16 Leases (Lessee) s19 Final

Solutions to GAAP : Graded Questions Leases: lessee accounting
Solution 16.1
a) Under IFRS 16, a lease is defined as a contract, or part of a contract, that conveys the
right to use an underlying asset for a period of time in exchange for a consideration.
A contract can be a lease (or contain a lease) only if

 The underlying asset is identified
 The entity can control the use of the identified asset by having the right to
 Obtain all of the economic benefits from the use of the identified asset, and
 Direct the use of the identified asset
(IFRS 16.9; 16.B9 and Appendix A)
b) An asset is identified if
 it is explicitly specified in the contract , or
 implicitly specified when made available to the customer
An asset is not identified if the supplier has a substantive right to substitute another asset.
A physically distinct portion of an asset can be identified (for example, part of a building)
but a portion of an asset’s capacity cannot (for example, a capacity portion of a fibre optic
cable).
(IFRS 16.B13, 14 and 20)
c) When assessing whether it has the right to obtain substantially all of the economic
benefits from the use of an identified asset, a customer considers
 The direct and indirect benefits from the use of the asset such as using, holding or
sub-leasing the asset.
 Only the economic benefits from the use of the asset within the defined scope of its
right to use the asset (for example, if the use of a vehicle is limited to one territory,
only the economic benefits from the vehicle in that territory are considered).
(IFRS 16.B21 and 22)
d) A customer has the right to direct the use of an identified asset only if
 The customer has the right to decide how and for what purpose the asset is used, or
 The relevant decisions about use of the asset are predetermined and the customer has
 The right to operate the asset, or
 Has designed the asset (or aspects of it) that predetermines its use.
(IFRS 16.B24)
e) A lessee may elect not to apply the lease accounting model to:
 Short-term leases (i.e. leases of twelve months or less)
 Leases for which the underlying asset is of low value when it is new (i.e a
lease of a second-hand car would not qualify as a low value lease because a
car, when new, would not be of low value). Examples could include personal
computers, small items of equipment etc.
(IFRS 16.5; B5 and 6)
© Service & Kolitz, 2019 Chapter 16 : Page 1

Solution 16.1 continued . . .
f) At the commencement date, a lessee measures the lease liability at the present value of
the future lease payments.
 The present value is determined by discounting the lease payments using the interest
rate implicit in the lease, or if that cannot be readily determined, at the lessee’s
incremental borrowing rate.
 The future lease payments include
 Fixed payments
 Variable payments
 Amounts expected to be payable under a residual value guarantee (only included
if the lessee expects that the market value of the leased item will be less than
residual value guarantee)
 The exercise of a purchase option the lessee is reasonably certain to exercise
 Payments for early termination.
(IFRS 16.26 and 27)
g) The lease term is the non-cancellable period of the lease, together with
 Optional renewal periods if the lessee is reasonably certain to extend, or
 Period after an optional termination date if the lessee is reasonably certain
not to terminate early
When determining the lease term, a lessee considers all the relevant facts and
circumstances that create an economic incentive to exercise or forgo options to renew or
terminate early.
(IFRS 16.18; B37)
h) The implicit interest rate is the rate that causes

 The present value of the lease payments (includes guaranteed residual value), and
 The present value of the unguaranteed residual value (if any)
to equal
 The fair value of the underlying asset, and
 Any initial direct costs of the lessor.
i) The right of use asset is measured at cost, comprising

 The amount of the initial measurement of the lease liability, plus
 Any prepaid lease payments, plus
 Any initial direct costs of the lessee, plus
 Estimated costs to dismantle, remove or restore the underlying asset ito IAS 37.
Note that if there are no prepaid lease payments, initial direct costs of lessee or costs to
dismantle, then the right of use asset will equal the lease liability. In all other cases, the
right of use asset will be greater than the lease liability.
(IFRS 16.23 and 24)

j) A lessee depreciates the right of use asset ito IAS 16, implying that the depreciation
method reflects the pattern in which the future economic benefits are consumed, most
often on a straight-line basis.
Depreciation starts at the commencement date of the lease and the period is determined as
follows:
 If ownership is transferred to the lessee, or the lessee is reasonably certain to
exercise a purchase option, the depreciation period is equal to the useful life of
the underlying asset
 Otherwise, the depreciation period is equal the shorter of the useful life or the
lease term.
(IFRS 16.31 and 32)

Solution 16.2
Part A
At the inception of a contract, an entity is required to assess whether the contract is a lease or
contains a lease. This will be the case if the contract conveys the right to control the use of an
identified asset for a period of time in exchange for a consideration. IFRS 16.9

 Direct the use of the identified asset. IFRS16.B9
An asset can be either explicitly specified in a contract or implicitly specified at the time it is
made available for use by the lessee. IFRS 16.B13 The vehicles here are explicitly specified as the
contract specifies the model and capacity of the vehicles.
Dark & White Limited has the right to obtain substantially all of the economic benefits
throughout the period of use. It has the exclusive use of the vehicles, including when they are
not being used to transport goods (such as for storage).
Dark & White Limited also has the right to direct the use of the vehicles, including the
transporting goods of other manufacturers.
The arrangement thus does contain a lease. Big Deal Limited would recognise a right of use
asset and a corresponding liability.
Note that substitution rights are likely to be an important factor to consider in applying the
lease definition. Some element of substitution is often allowed in the leases of certain items,
such as fleets of vehicles, copiers and similar equipment.

