Chapter 7 Leases (Part 1)

Related standard: PFRS 16 Leases

Lease
Lease is "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."
(PFRS16.Appendix A)
 The following are the parties to a lease contract:
a. Lessee — the "entity that obtains the right to use an underlying asset for a period
of time in exchange for consideration."
b. Lessor — the "entity that provides the right to use an underlying asset for a period
of time in exchange for consideration." (PFRS 16.Appendix A)  
Identifying a lease
"A contract is, or 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." (PFRS
16.9)
  An entity has the right to control the use of an identified asset if it has both
of the following throughout the period of use:
a. the right to obtain substantially all of the economic benefits from the use of the
identified asset; and
b. the right to direct the use of the identified asset.
 Identified asset
An identified asset is essential in the definition of a lease. An asset can be
identified by being explicitly stated in the contract or by being implicitly specified at
the time the asset is made available for use by the customer.  
Portions of assets
A portion of an asset is an identified asset if it is physically distinct (e.g., a floor
of a building). If not physically distinct, the portion is not an identified asset, unless it
represents substantially all of the capacity of the asset thereby providing the customer
the right to obtain substantially all of the economic benefits from the asset.  
Substantive substitution rights
An asset is not an identified asset if the supplier has the substantive right to
substitute it throughout the period of use.
 A supplier's right to substitute an asset is substantive if both of the following
conditions exist:
a. the supplier has the practical ability to substitute alternative assets throughout
the period of use (for example, the customer cannot prevent the supplier from
substituting the asset and alternative assets are readily available to the supplier
or could be sourced by the supplier within a reasonable period of time); and
b. the supplier would benefit economically from the exercise of its right to-substitute
the asset (i.e., the economic associated with substituting the asset are expected
to exceed the costs associated with substituting the asset).
(PFRS 16.B14)  
A supplier's right to substitute an asset is not substantive if it cannot be exercised
throughout the period of use, such as when substitution is made:
a. only on a particular date or upon the occurrence of a specified event; or
b. only during repairs, maintenance or upgrading.  
A supplier's substitution right is presumed not substantive if it is not readily
determinable as substantive.  
Right to obtain economic benefits from use
A customer controls the use of an identified asset if it has the right to obtain
substantially all of the economic benefits from the asset throughout the period of use
(for example, by having exclusive of the asset throughout that period).
  Economic benefits include potential inflows from the asset's output, which can
be obtained directly or indirectly from using, holding or sub-leasing the asset.  
When assessing the right to obtain substantially all of the economic benefits from
use of an asset, an entity considers only the economic benefits within the defined scope
of its rights to use the asset. For example, if a contract limits the use of a motor vehicle
within a specific territory or up to a specified mileage, the entity considers only the
economic benefits from use of the asset within that territory, or up to that specified
mileage, and not beyond. (PFRS 15.B22)
  A stipulation in a contract requiring the customer to pay additional consideration
based on a portion of the cash flows derived from use of an asset (e.g., percentage of
sales derived from a retail space) does not prevent the customer from having the right
to obtain substantially all of the economic benefits from use of the asset.  
Right to direct the use
A customer has the right to direct the use of an identified asset throughout the period of
use if:
 a. the customer has the right to direct how and for what purpose the asset is used
throughout the period of use; or
b. the asset's use is predetermined and the supplier is precluded from changing
that predetermined use.  
The following decision-making rights may signify the existence of the right to change
how and for what purpose the asset is used:
a. rights to change the type of output that is produced by the asset (for example, to
decide whether to use a shipping container to transport goods or for storage, or
to decide upon the mix of products sold in a retail space);
b. rights to change when the output is produced (for example, to decide when a
machinery or a power plant will be used); rights to change where the output is
produced (for example, to decide upon the destination of a truck or a ship, or to
decide where an item of equipment is used); and
c. rights to change whether the output is produced, and the quantity of that output
(for example, to decide whether to produce energy from a power plant and how
much energy to produce from that power plant).
