TABANI’S SCHOOL OF ACCOUNTANCY

IFRS-16 LEASES
Q.1. Millennium Corporation leases a machine that has cost and fair value of Rs.1,000,000 from
Excel Leasing Company for five years. Millennium Corporation agrees to assume all risk of
normal ownership including such costs as insurance, taxes and maintenance. The machine has
a useful life of five years with no salvage value. The lease is signed on Jan 1, 1998. The
incremental borrowing rate for the millennium corporation is 16%. The annual rentals of
Rs.305,409 are payable at the end of each year.

Required:
a) Discuss the nature of lease arrangement and accounting method the lessee should
apply to the lease.
b) Prepare lease amortization schedule.

Q.2. Healthmen Club provides weight control, physical exercise and body building facilities to its
members. The club is desirous to acquire new advanced equipment, in addition to its existing
fleet of machines. Therefore, Mr.Aman, manager of the Club approaches Oasis Lease Limited
on 31 December 2016 to finance such equipment. The main terms of the lease agreement,
entered into between the Club and the leasing company are:

(i) Cost of the equipment is Rs.100,000 and its expected useful life is 4 years.
(ii) The lease transfers substantially all the risks and rewards of ownership to the club.
(iii) Rentals would be Rs.8,582 payable at the end of each quarter.
(iv) Total lease payments would be Rs.137,312.

Finance charges appropriated are:

Year ended 31 December

2017 Rs.14,870
2018 Rs.11,566
2019 Rs. 7,700
2020 Rs. 3,176
Rs.37,312

The allocation of financial charges is based on the use of an implicit interest rate of 16% as a
discount factor. Heathmen Club depreciates the equipment of this kind over a 4 year by
straight line method.

Required:
Disclose how the machine and lease liability will appear in the books of Healthmen Club in
the years 2017 to 2020. (Figures relating to corresponding years are not required.)

Q.3. Mars Limited (ML) is engaged in the manufacturing of chemicals. On July 1, 2008 it
obtained a motor vehicle on lease from a bank. Details of the lease agreement are as follows:

(i) Cost of motor vehicle is Rs. 1,600,000.

(ii) Installments of Rs. 480,000 are to be paid annually in advance.

(iii) The lease term and useful life is 4 years and 5 years respectively.

(iv) The interest rate implicit in the lease is 13.701%.

ML follows a policy of depreciating the motor vehicles over their useful life, on the
straight-line method. However, the tax department allows only the lease payments as a
deduction from taxable profits.

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TABANI’S SCHOOL OF ACCOUNTANCY
IFRS-16 LEASES
The tax rate applicable to the company is 30%. ML’s accounting profit before tax for the
year ended June 30, 2009 is Rs.4,900,000.

There are no temporary differences other than those evident from the information provided
above.

Required:
(a) Prepare journal entries in the books of Mars Limited for the year ended June 30,
2009 to record the above transactions including tax and deferred tax.

(b) Prepare a note to the financial statements related to disclosure of finance lease
liability, in accordance with the requirements of International Accounting
Standards.
(Ignore comparative figures.)

Q.4. Emotional Limited (EL) is preparing its financial statements for the year ended 30 June
2017. Following are the details of additions to property, plant and equipment made during the
year:

Addition 1: Construction of tanks and pipelines

Summary of cost incurred on tanks and pipelines is as follows:

Description Rs. in million Date of payments

Advance to contractor 200 1 August 2016
Construction permit fee 100 1 August 2016
Suppliers of construction material 600 1 September 2016
1st bill of contractor 500 1 January 2017
2nd bill of contractor 200 1 March 2017
Last bill of contractor 200 1 May 2017

In order to finance the project, EL obtained a 3 year loan of Rs.1,200 million at the rate
of 12% per annum on 1 August 2016. The principal is payable in three equal annual
instalments along with interest, from 1 August 2017. The surplus funds available from the loan
were invested in a saving account at 8% per annum.

The remaining cost was financed through cash withdrawals from EL’s existing running finance
facilities. Details of these facilities are as follows:

Name of Running finance

bank Limit Balance as on 30 June 17 Average balance Mark-up %
----------- Rs. in million -----------
Bank Q 500 450 400 12.5
Bank W 700 650 300 14.0

The tanks and pipelines were put into operation upon completion on 1 April 2017.