Part B

made available for use by the lessee. IFRS 16.B13 The vehicles here are explicitly specified as the
contract specifies the model and capacity of the vehicles.
However, even if an asset is specified, a lessee does not control the use of an identified asset
if the lessor has a substantive right to substitute the asset for an alternative asset during the
lease term. IFRS 16.B14
A lessor’s substitution right is substantive if

 the lessor has the practical ability to substitute the asset, and
 the lessor would benefit economically from exercising its rights to substitute the asset.
IFRS 16.B14
In this scenario, the benefits to Wheels Limited of substituting the vehicles are greater than
the costs because
 the vehicles are parked at Wheels Limited’s premises
 Wheels Limited has a large pool of similar vehicles
 the substitution costs are minimal.
Wheels Limited’s substitution rights are substantive and the arrangement does not contain a
lease. The payments made by Wheels Limited would be recognised as an expense in the
statement of comprehensive income. No asset or related liability would be recognised.
A discussion of the economic benefits from, and right to use the vehicles is not relevant here
because of the substantive substitution rights.
Note that substitution rights are likely to be an important factor to consider in applying the
lease definition. Some element of substitution is often allowed in the leases of certain items,
such as fleets of vehicles, copiers and similar equipment.

Solution 16.3

made available for use by the lessee. IFRS 16.B13 The aircraft here is explicitly specified as the
contract specifies a particular model of jet, the Wizz 727 and its customisation.
However, even if an asset is specified, a lessee does not control the use of an identified asset
if the lessor has a substantive right to substitute the asset for an alternative asset during the
lease term. IFRS 16.B14
A lessor’s substitution right is substantive if

 the lessor has the practical ability to substitute the asset, and
 the lessor would benefit economically from exercising its rights to substitute the asset.
IFRS 16.B14
In this scenario, it would be uneconomical for Wings Limited to exercise its right
to substitute the aircraft because of the substantial costs of customising another aircraft
and Wings Limited’s substitution rights are thus not substantive.
Big Deal Limited has the right to obtain substantially all of the economic benefits throughout
the period of use and it has the right to direct the use of the aircraft by deciding, for example,
which routes to fly.
The contractual restrictions on where the aircraft can fly and the prohibition of carrying
explosive cargo are protective rights of Wings Limited and define, but do not limit Big Deal’s
ability to direct the use of the aircraft. IFRS 16.B30
The arrangement thus does contain a lease. Big Deal Limited would recognise a right of use

Solution 16.4
Part A

made available for use by the lessee. IFRS 16.B13 The strands are distinct and are specified in the
contract and are separate from other strands within the cable.
Interdata Limited cannot substitute the strands, other than for the purposes of repairs and
maintenance.
Hello Limited can control the use of the strands throughout the twenty year period because
 It has the right to obtain substantially all of the economic benefits from the strands over
the period of use.
 It has the right to direct the use of the strands because it decides the type and quantity of
data that will be transported and is responsible for the technical connections to its
equipment.
The arrangement thus does contain a lease. Hello Limited would recognise a right of use
Note that the requirement that a portion of an asset can meet the identifiability criterion can be
seen as a potential ‘anti-avoidance’ provision of the standard. Without this, a contract could
exclude a small portion of an asset’s capacity, and thus not meet the identifiability criterion.

Part B

made available for use by the lessee. IFRS 16.B13 The capacity portion of the network that is
used by Hello Limited is not physically distinct from the remaining capacity of the cable and
does not represent substantially all of the capacity of the cable. IFRS 16.B20
Further, Hello Limited cannot control the use of the strands throughout the twenty year period
because Interdata Limited makes all decisions about the transmissions of its customers’ data.
The arrangement thus does not contain a lease.
Note that if the contract specified an amount of capacity equivalent to say 950 strands of fibre
within the 1 000 strand cable, the contract would contain a lease as this represents
substantially all of the cable’s capacity.

Solution 16.5
Part A

There is an identified asset as the ship is explicitly specified in the contract.
Big Red Limited has the right to obtain substantially all of the economic benefits from the use
of the ship. The cargo of apples will occupy substantially all of the ship’s capacity, thus
preventing others from obtaining economic benefits from the use of the ship.
A customer has the right to direct the use of an identified asset when
 It has the right to decide how and for what purpose the asset is used, or
 If relevant decisions about use of the asset are pre-determined,
 the customer has the right to operate the asset, or
 the customer designed the asset in a way that predetermines its use. IFRS 16.B24
Big Red Limited does not have the right to direct the use of the ship as it does not have the
right to direct how and for what purpose the ship is being used. The journey from Cape Town
to Southhampton transporting the apples is predetermined in the contract. Big Red Limited
also does not have the right to operate the ship and did not design the ship in a way that
predetermined its use. In effect, Big Red has the same rights relating to the use of the shiop
as if it were only one of a number of customers transporting cargo on the ship.
The contract therefore does not contain a lease.