(PFRS 15.826)
Although essential for the efficient use of an asset, rights to operate or maintain
the asset do not necessarily grant the right to direct how and for what purpose the asset
is used. However, rights to operate an asset may grant the customer the right to direct
the use of the asset if the relevant decisions about how and for what purpose the asset
is used are predetermined.  
Protective rights
Protective rights include contractual restrictions designed to protect the
supplier's interest in the asset or its personnel, or to ensure compliance with laws or
regulations.  
For example, a contract may:
(i) specify the maximum amount of use of an asset or limit where or when the
Customer use the asset,
(ii) require a customer to follow particular operating procedures, or
(iii) require a customer to inform the supplier of changes on how an asset will be
used.  
Protective rights typically define the scope of the customer's right of use but do not, in
isolation, prevent the customer from having the right to direct the use of an asset.
Lease term
Lease term is "the non-cancellable period of a lease, together with both:  
 a. periods covered by an option to extend the lease if the lessee is reasonably
certain to exercise that option; and
b. periods covered by an option to terminate the lease if the lessee is reasonably
certain not to exercise that option." (PFRS 15.18)
Non-cancellable period is the period in which the contract is enforceable. A lease
is no longer enforceable when each of the lessor and the lessee can terminate the lease
without permission from the other and subject only to an insignificant penalty.
-If only the lessee has the right to terminate the lease, the lessee considers this right
when determining the lease term (i.e., whether exercise is reasonably certain or not).
-If only the lessor has the right to terminate a lease, the non- cancellable period of
the lease includes the period covered by the option to terminate the lease.  
In assessing whether a lessee is reasonably certain to exercise an option to
extend a lease, or not to exercise an option to terminate a lease, an entity considers all
relevant facts and circumstances that create an economic incentive for the lessee to
exercise the option to extend the lease, or not to exercise the option to terminate the
lease.
For example:
 The lessee may be reasonably certain to exercise an option to extend the
lease if:
-lease payments on the extended period are expected to be below market rate.
 -the lessee made significant leasehold improvements with useful life longer than the
original lease term.
 The lessee may be reasonably certain not to exercise an option to
terminate the lease if:
-the costs of terminating the lease (e.g., relocation costs) are Significant.
-the leased asset is important to the lessee's operations (e.g., because it is specialized
in nature or because of its location and it would be difficult to find a replacement asset if
the lease is terminated).  
The shorter the non-cancellable period is, the more likely that a lessee will
exercise its right to extend (or not to exercise its right to terminate) the lease because
the shorter the non- cancellable period is, the more likely that the costs associated with
obtaining a replacement asset would be higher.  
The lease term begins at the commencement date and includes any rent-free
periods provided by the lessor to the lessee.
 Accounting for leases by Lessee
Recognition
A lessee recognizes a lease liability and a right-of-use asset at the commencement
date. 
Initial measurement of Lease liability
The lease liability is initially measured at the present value of the lease
payments that are not yet paid as at the commencement date.
Lease payments include the following:
a. Fixed payments, including in-substance fixed payments, less any lease
incentives receivable;
b. Variable lease payments that depend on an index or a rate, initially measured
using the index or rate as at the commencement date;
c. Amounts expected to be payable by the lessee under residual value guarantees;
d. The exercise price of a purchase option if the lessee is reasonably certain to
exercise that option; and
e. Payments of penalties for terminating the lease, if the lease term reflects the
lessee exercising an option to terminate the lease.
(PFRS 1627)  
Lease payments do not include:
i. payments for non-lease elements (except when the entity elects to apply the
'practical expedient' — see below)
ii. payments in optional extension periods, unless the extension is 'reasonably certain'
iii. future changes in variable payments that depend on an index or rate
iv. variable payments linked to the lessee's future sales or usage of the underlying
asset.  
Discount rate
The lease payments are discounted using the interest rate implicit in the lease.
If that rate is not readily determinable, the lessee's, incremental borrowing rate is
used.
