Intermediate Accounting 2 Portions of assets

PFRS 16 Leases • A portion of an asset is an identified asset if it is

physically distinct
Lease
• If not physically distinct, it is not an identified asset,
unless it represents substantially all of the capacity of the
• A contract, or part of a contract, that conveys the right
asset
to use an asset (the underlying asset) for a period of time
in exchange for consideration.
Substantive substitution rights
Parties to a Lease Contract
• An asset is not an identified asset if the supplier has the
1. Lessee – entity that obtains the right to use an substantive right to substitute it throughout the period
underlying asset of use

2. Lessor – entity that provides the right to use an Supplier’s right to substitute an asset is substantive if
underlying asset the following conditions exist:

An entity has the right to control an underlying 1. The supplier has the practical ability to substitute
asset when it has both of the following: alternative assets throughout the period of use

1. Right to obtain substantially all the economic benefits 2. The supplier would benefit economically from the
from the use of the asset exercise of its right to substitute the asset

2. Right to direct the use of the identified asset Supplier’s right to substitute an asset is not
substantive when substitution is made:
An asset can be identified by being: (identified
asset) 1. Only on a particular date or upon the occurrence of a
specified event
a. Explicitly stated in the contract
2. Only during repairs, maintenance or upgrading
b. Implicitly specified at the time it is made available for
use
NOTE: A supplier’s substitution right is presumed not substantive if it
is not readily determinable as substantive
Right to obtain economic benefits from use
• 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
• An entity considers only the economic benefits within
the defined scope of its rights to use the asset
b. Rights to change when the output is produced
c. Rights to change where the output is produced
d. Rights to change whether the output is
produced, and the quantity of the output
NOTE: Rights to operate or maintain the asset do not necessarily
grant the right to direct how and for what purpose the asset is used.
Protective Rights

• 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 does not prevent the
customer from having the right to obtain substantially all
of the economic benefits from use of the asset
• Include contractual restrictions designed to protect the
supplier’s interest in the asset or its personnel, or to
ensure compliance with laws or regulation
• Examples:

a. Specify the maximum amount of use

Right to direct the use
b. Limit when or where the customer can use the asset
• A customer has the right to direct the use of the asset if:
c. Require customer to follow certain operating
a. The customer has the right to direct how and
procedures
for what purpose the asset is used
d. Require customer to inform the supplier of changes
b. Asset’s use is predetermined and the supplier is on how asset will be used
precluded from changing that use

• The following may signify the existence of right to

change how and for what purpose the asset is used:

a. Rights to change the type of output

Flowchart: Identifying a Lease
Lease Term

• The non-cancellable period of lease

• Periods covered by an option to extend the lease if the

lessee is reasonably certain to exercise that option

• Periods covered by an option to terminate the lease if

the lessee is reasonably certain not to exercise that
option

NOTE: Includes any rent-free periods provided by the lessor to the

lessee.

Non-cancellable Period

• The period which the contract is enforceable

• A lease is no longer enforceable when both the lessee

and lessor can terminate the lease without permission
from each other

• If only the lessee has the right to terminate the lease, the
lessee should consider whether it is reasonably certain
or not

• If only the lessor has the right to terminate the lease, the
non-cancellable period of the lease includes the period
covered by the option to terminate the lease
The lessee may be reasonably certain to exercise an
option to extend if:

a. Lease payments on the extended period are expected

to be below market value

b. 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 if:

a. The cost of terminating the lease are significant

b. The leased asset is important to the lessee’s operations

Discount Rate

• Lease payments are discounted using the interest rate

implicit in the lease or the lessee’s incremental
borrowing rate if the former is not readily determinable