Part B

There is an identified asset as the ship is explicitly specified in the contract.
Big Red Limited has the right to obtain substantially all of the economic benefits from the use
of the ship over the three year period. It also has exclusive use of the ship throughout the
period of use, thus preventing others from obtaining economic benefits from the use of the
ship.
A customer has the right to direct the use of an identified asset when
 It has the right to decide how and for what purpose the asset is used, or
 If relevant decisions about use of the asset are pre-determined,
 the customer has the right to operate the asset, or
 the customer designed the asset in a way that predetermines its use. IFRS 16.B24
Big Red Limited also has the right to direct the use of the ship as it has the right to direct how
and for what purpose the ship is being used. It determines the quantity, grade and packaging
of the apples and can use spare capacity for other produce and can decide on the departure
and arrival ports.
The contract therefore does contain a lease and will be recognised as a right of use asset with
a corresponding liability.

Solution 16.6
A lessee may elect not to apply the recognition requirements of IFRS 16 Leases (recognise a
right to use asset and a corresponding lease liability) in respect of
 Short-term leases
 Low value asset leases IFRS 16.5
A short-term lease is defined as a lease that, at the commencement date has a lease term of 12
months or less. IFRS 16 (Appendix A)
At the commencement of the lease, a lessee considers all the relevant facts and circumstances
that create an economic incentive to exercise or forfeit options to renew the lease or terminate
it early. IFRS 16.B37
As Point to Point Limited has the right to terminate the lease at the end of the first and second
years, that right must be considered in determining the lease term. IFRS 16.B35
This lease will qualify for the short term election as

 There is no termination penalty
 The rentals in the second and third years are not below market
 The changing market for airport transfers may result in the existing 25 seater busses not
being suitable for the three year period.
Point to Point Limited thus has an accounting policy choice – to apply the IFRS 16
recognition requirements or to recognise the lease payments as an expense on a straight line
basis over the lease term. IFRS 16.6 The policy must be applied consistently to all short-term
leases of underlying assets of the same class.

Solution 16.7
A lessee may elect not to apply the recognition requirements of IFRS 16 Leases (recognise a
right to use asset and a corresponding lease liability) in respect of
 Short-term leases
 Low value asset leases IFRS 16.5
The assessment of low value leases is based on the value of the underlying asset when new,
regardless of its actual age. IFRS 16.B3. The exemption is available whether or not these leases
are individually or collectively material to the reporting entity. IFRS 16.B4
Currently, low value leases are taken to refer to leases of assets with a value when new of
around USD5 000 or less. IFRS 16 (Basis for Conclusions). The reference to USD 5 000 threshold is not
in the main body of the standard and is not an absolute cut-off. Factors such as inflation and
changes in exchange rates (for entities whose functional currency is not the US Dollar) may
change the relevance of this over time.
An underlying asset can be low value only if

 The lessee can benefit from the use of the underlying asset on its own or together with
other assets that are available to the lessee, and
 The underlying asset is not highly dependent on, or highly interrelated with, other assets.
IFRS 16.B5
Teach Limited benefits from each printer on its own and the printers are not dependent on, or
related to other assets. In other words, each printer can operate on its own.
For the twenty low value printers, Teach Limited thus has an accounting policy choice – to
apply the IFRS 16 recognition requirements or to recognise the lease payments as an expense
on a straight line basis over the lease term. IFRS 16.6 The policy must be applied consistently to
all short-term leases of underlying assets of the same class.
For the one high value printer, the contract contains a lease and Teach Limited must recognise
a right of use asset and corresponding liability.

Solution 16.8
a) Identification of lease components
This contract provides Build Limited with the right to use an asset (the equipment) as well as
monthly maintenance services.
The right to use the equipment represents a lease component. The provision of the
maintenance services does not represent the right to use an asset and is thus a non-lease
component.
Although the contract states that part of the consideration also includes the provision of
insurance, the insurance is not a good or service from which Build Limited benefits (the lessor
benefits from the insurance) and thus the provision of insurance is not a separate component
of the contract and is disregarded when allocating the consideration to the components of the
lease.
b) Allocation to components
Part A
Total annual consideration – stand-alone price of non-lease component = stand-alone price of

the lease equipment
C24 000 – C10 000 = C14 000
Part B
The total consideration is allocated based on the stand-alone price per lease component and
the aggregate stand-alone prices of the non-lease components (in this case there is only one
non-lease component) as follows:
Stand-alone prices
Allocation of annual contractual consideration:
C
Stand-alone prices for the non-lease component/s Given – maintenance only 10 000
Stand-alone price for the lease component Given – equipment 20 000
Total stand-alone prices 30 000
Annual contractual consideration allocated as follows: 24 000
 Non-lease component C24 000 x 10 000 / 30 000 8 000
 Lease component C24 000 x 20 000 / 30 000 16 000
c) Journal entries for Part A
Debit Credit
Short-term lease expense (E) 14 000
Service costs (E) 10 000
Bank 24 000
Payment of lease instalment and allocation to lease and non-lease
component