The lessee's incremental borrowing rate is "the rate of interest that a lessee
would have to pay to borrow over a similar term, and with a similar security, the funds
necessary to obtain an asset of a similar value to the right-of-use asset in a similar
economic environment." (PFRS IGAppendix A)  
Initial measurement of Right of use asset
The right-of-use asset is initially measured at cost. The cost comprises the
following:
a. The amount of the initial measurement of the lease liability;
b. Any lease payments made at or before the commencement date, less any lease
incentives received;
c. Any initial direct costs incurred by the lessee; and
d. The present value of any decommissioning and restoration costs for which the entity
has incurred an obligation, unless those costs are incurred to produce inventories.
(PFRS 1624)
Subsequent measurement of Lease liability
The lease liability is subsequently measured similar to an amortized cost financial
liability (but remeasured to reflect any reassessments or lease modifications).
Accordingly:
 Interest on the lease liability is computed using the effective interest method and
recognized in profit or loss, unless it forms part of the carrying amount of another
asset. Interest in each period reflects a constant periodic rate of interest on the
remaining balance of the lease liability.
 Lease payments are apportioned between the interest and a reduction to the
lease liability.
Subsequent measurement of the Right-of-use asset
The right-of-use asset is subsequently measured similar to a purchased asset.
Accordingly, the asset is subsequently measured under the cost model, except when:
a. it relates to a class of PPE that is measured under the revaluation model, in which
case, the asset may be measured under the revaluation model.
b. it meets the definition of an investment property and the entity uses the fair value
model, in which case, the asset is measured under the fair value model.  
Cost model
Under the cost model, the right-of-use asset is measured at cost:
a. less any accumulated depreciation and any accumulated impairment losses; and
b. adjusted for any remeasurement of the lease liability.
Depreciation
The lessee depreciates the underlying asset over its useful life if:
a. The contract provides for the transfer of ownership to the lessee by the end of the
lease term; or
b. There is a reasonable certainty that the lessee will exercise a purchase option.
 
In any other case, the, lessee depreciates the underlying asset over the shorter
of the asset's useful life and the lease term. Depreciation starts from the
commencement date of the lease.  
Recognition exemptions
A lessee may elect not to apply the recognition requirements described earlier
(i.e., recognition of lease liability and right-of-use asset) for:
a. Short-term leases; and
b. Leases for which the underlying asset is of low value.  
Short-term lease
A short-term lease is "a lease that, at the commencement date, has a lease
term of 12 months or less. A lease that contains a purchase option is not a short-term
lease." (PFRS 16. Appendix A)
The election for short-term leases is made based on the class (i.e., grouping of
assets with similar nature and use) of underlying asset to which the right of use relates.
 Low valued asset
The assessment of value is based on the value of the asset when it is new,
regardless of the age of the asset being leased. For example, an old car cannot qualify
as a low valued asset because a car, when new, is not considered of low value.
  The assessment is performed on an absolute basis, meaning it is not affected by
materiality or the lessee's size, nature or circumstances. Thus, an asset is considered of
low value regardless of whether the lessee is a small or a big company.
 Examples of assets of low value include tablet and personal computers, small items of
office furniture and telephones. (PFRS 16.B8)
If the leased asset is subleased, the head lease does not qualify as a lease of a low-
value asset.  
The election for leases of low valued assets can be made on a lease-by-lease
basis. The Basis for Conclusions accompanying IFRS 16 states that, at the time of
reaching its decisions about the exemption, the IASB had in mind leases of underlying
assets with a value, when new, of US$5,000 or less. This threshold is not in the main
body of the Standard and, hence, is not a requirement. Factors such as inflation and
changes in foreign exchange rates may reduce the relevance of this guideline over time.
Accounting
The lessee may elect to recognize the lease payments associated with a (a)
short-term lease or (b) lease of a low valued asset as an expense on a straight-line
basis over the lease term, unless another systematic basis is more representative of the
pattern of the lessee's benefit.