Addition 2: Acquisition of machinery on lease

On 1 January 2017 EL acquired machinery having fair value of Rs.185 million, on lease
for a non-cancellable period of four years. Rentals of Rs.54 million are to be paid annually
in advance on 1 January. EL’s incremental borrowing rate is 13.7%. EL also paid initial
direct cost of Rs.10 million in respect of the machinery.

The following information is also available:

From the desk of Sir Majid Masood Page 2 of 7

TABANI’S SCHOOL OF ACCOUNTANCY
IFRS-16 LEASES
(i) During the year ended 30 June 2017, EL made a profit before tax of Rs. 500
million, after incorporating the effects of above transactions.

(ii) EL charges depreciation at the rate of 10% on tanks and pipelines.

(iii) EL’s tax rate is 30%. Tax authorities allow depreciation at the rate of 20% on
tanks and pipelines. Full year’s tax depreciation is allowed in the year of addition.

(iv) As per tax laws:

all lease related payments are allowed in the year of payment; and
borrowing costs are allowed when incurred.
investment income is taxable when earned.

(v) There are no temporary differences in current and previous years other than those
evident from the information provided above.

Required:
Prepare relevant extracts from EL’s statement of financial position as on 30 June 2017. Notes
to the financial statements are not required. Borrowing costs are to be calculated on the basis of
number of months. (18)

Q.5. On 1 July 2010, Miracle Textile (MTL) acquired a machine on lease, from a bank. Details of
the lease are as follows:

(i) Cost of machine is Rs.20 million

(ii) The lease term and useful life is 4 year and 10 years respectively.

(iii) Installment of Rs.5.80 million is to be paid annually in advance on 1 July.

(iv) The interest rate implicit in the lease is 15.725879%.

(v) At the end of lease term, MTL has an option to purchase the machine on payment
of Rs.2 million. The fair value of the machine at the end of lease term is expected
to be Rs.3 million.

MTL deprecates the machine on the straight-line method to a nil residual values.

Required:
Prepare relevant extracts of the statement of financial position and related notes to the
financial statements for the year ended 30 June 2012 along with comparative. Ignore
taxation. (16)

Q.6. Neptune Limited (NL) had established its business in December 2008 as a supplier of plant
and machinery. During the year ended December 31, 2009 the company sold two machines
under lease arrangements. The details are as under:

A B
Date of commencement of lease January 1, 2009 January 1, 2009
Lease period 6 years 3 years
Lease installments payable annually in advance Rs. 2,000,000 Rs. 4,000,000
(to be reduced
annually by 5%)
Cost of machine Rs. 6,963,448 Rs. 15,000,000
Economic life 6 years 6 years
From the desk of Sir Majid Masood Page 3 of 7
TABANI’S SCHOOL OF ACCOUNTANCY
IFRS-16 LEASES

NL sells machines on cash at cost plus 25%. It depreciates its assets under straight line
method with no residual value. Fair market annual interest rate is 15%.

Required:
(a) Prepare journal entries to record the above transactions.

(b) Prepare notes to the financial statements for the year ended December 31, 2009
in accordance with the requirements of IAS - 17 (Leases).
(Ignore taxation and comparative figures)

Q.7. Quartz Auto Limited (QAL) is engaged in the business of manufacturing of trucks. Since a
number of the prospective customers do not have adequate funds to purchase the vehicles
against full payment, QAL provides lease financing facility to its customers. It expects to
receive a return at the rate of 15% per annum on the amount of lease finance.

On 1 July 2010, QAL sold seven trucks to Emerald Goods Transport Company (EGTC) on
lease. The terms of the least and related information is as follows:

(i) The lease period is 4 years, extendable up to the expected useful life of the trucks i.e.
5 years.

(ii) EGTC has guaranteed a residual value of Rs.360,000 for each truck, till the end of the
fourth year. However, the guarantee would lapse if the lease term is extended to the
fifth year. EGTC will return the truck at the end of the lease term.

(iii) Lease rentals amount to Rs.2,715,224 per annum and are payable in arrears i.e. on 30
June.

(iv) The cost of each truck is Rs.900,000. Price in case of outright sale is Rs.1,350,000 per
truck.

(v) The expected residual value of each truck at the end of the 4th and 5th year is
Rs.150,000 and Rs.100,000 respectively.