Solution 16.9
Part A
The lease term is the non-cancellable period of the lease, including

 Optional renewal periods if the lessee is reasonably certain not to terminate early, and
 Periods after an optional termination date if the lessee is reasonably certain not to
terminate early. IFRS 16.18.
When determining the lease term, a lessee considers all relevant facts and circumstances that
create an economic incentive to exercise or forfeit options to renew or to terminate early. IFRS
16.19 / B37
Food for All Limited has significant economic incentive to extend the lease. Facts and
circumstances include
 The monthly rental will remain constant in the three years following the initial term
whereas market rentals are expected to increase by 10%.
 It intends to expand its retail outlets in the surrounding areas and the road network is to be
improved.
The contract contains a lease and Food for All Limited should use a lease term of six years in
accounting for the lease.
Note that the assessment of the lease term is a crucial estimate and a key input to the
measurement of the right to use asset and lease liability.
Part B
The lease term is the non-cancellable period of the lease, including

 Optional renewal periods if the lessee is reasonably certain not to terminate early, and
 Periods after an optional termination date if the lessee is reasonably certain not to
terminate early. IFRS 16.18.
When determining the lease term, a lessee considers all relevant facts and circumstances that
create an economic incentive to exercise or forfeit options to renew or to terminate early. IFRS
16.19 / B37
Food for All Limited has little economic incentive to extend the lease. Facts and
circumstances include
 The monthly rental will increase to C55 000 in the three years following the initial term.
 There is a possibility that some stores in the surrounding area will close, reducing the
need for a warehouse in that location.
The contract contains a lease and Food for All Limited should use a lease term of three years
in accounting for the lease.
Note that the assessment of the lease term is a crucial estimate and a key input to the
measurement of the right to use asset and lease liability

Solution 16.10
A residual value guarantee is defined as a guarantee made to a lessor by an unrelated party

that the value of an underlying asset at the end of the lease will be at least a specified amount.
IFRS 16 Appendix A
At the commencement date of a lease, a lessee measures the lease liability at the present value
of future lease payments. IFRS 16.26
The lease payments include all lease rental payments and any expected payments at the end of
the lease, including amounts expected to be paid by the lessee under residual guarantees.
IFRS 16.27
In theory, the residual value guarantee should equal the market value of the underlying asset
at the end of the lease term (in which case the lessee would sell the asset for its market value
and pay the amount over to the lessor and the amount to include in the calculation of the
future lease payments iro the residual value guarantee would be zero).
The amount to include as the residual value guarantee is the expected amount payable (and
not the maximum exposure). Thus Villa Limited includes C20 000 (C100 000 – C80 000) in
the calculation of the present value of future lease payments.
Note
The payment resulting from a residual value guarantee cannot be avoided by the lessee and
the lessee has an unconditional obligation to make a payment to the lessor if the value of an
underlying asset moves in a particular way. The uncertainty relates to the amount the lessee
may have to pay, which can vary in response to movements in the fair value of the underlying
asset.

Solution 16.11
Dr Cr
31/12/X1 Low value asset lease expense (E) (2 500 X 9) 22 500
Low value lease accrual (L) (Balancing) 4 500
Bank (2 000 X 9) 18 000
Lease payment
Bank [(2 000 X 3) + (3 000 X 9)] 33 000
Lease payment

Bank (3 000 X 3) 9 000
Lease payment
W1: Straight line equalisation of lease payments
Total lease payments = C60 000 [(2 000 X 12) + (3 000 X 12)]
C60 000 / 24 months = C2 500 per month

Solution 16.12
a) Journal entries
Debit Credit
01/01/20X2
Low value asset lease expense (E) 10 000
Bank 10 000
First rental payment
31/12/20X2
Low value asset lease expense (E) 4 375
Low value asset lease accrual (L) 4 375
Straight-line equalisation (W1: 14 375 – Paid: 10 000)
Income tax expense (E) 226 313
Current tax payable: income tax (L) 226 313
Raising the years current tax (W2)
Deferred tax (A) 1 313
Raising a deferred tax asset (W3)
b) Disclosure in SOCI and SOFP
COW LIMITED
EXTRACTS FROM THE STATEMENT OF COMPREHENSIVE INCOME
FOR THE YEAR ENDED 31 DECEMBER 20X2
Note 20X2
C
Profit before tax (given) 750 000
Income tax expense 4 (225 000)
Profit for the period 525 000
Other comprehensive income 0
Total comprehensive income 525 000
COW LIMITED
EXTRACTS FROM THE STATEMENT OF FINANCIAL POSITION
AS AT 31 DECEMBER 20X2
Note 20X2
C
ASSETS
Non-current assets
Deferred tax: income tax 1 313
EQUITY AND LIABILITIES

Current liabilities
Current income tax payable (112 000 – 226 313) 114 313
Low value asset lease accrual 4 375

