identifyinga lease Question APIN enters a contract with NAUTH to use some space in its LAB to Screen clients' samples for a three-year period. APIN owns the Lab Equipments. The contract stipulates the amount of space and states that the space may be located at any one of several LABs within the Hospital. The LAB operator (NAUTH) can change the location of the space allocated to APIN at any time during the period of use, and the costs that the NAUTH would incur to do this would be minimal. There are many areas in the Hospital that are suitable for the LAB Operations. Required: Does the contract contain a lease?
- 7. Illustration on Identifyinga lease Solution The contract does not contain a lease because there is no identified asset. The contract is for space in the LAB, and the LAB operator (NAUTH) has the practical right to substitute this during the period of use because: • There are many areas available in the Hospital that would meet the contract terms, providing the NAUTH with a practical ability to substitute. • The LAB operator (NAUTH) would benefit economically from substituting the space because there would be minimal cost associated with it. This would allow the operator (NAUTH) to make the most effective use of its available space, thus maximizing profits.
- 8. Group Activity onIdentifying a lease APIN enters into a contract with UMTH, the supplier, to use a specified Ambulance for a five-year period. UMTH has no substitution rights. During the contract period, APIN decides what Patient will be transported, when the Ambulance will be use, and to which Hospital it will drive to. However, there are some restrictions specified in the contract. Those restrictions prevent APIN from carrying suicide bombers as Patient or from driving the Ambulance into areas where terrorism is a risk. UMTH operates and maintains the Ambulance and is responsible for renewal of the Ambulance vehicle particulars. APIN is prohibited from hiring another driver for the Ambulance, and from operating the Ambulance itself during the term of the contract. Required: Does the contract contain a lease? .
- 9. Group Activity solutionon Identifying a lease APIN has the right to use an identified asset (An Ambulance) for a period of time (five years). UMTH cannot substitute the specified Ambulance for an alternative. APIN has the right to control the use of the Ambulance throughout the five-year period of use because: 1. it has the right to obtain substantially all of the economic benefits from use of the Ambulance over the five-year period due to its exclusive use of the Ambulance throughout the period of use.
- 10. Group Activity solutionon Identifying a lease 2. it has the right to direct the use of the Ambulance. Although contractual terms exist that limit where the Ambulance can sail and what Patient can be transported, this acts to define the scope of APIN’s right to use the Ambulance rather than restricting APIN's ability to direct the use of the Ambulance. Within the scope of its right of use, APIN makes the relevant decisions about how and for what purpose the Ambulance is used throughout the five-year period of use because it decides whether, where and when the Ambulance drives to, as well as the Patient it will transport. UMTH's operation and maintenance of the Ambulance does not prevent APIN from directing how, and for what purpose, the Ambulance is used. Therefore, based on the above, the contract contains a lease.
- 11. Lessee Accounting • BasicPrinciple At the commencement of the lease, IFRS 16 requires that the lessee recognizes a lease liability and a right-of-use asset DR Right of Use Asset xx CR lease Liability xx Initial Measurement : How do you determine this lease liability at initial. IFRS 16 states that lease payments include the following: Fixed payments Variable payments that depend on an index or rate Present Value Amounts expected to be payable under residual value guarantees Present value Options to purchase the asset that are reasonably certain to be exercised Termination penalties, if the lease term reflects the expectation that these will be incurred.