Required:
Assuming the QAL and EGTC intend to extend to lease for a period of five years, prepare:
(a) Journal entries to record the transactions for the year ended 30 June 2011. (08)
(b) A note for inclusion in the financial statements, for the year ended 30 June 2011, in
accordance with the requirements of IAS-17 ‘Leases’. (07)

Q.8. On 1 January 2019, French Vanilla Leasing Limited (FVLL) purchased a machine costing
Rs. 200 million having useful life of 8 years. Residual value of the machine at end of its useful
life is estimated at Rs. 16 million.

On 1 February 2019, FVLL entered into a lease agreement for this machine with
Cotton Candy Limited (CCL) for a non-cancellable period of 2.5 years with effect
from1 March 2019. Under the agreement, eight instalments of Rs.12 million are to
be paid quarterly in arrears commencing from the end of 3rd quarter i.e. 30 November
2019.

FVLL has incorporated an implicit rate of 15% per annum which is not known to
CCL. Incremental borrowing rate of CCL is 16% per annum.

From the desk of Sir Majid Masood Page 4 of 7

TABANI’S SCHOOL OF ACCOUNTANCY
IFRS-16 LEASES
On 1 April 2019, CCL completed installation of the machine at a cost of Rs. 4 million and
put it into use.

Both companies follow straight line method for charging depreciation.

Required:
Prepare journal entries for the year ended 31 December 2019 in the books of FVLL and
CCL to record the above transactions. (15)

Q.9. On 1 January 2020, Dettol Limited (DL) acquired a machine on lease from Lifebuoy Leasing
Limited (LLL) for 3 years. The first annual instalment amounting to Rs. 35 million was paid
on 1 January 2020 and all subsequent annual instalments are payable on 1 January subject to
increase of 10% each year.

DL incurred initial direct cost of Rs. 5 million. As an incentive to DL for entering into the
lease, LLL reimbursed Rs. 2 million.

LLL has incorporated an implicit rate of 11% per annum which is not known to DL.

The residual value of the machine at the end of 3 years is estimated at Rs. 30 million, out of
which DL has guaranteed Rs. 20 million.

DL is also obliged to incur decommissioning cost of Rs. 4 million at the end of the lease
term.

Discount rate of 12% may be assumed wherever required but not given.

Required:
Prepare relevant extracts from DL’s statement of profit or loss for the year ended 31
December 2020 and statement of financial position as on that date. (09)

Q.10. Sagahi Autos Limited (SAL) is a dealer of specialized vehicles. SAL acquires each unit of
vehicle ‘Alpha’ from manufacturer at a cost of Rs.26 million and sells it for Rs.30 million.
The estimated economic life of Alpha is five years.

Few prospective customers did not have adequate funds to purchase Alpha on cash.
Therefore, SAL entered into the following arrangements during the year ended 31
December 2020:

(i) On 1 January 2020, SAL leased Alpha to Haris for a non-cancellable period of four
years. The rate of interest implicit in the lease is 10% per annum. The payment is to be
made in four equal annual instalments payable on 31 December each year. The residual
value at the end of four years is estimated at Rs. 5 million which is guaranteed by a
third party related to SAL.

(ii) On 1 April 2020, SAL leased Alpha to Yasir for a non-cancellable period of three years.
The rate of interest implicit in the lease is 18% per annum. Annual instalment of
Rs. 10 million is to be paid in advance. At the end of the lease term, Yasir has an option
to purchase Alpha at Rs. 7.14 million. It is reasonably certain that Yasir will exercise
this option.

(iii) On 1 August 2020, SAL leased Alpha to Faisal for a non-cancellable period of one and a
half years. Quarterly instalment of Rs. 3 million is to be paid in arrears. SAL will
dispose this unit of Alpha at the end of two years at an estimated residual value of
Rs. 11 million.
From the desk of Sir Majid Masood Page 5 of 7
TABANI’S SCHOOL OF ACCOUNTANCY
IFRS-16 LEASES

Direct cost of Rs. 1 million was incurred by SAL for each of the above arrangements. Market
rate of interest is 15% per annum.