Solution 16.12 continued …
c) Disclosure in notes
COW LIMITED
EXTRACTS OF THE NOTES TO THE FINANCIAL STATEMENTS
20X2
C
4. Income tax expense
Current tax (W2) 226 313
Deferred tax (W3) (1 313)
225 000
10. Leases
Cow Limited has elected the recognition exemption on the low value lease of office furniture.
10.1 Income and expenses related to leases

Expenses
Low value lease expense 14 375
Workings
W1: Straight line equalisation of lease payments
Year C
20X2 10 000
20X3 – 20X5 (25 000 x 3) 75 000
20X6 0
20X7 – 20X9 (10 000 x 3) 30 000
115 000
Average (115 000 / 8 years) 14 375
W2: Current tax calculation
20X3
Accounting profit 750 000
Temporary differences:
Add: Low value lease expense 14 375
Less Low value lease payment (10 000)
Taxable profit 754 375
Current tax (at 30%) 226 313
W3: Deferred tax
Carrying Tax Temporary Deferred

amount base difference taxation
Low value asset lease
accrual
Balances at 1/1/20X3: 0 0 0 0
Movement (4 375) 1 313 Dr DT
Cr TE
Balances at 31/12/20X3: (4 375) 0 4 375 1 313 Asset

Solution 16.13
a) Implicit interest rate
The implicit interest rate in the lease is the discount rate that causes the present value of:
 the lease payments; and
 the unguaranteed residual value
to equal the sum of the
 fair value of the underlying asset; and the
 initial direct costs of the lessor IFRS 16.Appendix A
C
Advance payment (6 000 x 1) 6 000
Arrear payments (Annuity of ten payments in (5 250 x 6,1446) 32 259
arrear discounted at10%)
Unguaranteed residual 0
38 259
The discounted value of C38 259 is the same as the fair value of the leased asset at inception.
Therefore, 10% is the implicit interest rate.
b) Initial amount of lease liability and right of use asset
Lease liability
At the commencement date, a lessee measures the lease liability at the present value of the
future lease payments. IFRS 16.26 This is equal to the present value of lease rentals + the present
value of expected payments at the end of the lease.
Highlands Limited will record the initial lease liability at an amount of C38 259 (the present
value of the lease payment as calculated in (a). (Note that a residual value guarantee by the
lessee would be included in the future lease payments but an unguaranteed residual would
not.)
Right of use asset
At the commencement date, a lessee measures a right of use asset at a cost that includes
 The amount of the initial measurement of the lease liability, plus
 Initial direct costs, plus
 Prepaid lease expenses (reduced by lease incentives received), plus
 Estimate costs to dismantle and remove the asset IFRS 16.24
Highlands Limited will record the right of use asset at an amount of C38 259 + C1 741
= C40 000

Solution 16.13 continued ...
c) Journal entries
Debit Credit
1/4/20X5
Commission and legal fees (E) 1 741
Bank 1 741
Payment of initial direct costs of lease
Right of use asset: cost (A) 40 000
Lease liability (L) 38 259
Commission and legal fees 1 741
Recognition of right of use asset and lease liability
Bank 6 000
First lease instalment (no interest yet accrued)
31/3/20X6
Lease interest (E) 3 226
Interest accrued (38 259 - 6000) x 10% or W1
Depreciation (E) 4 000
Right of use asset: accumulated depreciation (-A) 4 000
Depreciation expense C40 000/ 10 years
Bank 5 250
Second lease instalment
Workings
W1: Effective interest rate table
Date 10% Interest Instalment Liability balance

01/4/20X5 38 259
01/4/20X5 (6 000) 32 259
31/3/20X6 3 226 35 485
31/3/20X6 (5 250) 30 235
31/3/20X7 3 024 33 259
31/3/20X7 (5 250) 28 009
31/3/20X8 2 801 30 810
31/3/20X8 (5 250) 25 560
… … … …

Solution 16.14
(a) Journal entries
Debit Credit
01/04/X5 Right of use asset (A) 427 283

Bank 110 000
Initial payment
31/03/X6 Interest expense (E) 22 210

Interest accrued (C317 283 x 7% or W2)
Depreciation expense (E) 106 821

Accumulated depreciation (-A) 106 821
Depreciation on right of use asset (*C427 283 / ^4 yrs)
01/04/X8 Lease liability 110 000

Bank 110 000
Payment of lease instalment
31/03/X9 Interest expense (E) 2 453


Bank 37 500
Payment of residual value guarantee
Depreciation expense (E) 106 821

Accumulated depreciation (-A) 106 821
Depreciation on right of use asset (C427 283 / 4 yrs)
* The residual value is defined in IAS 16 as the estimated amount that an entity would currently obtain
from disposal of the asset if the asset were already of the age and in the condition expected at the end
of its useful life IAS 16.6. Eagle Limited will receive zero from disposal as the bus is returned to BigFin
Limited, who would then dispose of it. Thus no residual value is used in the depreciation calculation.
^ The right of use asset is depreciated from the commencement date to the earlier of the end of the
useful life of the right-of-use asset or the end of the lease term IFRS 16.32. Thus, a period of four years is
used.