- 12. Subsequent Measurement :How do you account for the lease liability thereafter. IFRS 16 states that lease payments include the following: 1. The carrying amount of the lease liability is increased by the interest charge. This interest is also recorded in the statement of profit or loss: Dr Finance costs (P/L XX Cr Lease liability XX 2. The carrying amount of the lease liability is reduced by cash repayments: Dr Lease liability XX Cr Cash XX Lessee Accounting cont’d
- 13. Initial Measurement ofRight-of-Use-Asset The right-of-use asset is initially recognized at cost. IFRS 16 says that the initial cost of the right-of-use asset comprises • The amount of the initial measurement of the lease liability (see above) • Lease payments made at or before the commencement date • Initial direct costs • The estimated costs of removing or dismantling the underlying asset as per the conditions of the lease Lessee Accounting cont’d
- 14. Subsequent Measurement ofRight-of-Use-Asset The right-of-use asset The right-of-use asset is measured using the cost model (unless another measurement model is chosen). This means that it is measured at its initial cost less accumulated depreciation and impairment losses. Depreciation is calculated 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 remaining useful economic life, • Otherwise, depreciation is charged over the shorter of the useful life and the lease term (as defined previously). Lessee Accounting cont’d
- 15. Example 1: Exampleof Residual value Guarantee Effect of Residual Value Guarantee on lease liability according to IFRS 16 The RVG only affects the calculation of the lease liability when: a) The lease contain a guaranteed residual value, and b) The lessee’s expected residual value is lower than the RVG A little more complication may arise : for instance, What if the ERV is less than the GRV and the shortfall is greater than the lessee has anticipated. Summary S/N Situation Effect on the computation of lease liability 1 Expected Residual Value > Guarantee residual value No effect 2 Expected Residual Value < Guarantee residual value The present value of diff between(a) and (b) is included in the compuation of lease liability 3No Guarnateed Residual Value No effect
- 16. Example 2: Exampleof Residual value Guarantee APIN rented a lab equipment from FHI and guaranteed a residual value of N15,000. FHI’s Expected Residual Value is N10,000. But the actual Residual Value turned out to be just N8,000 at the end of the lease. Show the calculation and accounting entry in the book of the lessee
- 17. solution 2: Exampleof Residual value Guarantee The lessee would pay the lessor a total of N7,000 at the end of the lease. N2,000 of the N7,000 corresponds to the loss. The other N5,000 is treated as final lease payment. See Journal below. For the extra N2000 DR loss on lease N2,000 CR Bank N2,000
- 18. Initial Measurement ofRight-of-Use-Asset The lease term To calculate the initial value of the liability and right-of-use asset, the lessee must consider the length of the lease term. IFRS 16 says that 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 reasonably certain not to be exercised.
- 19. Illustrations to buttresspoints made so far APIN enters into a lease of a lab with National Hospital, the following details are available. Required: • Lease liability • ROUA • Extract of p or l • Extract of SOFP Lease terem 3 Lessors incremental Borrowing rate 6% Unguaranteed Residual Value 15,000.00 Rental Payment made at the begening of the year 20,000.00 Present value of lease payments 56,668.00 Present value of the residual value 12,594.00 Fair value of the asset being leased 62,262.00 Bargain purchase option 5,000.00 Present value of bargain purchase option 4,198.00 Economic Life of the Asset in years 4
- 20. Activity 1: Accountingby Lessees-Asset • On 1 January 20X1, APIN entered into a two-year lease for a Lab equipment. The contract contains an option to extend the lease term for a further year. APIN believes that it is reasonably certain to exercise this option. Lorries have a useful economic life of ten years. • Lease payments are $10,000 per year for the initial term and $15,000 per year for the option period. All payments are due at the end of the year. • To obtain the lease, APIN incurs initial direct costs of $3,000. The lessor reimburses $1,000 of these costs. • The interest rate within the lease is not readily determinable. APIN’s incremental rate of borrowing is 5%.
- 21. Lessors Accounting A lessormust classify its leases as finance leases or operating leases. IFRS 16 provides the following definitions: • A finance lease is a lease where the risks and rewards of the underlying asset substantially transfer to the lessee. • An operating lease is a lease that does not meet the definition of a finance lease.
- 22. Lessors Accounting Initial treatmentmeasurement At the inception of a lease, lessors present assets held under a finance lease as a receivable. The value of the receivable should be equal to the net investment in the lease. DR Receivable xx CR Asset xx Subsequent treatment The carrying amount of the lease receivable is increased by finance income earned, which is also credited to the statement of profit or loss. The carrying amount of the lease receivable is reduced by cash receipts
- 23. Lessors Accounting IFRS 16Leases states that a lease is probably a finance lease if one or more of the following apply: • Ownership is transferred to the lessee at the end of the lease • The lessee has the option to purchase the asset for less than its expected fair value at the date the option becomes exercisable, and it is reasonably certain that the option will be exercised • The lease term (including any secondary periods) is for the major part of the asset's economic life • 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 How to classify a lease by lessor
- 24. Lessors Accounting • Theleased assets are of a specialized nature so that only the lessee can use them without major modifications being made • The lessee will compensate the lessor for their losses if the lease is cancelled • The lessee can continue the lease for a secondary period in exchange for substantially lower than market rent payments. How to classify a lease by lessor contd