The accounting described above is similar to for in PAS 17 (the old standard replaced
by PFRS 16) 
Separating the components of a contract
An entity accounts for each lease component of a contract separately from the
non-lease components of that contract.
  A lessee allocates the consideration in the contract to each lease component
based on the relative stand-alone price of the lease component and the aggregate
stand-alone price of the non. lease components.
  Relative stand-alone price is the price that the lessor or similar supplier would
charge for a component (or similar component) separately. If a separate price is not
readily available, lessee shall estimate it, maximizing the use of observable information.
Lease of multiple assets
For a contract that contains rights to use multiple assets (e.g., a lease of two or more
pieces of equipment), the right to use each asset is considered a separate lease
component if both of the following criteria are met:
a. The lessee can benefit from the use of the asset either on its own or together
with other resources that are readily available to the lessee; and
b. The underlying asset is neither highly dependent on, nor highly interrelated with,
the Other underlying assets in the contract. (For example, the lessee's decision
of not leasing one asset does not affect its right to use the Other assets in the
contract.)
  If the criteria are not met, the right to use multiple assets is considered a single
lease component.
 Non-lease elements
A non-lease element is considered a separate element if it transfers goods or services
to the lessee.
Examples of non-lease elements:
1. Maintenance (e.g., cleaning of common areas in a building, garbage collection,
repairs, etc.)
2. Security services
3. Supply of utilities (e.g., water, heat, electricity, internet, air conditioning, etc.)
4. Supply of goods (e.g., consumables for a manufacturing equipment)
5. Supply of operational services (e.g., a driver for a leased vehicle, a machine operator
for a leased equipment, etc.)  
Non-lease components are accounted for under other applicable Standards.
 Payments for activities or costs that do not transfer goods or services to the
lessee are not a separate component of the contract.
Examples:
1. Administrative tasks.
2. Real property taxes for which the lessor is liable regardless of whether it has leased
the property.
3. Insurance costs that protect the lessor's investment in the asset and, in which, the
lessor is the beneficiary.  
The payments for these items are included in the total consideration that is
allocated to the separately identified components of the contract.
 
Practical expedient
PFRS 16 allows an entity to elect, by class of underlying asset not to separate
the lease and non-lease components of a contract and instead account for them as a
single lease component.
Applying the practical expedient simplifies accounting but it would increase the
amounts recognized for the lease liability and right-of-use asset and this could have
implications for impairment.  
RECOGNITION EXEMPTION - PRACTICAL EXPEDIENT
A lessee may elect to recognize the lease payments as expense on a straight-line
basis (or another more appropriate basis) if the lease is (a) short-term or (b) of low
value.
 In-substance fixed lease payments
In-substance fixed lease payments are payments that are variable in legal form
but, in substance, are unavoidable. Examples:
  Payments that must be made only if an asset is proven to be capable of
operating during the lease, or only if an event occurs that has no genuine
possibility of not occurring.
 Payments that are initially variable but for which the variability will be resolved in
the future (which become 'in- substance fixed' when resolved).
 Arrangements in which there is more than one set of payments that a lessee
could make, but only one of those sets of payments is realistic. In this case, the
lease payments are the realistic set of payments.  
Lease incentives
Lease incentives are "payments made by a lessor to a lessee associated with a lease,
or the reimbursement or assumption by a lessor of costs of a lessee." (PFRS 16.
Appendix A)
Variable lease payments
Variable lease payments are "the portion of payments made by a lessee to a
lessor for the right to use an underlying asset during the lease term that varies because
of changes in facts or circumstances occurring after the commencement date, other
than the passage of time." (PFRS 16. Appendix A)  
Residual value guarantee
Residual value (of an asset) is "the estimated amount that an entity would currently
obtain from disposal of an asset, after deducting the estimated costs Of disposal, if the
asset were already of the age and in the condition expected at the end of its useful life ."
(PAS 16.6)  
A lessee includes the residual value of an underlying asset in the lease
payments (and consequently in the measurement of lease liability and right—of-use
asset) only if the residual value is guaranteed.