b) Statement of financial position
EAGLE LIMITED
EXTRACT FROM STATEMENT OF FINANCIAL POSITION
AT 31 MARCH 20X6
20X6
C
ASSETS
Non-current assets
Right of use asset (427 283 – 106 821) 320 462

Non-current liabilities
Non-current portion of lease liability (339 493 – 110 000) / W2 229 493
Current liabilities
Current portion of lease liability 110 000
c) Lease note
7. Leases
7.1 Right of use asset
Vehicles Total
C C
01/04/X5 Cost 427 283 427 283
Depreciation (427 283 / 4) (106 821) (106 821)
31/03/X6 Carrying amount 320 462 320 462
7.2 Maturity analysis of future lease payment
C
20X7 110 000
20X8 110 000
20X9 147 500
367 500
7.3 Cash outflows relating to leases
Cash payments included in statement of cash flows 110 000
7.4 Interest expense on lease liabilities
Interest expense included in finance costs (317 283 x 7% / W2) 22 210

Workings
W1: Calculation of lease liability and right of use asset
C
PV of annuity of lease payments for 4 years in advance 110 000 x 3,6243 398 674
PV of expected RV payment at end of year 4 *37 500 x 0,76289 28 609
427 283
* (80 000 – 42 500)
W2: Amortisation table
Interest (7%) Instalment Lease liability

01/04/X5 427 283
- (110 000) (110 000)
317 283
31/03/X6 22 210 22 210
339 493
01/04/X6 (110 000) (110 000)
229 493
31/03/X7 16 065 16 065
245 558
01/04/X7 (110 000 (110 000)
135 558
31/03/X8 9 489 9 489
145 057
01/04/X8 (110 000) (110 000)
35 047
31/03/X9 2 453 (37 500) (35 047)
49 624 (477 500) 0

Solution 16.15
a) Implicit interest rate
The implicit interest rate in the lease is the discount rate that causes the present value of:
 the lease payments; and
 the unguaranteed residual value
to equal the sum of the
 fair value of the underlying asset; and the
 initial direct costs of the lessor IFRS 16.Appendix A
C
Arrear payments C135 000 per year is
discounted at 12% over C135 000 x 3.6048 486 648
five years
Bargain purchase option C10 000 is discounted at
12% to the end of the five C10 000 x 0.5674 5 674
years
492 322
The discounted value of C492 322 is the same as the fair value of the leased asset at
inception. Therefore, 12% is the implicit interest rate.
b) Journal entries
Debit Credit
01/07/20X0
30/06/20X1
Bank 135 000
First lease instalment
Depreciation expense (492 322 –7,000)/ 8*
* If ownership of the underlying asset is transferred to the lessee, or the lessee is reasonably certain to
exercise a purchase option, then the depreciation period runs to the end of the useful life of the
underlying asset. IFRS 16.32

Solution 16.15 continued...
c) Disclosure
DEVON COACH TOURS LIMITED

AT 30 JUNE 20X2
20X2
C
ASSETS
Non-current assets
Right of use asset (492 322 – 60 665 – 60 665) 370 992

Non-current portion of lease liability (331 369 – 95 236) 236 133
Current liabilities
Current portion of lease liability (135 000 – 39 764) 95 236
d) Lease note
5. Leases
Vehicles Total
C C
Depreciation (492 322 –7,000) / 8 (60 665) (60 665)
C
20X3 135 000
20X4 135 000
20X5 145 000
415 000
Interest expense included in finance costs (416 401 x 12% / W1) 49 968

Workings

01/07/20X0 492 322
30/06/20X1 59 079 (135 000) 416 401
30/06/20X2 49 968 (135 000) 331 369
30/06/20X3 39 764 (135 000) 236 133
30/06/20X4 28 336 (135 000) 129 469
30/06/20X5 15 536 (145 000) *(5)
795 000
*rounding

Solution 16.16
a) Lease term
The lease term is the non-cancellable period of the lease, together with
 Optional renewal periods if the lessee is reasonably certain to extend
 Periods after an optional termination if the lessee is reasonably certain not to terminate
early IFRS 16.18
When determining the lease term, lessees consider all relevant facts and circumstances that
create an economic incentive to exercise or forfeit options to renew or terminate early IFRS 16.19
The lease term is for five years and Roasted Bean Limited has an option to extend the lease
contract for a further five years. At the commencement date, the exercise of the option is not
reasonably certain:
 The coffee shop format is not tested in the local market or by Roasted Bean Limited
 The leasehold improvements provided by the lessor are expected to be at the end their
useful lives by the end of the fifth year
 The lease rentals are not below market rates during the extension period.
The initial lease term is thus considered to be five years.
After the commencement date, a lessee reassess the lease term upon the occurrence of a
significant event or significant change in circumstances that is within the lessee’s control and
affects whether the lessee is reasonably certain to exercise an option not previously included
in the determination of the lease term IFRS 16.20 / B41
At 31 December 20X3, management of Roasted Bean Limited takes the decision to change
the format of the coffee shop and to incur significant costs to change the shop fittings and for
decoration. This is considered to be a significant change in circumstance that makes the
option to extend the contract for a further five years reasonably certain.
The lease term is therefore reassessed to be a total of ten years, of which three have passed
and seven remain.
b) Journal entries
Debit Credit
01/01/X1
Commissions and legal fees (E) 850
Bank 850
Payment of initial direct costs of lessee
Commission and legal fees (E) 850
Bank 5 000