Required:
Prepare journal entries for each of above lease transactions in the books of SAL for the year
ended 31 December 2020. (16)

Q.11. Munir Niazi Corporation a lessor, purchased a new machine for Rs.1,200,000 on December
31, 2015, which was delivered the same day (prior arrangement) to Ahmad Nadeem &
Company, the lessee.

Following information relating to lease transaction is available:

(i) The Lease Asset has an estimated useful life of 5 years, which coincides with the
Lease term.

(ii) At the end of lease term, Machine will revert to Munir Niazi Corporation, at which
time it is expected to have a residual value of Rs.100,000. (None of which is
guaranteed by Ahmad Nadeem & Company).

(iii) Munir Niazi Corporation’s implicit interest rate is 8% which is known to Ahmed
Nadeem & Company.

(iv) Ahmed Nadeem & Company’s incremental borrowing rate is 10% at December 31,
2015.

(v) Lease rentals consist of five equal annual payments, the first of which was paid on
December 31, 2015.

(vi) Both the lessor and the lessee use calendar year as their accounts period and
depreciate all fixed on straight line basis.

Required:
(a) Compute the annual rental under the lease.
(b) Compute the amounts of Gross Investment and unearned finance income that Munir
Niazi Corporation should disclose at the inception of the lease December 31, 2015.

Q.12. Copper Leasing Limited engaged in leasing of high-cost sports equipment undertook
following transactions on June 01, 2006:

(i) A speed boat of a famous brand ABC was given on 3 years lease to Mr. Carbon at an
annual lease rental of Rs.215,365 payable at the end of each year.

(ii) A motor boat of XYZ make was leased to Ms.Chlorine at an annual rent of
Rs.1,040,886 payable at the end of each year for three years. The price charged in
case of outright sale price of this boat is Rs. 2,500,000.

(iii) A water bike of XYZ make was leased to Mr. Sulphur at an annual rent of Rs.98,763
payable at the end of each year. The agreed lease term is three year's. Outright sales
price of this bike is Rs. 250,000.

(iv) The following additional information is available:

From the desk of Sir Majid Masood Page 6 of 7

TABANI’S SCHOOL OF ACCOUNTANCY
IFRS-16 LEASES
• The company is also a sole dealer of XYZ make in the city and operates an outlet
for that purpose.

• At the above outlet 25% area is used as company's administrative office.

• Outlet's rent and other maintenance expenditures are approximately Rs.660,000

per month.

• Marketing staff is given a commission at 2% of price of goods whether they are

leased or sold outright.

• The company paid Rs.3,770 to a local authority, for inspection of each unit.

• Registration charges incurred by the company for each unit of speed boat, motor
boat and water bike were Rs.3,500 Rs.22,500 and Rs.2,000, respectively.

• Cost of speed boat, motor boat and water bike were Rs.500,000 Rs.2,400,000 and
Rs.230,000, respectively.

• The ownership is transferred to lessees at the end of the lease.

• The company charges 9% markup on leases of water bikes as against prevailing

market rate of 11%.

Required:
(a) Compute gross investment in lease and ‘unearned financial income’ in respect of each
lease.
(b) Prepare all necessary journal entries on June 01, 2006 and on receipt of first rental.

Note: Present value of an annuity of Re.1 received at the end of the year for three years.

Rate 8% 9% 10% 11% 12% 13% 14%

Present Value 2.5771 2.5313 2.4869 2.4437 2.4018 2.3612 2.3216

Q.13. On 1 July 2021, Nonagon Leasing (NL) leased a machine to Decagon Limited (DL). Details are
as follows:
(i) The non-cancellable lease term is five years during which annual instalment of
Rs. 6 million is payable by DL in arrears.
(ii) DL has an option to extend the lease term by one year by paying Rs. 4 million at
start of sixth year. It is reasonably certain that DL will exercise this option.

(iii) NL estimates the residual value of the machine at the end of lease term to be
Rs. 10 million out of which DL has guaranteed Rs. 8 million. DL expects that the
machine will have market value of Rs. 5 million at the end of lease term.

(iv) NL incurred initial direct cost of Rs. 1 million.

(v) The rate of interest implicit in the lease is 11% per annum.

(vi) The useful life of the machine is eight years.

Required:
Prepare note(s) for inclusion in the financial statements of NL for the year ended 30 June
2022. (09)
From the desk of Sir Majid Masood Page 7 of 7