Residual value guarantee is a guarantee made to a lessor by a party unrelated to the
lessor that the value (or part of the value) of an underlying asset at the end of a lease
will be at least a specified amount.
As to the lessee, a residual value is guaranteed if it is:
a. Guaranteed by the lessee; or
b. Guaranteed by a party related to the lessee.
When a lessee accounts for a residual value, this presupposes that the asset will
revert back to the lessor at the end of the lease term. If the asset does not revert back
to the lessor, e.g., ownership will be transferred to the lessee, this indicates that the
residual value is not guaranteed because it inures to the benefit of the lessee rather
than the lessor.  
Purchase option
The exercise price of a purchase option is included in the lease payments
(and consequently, in the measurement of the lease liability and right-of-use asset) if
the exercise is reasonably certain.
NOTE: under PAS 17 (superseded by PFRS 16), a lessee accounts for a purchase
option only if it is 'bargain', i.e., the option price is below the expected fair value of the
leased asset. PFRS 16 does not require that the purchase option must be 'bargain'
before it is included in the lease liability.
 Initial direct costs
Initial direct costs are "incremental costs of obtaining a lease that would not
have been incurred if the lease had not been obtained, except for such costs incurred
by a manufacturer or dealer lessor in connection with a finance lease." (PFRS 16.
Appendix A)  
A lessee capitalizes initial direct costs as follows:
General recognition
-Treat as part of the cost of the right-use- asset and include in depreciation.
Recognition Exemption
-Treat as prepaid rent and recognized as expensed under the straight-line basis (or
another more appropriate basis.) 
Lease payments made to lessor at or before commencement date
Examples of lease payments made to the lessor at or before commencement date:
 Advance rent
General recognition
-arises when rentals are payable at the beginning of each period.
-excluded from the initial measurement of lease liability but included in the initial
measurement of right-of-use asset.
Recognition exemption
-treated as prepaid rent and recognized as expense under the straight-line basis (or
another more appropriate basis).  
 Lease bonus
General recognition
-is an additional payment made by a lessee to a lessor to induce granting of
leasehold rights to the lessee. Lease bonus is the opposite of 'lease incentive.'
-same accounting as advance rent above.

Recognition exemption
-same accounting as advance rent above.  
Security deposits
Another form of payment made to the lessor at or before commencement date is
security deposit. Security deposits are intended to compensate for any damages
caused to the leased Property. If no damage is made to the leased property, the lessor
returns the security deposit to the lessee at the end of the lease term.
The lessee accounts for a security deposit as a receivable measured at
amortized cost. (The lessor accounts for it oppositely, i.e., as a payable measured at
amortized cost.) Consequently, security deposits do not affect the lessee's lease liability
and right-of-use asset.  
Deposits to be applied as rental payment at the end of the lease term are not
security deposits but rather advance rent.  
Reassessment of the lease liability
A lessee remeasures the lease liability (and adjusts the right-of-use asset) if there
are subsequent changes to the lease payments. However, if the carrying amount of the
right-of-use asset is reduced to zero and there is a further reduction, the excess
adjustment is charged to profit or loss.
 The lease liability is remeasured by discounting the revised lease payments
using a revised discount rate if there is a:
a. Change in the lease term — the revised lease payments are determined based
on the revised lease term.
Changes in the certainty or uncertainty of the lessee exercising an extension
option, or not exercising a termination option, result to a change in the lease term.
b. Change in the assessment of a purchase option — the revised lease
payments shall reflect the change in the amount payable under the purchase
option.
 The revised discount rate is the interest rate implicit in the lease for the
remainder of the lease tern. If that rate cannot be determined, the revised discount rate
is the lessee's incremental borrowing rate at the date of reassessment.