Debit Credit
31/12/X1
Lease interest (E) 726
Lease liability (L) 726
Interest accrued (23 150 – 5 000) x 4% or W2
Depreciation expense (C24 000/ 5 years) or W4
01/01/X2
Bank 5 000
Second lease instalment
31/12/X2
Lease liability(L) 555
Interest accrued (13 876 x 4%) or W1
Depreciation expense (C24 000/ 5 years)
01/01/X3
Bank 5 000
Third lease instalment
31/12/X3
Lease liability (L) 377
Interest accrued (9 431 x 4%) or W1
Right of use asset: accumulated depreciation 4 800
Depreciation expense (C24 000/ 5 years)
Right of use asset (A) 26 724
Reassessment of extension option W3 / W4

Workings
W1: Initial measurement of lease liability
C
Five payments in advance on PV annuity of C5 000 per year
(C5 000 x 4,62999) 23 150
01/01/X2, X3, X4 and X5 in advance for five years at 4%
Using Casio financial calculator

 CMPD function
 Set = Begin (advance payments)
 i% = 4
 n=5
 PMT = 1
 SOLVE for PV
 = 4,62999 = PV of annuity of C1 at 4% in advance
or
 CMPD function
 i% = 4
 n=5
 PMT = 5 000
 SOLVE for PV
 = C23 150 = PV of annuity of C5 000 at 4% in advance
W2: Effective interest rate table (Initial assessment of lease term)

01/01/X1 23 150
(5 000) 18 150
31/12/X1 726 18 876
01/01/X2 (5 000) 13 876
31/12/X2 555 14 431
01/01/X3 (5 000) 9 431
31/12/X3 377 9 808

W3: Reassessment of lease liability
C
Two payments in advance on PV annuity of C6 000 (C5 000 x 1,97087)
01/01/X4 and X5 per year for two years at 9 854
3%
Five payments in advance on PV annuity of C6 000
01/01/X6, X7, X8, X9 and X10 per year for five years
(6 000 x 4,44632) 26 678
(starting in two years’
time) at 3%
36 532
Balance on lease liability at
9 808
31/12/X3
Adjustment 26 724
Using Casio financial calculator
Two advance payments on 01/01/X4 and X5:
 CMPD function
 i% = 3
 n=2
 PMT = 1
 SOLVE for PV
 = 1,97087 = PV of annuity of C1 at 3% in advance for two years
Five advance payments on 01/01/X6, X7, X8, X9 and X10:
 CMPD function
 i% = 3
 n=7
 PMT = 1
 SOLVE for PV
 = 6,41719 = PV of annuity of C1 at 3% in advance for seven years.
then
 CMPD function
 i% = 3
 n=2
 PMT = 1
 SOLVE for PV
 = 1,99087 = PV of annuity of C1 in advance for two years.
Thus, 6,41719 – 1,99087 = 4,44632 = PV of an annuity of C1 at 3% in advance for five years,

commencing in two years’ time.

W4: Right of use asset
C
01/01/X1 Cost (23 150 + 850) 24 000
01/01/X1 – 31/12/X3 Accumulated depreciation (24 000 / 5yrs x 3yrs) (14 400)
31/12/X3 Carrying amount 9 600
Re-measurement W3 26 724

Solution 16.17
a) Journal entries
Debit Credit
1/1/20X3

Bank 200 754
31/12/20X3
Interest accrued (700 000 – 200 754) x 10% or W1

Depreciation expense (700 000 – 0) / 4 years

Current tax payable: income tax (L) 277 251
Current tax payable for the year (W2)
Deferred tax: income tax (A) 7 251

Deferred tax asset arising on lease (W3)


b) SOCI extract
CHIRP LIMITED
EXTRACT FROM STATEMENT OF COMPREHENSIVE INCOME
20X3
C
Profit before finance charges : (900 000 + 49 925) 949 925
Finance charges (W1 / journals and given that the only (49 925)
interest incurred related to this lease)
Profit before tax (given) 900 000
Income tax expense (277 251 – 7 251) / W2 and 3 (270 000)
Profit for the year 630 000
Other comprehensive income for the year -
Total comprehensive income for the year 630 000
c) SOFP extract
CHIRP LIMITED
AT 31 DECEMBER 20X3
20X3
C
ASSETS
Non-current assets
Right of use asset (700 000 – 175 000) / W4 525 000
Deferred tax: income tax 7 251

Non-current portion of lease liability (549 171 – 200 754) 348 417
Current liabilities
Current portion of lease liability (200 754 – *0) 200 754
Current tax payable: income tax (200 000 – 277 251) 277 251
* When the lease payments are due in advance, it means that each payment will be reducing the capital
sum owing – in other words, none of the lease payment will be in lieu of interest owing. For this
reason, the full amount of the instalment is considered to be the current portion of the liability.