- 25. Lessors Accounting APIN isa lessor and is drawing up a lease agreement for a building. The building has a remaining useful economic life of 50 years. The lease term, which would commence on 1 January 20X0, is for 30 years. APIN would receive 40% of the asset’s value upfront from the lessee. At the end of each of the 30 years, APIN will receive 6% of the asset’s fair value as at 1 January 20X0. Legal title at the end of the lease remains with APIN, but the lessee can continue to lease the asset indefinitely at a rental that is substantially below its market value. If the lessee cancels the lease, it must make a payment to APIN to recover its remaining investment Required: Per IFRS 16 Leases, should the lease be classified as an operating lease or a finance lease? How to classify a lease by lessor contd Group Activity
- 26. Lessors Accounting A financelease is defined by IFRS 16 as a lease where the risks and rewards of ownership transfer from the lessor to the lessee. Key indications, according to IFRS 16, that a lease is a finance lease are as follows: • The lease transfers ownership of the asset to the lessee by the end of the lease term. • The lease term is for the major part of the asset’s economic life. • 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. • If the lessee can cancel the lease, the lessor’s losses are borne by the lessee. • The lessee can continue the lease for a secondary period in exchange for substantially lower than market rent payments. The lease term is only for 60% (30 years/50 years) of the asset’s useful life. Legal title also does not pass at the end of the lease. These factors suggest that the lease is an operating lease. How to classify a lease by lessor contd Group Activity Solution
- 27. Lessors Accounting However, thelessee can continue to lease the asset at the end of the lease term for a value that is substantially below market value. This suggests that the lessee will benefit from the building over its useful life and is therefore an indication of a finance lease. The lessee is also unable to cancel the lease without paying DanBob. This is an indication that DanBob is guaranteed to recoup its investment and therefore that they have relinquished the risks of ownership. It also seems likely that the present value of the minimum lease payments will be substantially all of the asset’s fair value. The minimum lease payments (ignoring discounting) equate to 40% of the fair value, payable upfront, and then another 180% (30 years × 6%) of the fair value over the lease term. Therefore this again suggests that the lease is a finance lease. All things considered, it would appear that the lease is a finance lease How to classify a lease by lessor contd Group Activity Solution contd
- 28. Accounting for leaseby Lessors Accounting At the inception of a lease, lessors present assets held under a finance lease as a receivable. The value of the receivable should be equal to the net investment in the lease.. • Fixed payments • Variable payments • Residual value guarantees • Unguaranteed residual values • Purchase options that are reasonably certain to be exercised • Termination penalties, if the lease term reflects the expectation that • these will be incurred. Initial Measurement : if it is a finance lease
- 29. Accounting for leaseby Lessors Accounting On 31 December 20X1, APIN leases a machine to MSH on a three year finance lease and will receive $10,000 per year in arrears. MSH 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 APIN’s net investment in the lease at 31 December 20X1.. . Calculation of net investment in the lease
- 30. Activity 2: Accountingby Lessors • Please include example as per comments Question APIN leases machinery to SFH. The lease is for four years at an annual cost of $2,000 payable annually in arrears. The present value of the lease payments is $5,710. The implicit rate of interest is 15%. Required: How should APIN account for their net investment in the lease?
- 31. Activity 2: Accountingby Lessors Solution APIN recognises the net investment in the lease as a receivable. This is the present value of the lease payments of $5,710. The receivable is increased by finance income. The receivable is reduced by the cash receipts. Year Opening Bal Finance Income Cash Received Clossing Balance 1 5,710 856 -2,000 4,566 2 4,566 685 -2,000 3,251 3 3,251 488 -2,000 1,739 4 1,739 261 -2,000 –
- 32. Activity 2: Accountingby Lessors Solution Contd Extract from the statement of financial position at the end of Non-current assets: $ Net investment in finance leases (see note) 3,251 Current assets: ––––– Net investment in finance leases 1,315 ––––– Note: the current asset is the next instalment less next year’s interest ($2,000 – $685). The non-current asset is the remainder ($4,66-1,315)
- 33. Activity 2: Accountingby Lessors Solution Contd Operating leases A lessor recognizes income from an operating lease on a straight line basis over the lease term. Any direct costs of negotiating the lease are added to the cost of the underlying asset. The underlying asset should be depreciated in accordance with IAS 16 Property, Plant and Equipment or IAS 38 Intangible Assets assets:
- 34. Sale and leasebacktransactions • To determine whether the transfer of an asset is accounted for as a sale an entity applies the requirements of IFRS 15 for determining when a performance obligation is satisfied. • If an asset transfer satisfies IFRS 15’s requirements to be accounted for as a sale the seller measures the right-of-use asset at the proportion of the previous carrying amount that relates to the right of use retained. Accordingly, the seller only recognizes the amount of gain or loss that relates to the rights transferred to the buyer.
- 35. Sale and leasebacktransactions( cont) • If the fair value of the sale consideration does not equal the asset’s fair value, or if the lease payments are not market rates, the sales proceeds are adjusted to fair value, either by accounting for prepayments or additional financing.
- 36. Disclosure • The objectiveof IFRS 16’s disclosures is for information to be provided in the notes that, together with information provided in the statement of financial position, statement of profit or loss and statement of cash flows, gives a basis for users to assess the effect that leases have.