 The lease liability is remeasured by discounting the revised lease payments
using an unchanged discount rate if there is a:
a. Change in the residual value guarantee — the revised lease payments shall
reflect the change in the amount expected to be payable under the residual value
guarantee.
b. Change in future lease payments resulting from a change in an index or a
rate used to determine those payments — the revised lease payments shall
reflect the change in the contractual cash flows resulting from the occurrence of
the specified event or condition.
Lease modifications
Lease modification is "a change in the scope of a lease, or the consideration for
a lease, that was not part of the original terms and conditions of the lease (for example,
adding or terminating the right to use one or more underlying assets, or extending or
shortening the contractual lease term)." (PFRS 16. Appendix A)  
Depending on its nature, a lease modification is accounted
for as a:
a. Separate lease; or
b. Remeasurement of the existing lease liability and right-of-use asset  
Separate lease
A lease modification is accounted for as a separate lease if both the scope and
consideration in the lease are increased due to the addition of a right to use one or
more underlying assets and the increase in the consideration reflects the stand-alone
price for the increase in scope.  No adjustment is made on the existing lease liability
and right-of-use asset from the original contract.  
Not a separate lease
A lease modification that does not result in a separate lease is accounted for as a
remeasurement of the existing lease liability and right-of-use asset. The lease liability is
remeasured by discounting the revised lease payments using a revised discount rate.
-For lease modifications that decrease the scope of the lease, the carrying amount of
the right-of-use asset is decreased to reflect the partial or full termination of the lease.
Any gain or loss is recognized in profit or loss.
-For all other lease modifications, a corresponding adjustment to the right-of-use asset
is made.  
Leasehold improvements
Leasehold improvements are recognized as asset, separate from the right-of-
use asset, and depreciated over the shorter of the life of the improvements and the
remaining lease term.

Presentation
Statement of financial position
Right-of-use assets are presented either:
a. Separately from other assets; or
b. Together with other assets as if they were owned, with disclosure of the line items
that include the right-of-use assets
  Right-of-use assets that meet the definition of investment property are
presented as investment property.
Lease liabilities are presented either:
a. Separately from other liabilities; or
b. Together with other liabilities, with disclosure of the line items
that include the lease liabilities. 
Statement of profit or loss and other comprehensive income
Depreciation and interest expense are presented separately (i.e., offsetting is
prohibited). Interest expense on the lease liability is a
component of finance costs.
 

Chapter 7: Summary
Essential elements
I. Identified asset
Guidance
-Identified explicitly or implicitly.
-Not identified if the supplier has substantive substitution rights.
-A portion of an asset that is: (a) physically distinct can be an identified
asset; (b) not physically distinct is not an identified asset.  
2. Right to obtain substantially all of the economic benefits
Guidance
-Consider direct and indirect benefits.
-Consider only the economic benefits within the defined scope of a
customer's rights to use an asset, and not beyond.
3. Right to direct the use
Guidance
Customer has the right to decide how and for what purpose the asset is used  
Lessee accounting
• General recognition: A lessee recognizes both a right-of-use asset and a lease liability.
• The lease liability is initially measured at the present value of the lease payments that
are not yet paid as at the commencement date and subsequently measured at
amortized cost.
• Lease payments consist of: (a) Fixed payments (less lease incentives receivable); (b)
Variable payments based on index/rate; (c) Amount expected to be payable under a
residual value guarantee; (d) Purchase option, if reasonably certain; (e) Termination
penalties and Payments in optional extension periods, if reasonably certain.
• The discount rate used is the interest rate implicit in the lease. If this is not
determinable, the lessee's incremental borrowing rate is used.
• The right-of-use asset is initially measured at cost and subsequently measured similar
to a purchased asset (i.e., cost model, revaluation model or fair value model, as
appropriate)
• Cost of right-of-use asset consists of: (a) Initial measurement of lease liability; (b)
Advance lease payments received less lease incentives received; (c) Initial direct costs;
(d) Decommissioning and restoration costs.
•Recognition exemption: For "short-term" and "low value" leases, the lessee may elect
to recognize lease payments as expense over the lease term using the straight-line
basis, or another more appropriate basis.