d) Lease note
5. Leases
Machinery Total
C C
Additions 700 000 700 000
Depreciation (W4) (175 000) (175 000)
C
20X4 200 754
20X5 200 754
20X6 200 754
602 262
Interest expense included in finance costs [(700 000 – 200 754) x 0,10 / W1) 49 925

Workings
10% Liability
Date Interest Instalment balance
1/1/20X3 700 000
1/1/20X3 (200 754) 499 246
31/12/20X3 49 925 549 171
1/1/20X4 (200 754) 348 417
31/12/20X4 34 842 383 258
1/1/20X5 (200 754) 182 504
31/12/20X5 18 250 200 754
1/1/20X6 (200 754) 0
103 017 (803 016)
W2: Current normal tax calculation
20X3
Profit before tax / Accounting profit (Given) 900 000
Adjust for temporary differences:
- Depreciation (700 000 – 0) / 4 years 175 000
- Finance charges (W1) 49 925
- Lease payment (W1) (200 754)
Taxable profit 924 171
Current tax (at 30%) 277 251
W3: Deferred tax
Carrying Tax Temporary Deferred

amount base difference taxation
Balances at 1/1/20X3: 0 0 0 0
Right of use asset 0 0 0 0
Lease liability 0 0 0 0
Movement 7 251 Dr DT
Cr TE
Balances at 31/12/20X3: (24 171) 0 24 171 7 251 Asset
Right of use asset (W4) 525 000 0
Lease liability (W1) (549 171) 0
W4: Right of use asset
C
01/01/X3 Cost 700 000
01/01/X3 – 31/12/X3 Accumulated depreciation (700 000 – 0) / 4 (175 000)

16 Leases (Lessee) s19 Final

Uploaded by

Document Information

Original Description:

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

16 Leases (Lessee) s19 Final

Uploaded by

Copyright:

Available Formats

Solutions to GAAP : Graded Questions Leases: lessee accounting

A contract can be a lease (or contain a lease) only if

© Service & Kolitz, 2019 Chapter 16 : Page 1

Solution 16.1 continued . . .

h) The implicit interest rate is the rate that causes

i) The right of use asset is measured at cost, comprising

(IFRS 16.23 and 24)

© Service & Kolitz, 2019 Chapter 16 : Page 2

Solution 16.1 continued . . .

© Service & Kolitz, 2019 Chapter 16 : Page 3

A contract can be a lease (or contain a lease) only if

© Service & Kolitz, 2019 Chapter 16 : Page 4

Solution 16.2 continued . . .

A contract can be a lease (or contain a lease) only if

A lessor’s substitution right is substantive if

© Service & Kolitz, 2019 Chapter 16 : Page 5

A contract can be a lease (or contain a lease) only if

A lessor’s substitution right is substantive if

© Service & Kolitz, 2019 Chapter 16 : Page 6

A contract can be a lease (or contain a lease) only if

© Service & Kolitz, 2019 Chapter 16 : Page 7

Solution 16.4 continued . . .

A contract can be a lease (or contain a lease) only if

The arrangement thus does not contain a lease.

© Service & Kolitz, 2019 Chapter 16 : Page 8

A contract can be a lease (or contain a lease) only if

There is an identified asset as the ship is explicitly specified in the contract.

The contract therefore does not contain a lease.

© Service & Kolitz, 2019 Chapter 16 : Page 9

Solution 16.5 continued . . .

A contract can be a lease (or contain a lease) only if

There is an identified asset as the ship is explicitly specified in the contract.

© Service & Kolitz, 2019 Chapter 16 : Page 10

This lease will qualify for the short term election as

© Service & Kolitz, 2019 Chapter 16 : Page 11

An underlying asset can be low value only if

© Service & Kolitz, 2019 Chapter 16 : Page 12

a) Identification of lease components

Total annual consideration – stand-alone price of non-lease component = stand-alone price of

C24 000 – C10 000 = C14 000

c) Journal entries for Part A

© Service & Kolitz, 2019 Chapter 16 : Page 13

The lease term is the non-cancellable period of the lease, including

The lease term is the non-cancellable period of the lease, including

© Service & Kolitz, 2019 Chapter 16 : Page 14

A residual value guarantee is defined as a guarantee made to a lessor by an unrelated party

© Service & Kolitz, 2019 Chapter 16 : Page 15

31/12/X3 Low value asset lease expense (E) (2 500 X 3) 7 500

W1: Straight line equalisation of lease payments

© Service & Kolitz, 2019 Chapter 16 : Page 16

b) Disclosure in SOCI and SOFP

EQUITY AND LIABILITIES

© Service & Kolitz, 2019 Chapter 16 : Page 17

Solution 16.12 continued …

10.1 Income and expenses related to leases

W1: Straight line equalisation of lease payments

Average (115 000 / 8 years) 14 375

W2: Current tax calculation

Current tax (at 30%) 226 313

W3: Deferred tax

Carrying Tax Temporary Deferred

© Service & Kolitz, 2019 Chapter 16 : Page 18

a) Implicit interest rate