Incremental Borrowing Rate

• 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
ACCOUNTING FOR LEASES BY LESSEE
Recognition
• A lessee recognizes
a. Lease liability
b. Right of use asset
Initial measurement of Lease Liability
• 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
NOTE: 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.
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
NOTE:
e. Payment of penalties for terminating the lease, if the
lease term reflects the lessee exercising an option to
terminate the lease
Lease payments do not include:
a. Payments for non-lease elements (except when the
entity elects to apply the ‘practical expedient’)
NOTE: Practical expedient, according to PFRS 16, allows an entity to
elect not to separate the lease and non-lease component of a contract
and instead account for them as a single lease component
NOTE: 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
b. Payments in optional extension periods, unless the
extension is ‘reasonably certain’
c. Future changes in variable payments that depend on an
index or rate
d. Variable payments linked to the lessee’s future sales or
usage of the underlying asset
Fixed Payments
 • Payments made by the lessee to the lessor for the rent
to use the underlying asset during the lease term
• In-substance fixed payments – variable in legal form but
fixed in substance
• Examples:
a. Payments that must be made only if an asset is
proven to be capable of operating during the lease
b. Payments that must be made only if an event occurs
with no genuine possibility of not occurring
c. Payments that are initially variable but for which the
variability will be resolved at some point and the
payments become in-substance fixed when resolved
d. When there is more than one set of payments only
the realistic set of payments should be considered
Variable Payments
• Are payments made by the lessee for the right to use the
underlying asset during the lease term that vary because
of changes in facts or circumstances occurring after the
commencement date other than passage of time
• Payments that are based on an index or interest rate, foe
example, payments linked to consumer price index or
benchmark interest rate are included in the lease
payments
• The lease liability is remeasured when the index or
interest rate changes and the lease payments are revised
Residual Value
• 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
• A lessee includes the residual value 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 Guaranteed
• 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
NOTE: The guaranteed residual value is not taken into account when
computing for the depreciation because the residual value inures to
the benefit of the lessor.
NOTE: Any subsequent change in the amount expected to be payable
on the guarantee is treated as a reassessment of the lease liability and
an adjustment to the carrying amount of the right of use asset (and
consequently, the depreciation)
Unguaranteed Residual Value
 • The portion of the residual value of the underlying asset,
the realization of which by the lessor is not assured or is
guaranteed solely by a party related to the lessor
As to the lessee, a residual value is guaranteed if it is:
1. Guaranteed by the lessee
2. Guaranteed by a party related to the lessee
NOTE: When a lessee accounts for residual value, it means that the
asset will revert back to the lessor. If the asset will not revert back to
the lessor, for instance ownership will be transferred to the lessee, it
indicates that the residual value is not guaranteed because it inures to
the benefit of the lessee rather than the lessor
Right of Use Asset
• An asset that represents the right of a lessee to use an
underlying asset over the lease term in a finance lease
Initial Measurement of Right of Use Asset
• Right of use asset is initially measured at cost
• The cost comprises the following:
a. The amount of the initial measurement of lease
liability or the present value of the lease payments
b. Any lease payments made at or before the
commencement date, less any lease incentives
received
NOTE: 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.
c. Any initial direct costs incurred by the lessee
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
Subsequent Measurement of Lease Liability
• Subsequently measured similar to an amortized cost
financial liability (but remeasured to reflect any
reassessments or lease modifications
• Interest on 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
NOTE: 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 Right to Use Asset
• Subsequently measured in cost model
• Exception:
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
• The right of use asset is measured at COST:
a. Less any accumulated depreciation and any
accumulated impairment losses
b. Adjusted for any remeasurement of the lease liability
Depreciation
• Depreciate over its useful life if:
a. The contract provides for the transfer of ownership
to the lessee by the end of the lease term
b. There is a reasonable certainty that the lessee will
exercise a purchase option
• If the abovementioned conditions are not met, the
underlying asset shall be depreciated over the shorter of
the asset’s useful life and the lease term.
NOTE: Depreciation starts from the commencement date of the
lease.
Recognition exemptions
• A lessee may elect not to apply the recognition of lease
liability and right of use asset for:
a. Short-term leases
b. Leases for which the underlying asset is of low
value
Short-term lease
• A lease that has a term of 12 months or less at the
commencement date
NOTE: A lease that contains a purchase option is NOT a short-term
lease
• The election for short-term lease shall be made by class
of underlying asset
Low Valued Asset
 • The assessment of low value asset is based on the value
of the asset when it is new, regardless of the age of the
asset being leased
NOTE: If the leased asset is subleased, the head lease does not
qualify as a lease of a low-value asset
Accounting for short-term lease and low valued
asset
• The lessee may elect to recognize the lease payments 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
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 component
• Relative stand-alone price is the price that the lessor or
similar supplier would charge for a component
separately
• If a separate price is not readily available, the lessee shall
estimate it, maximizing the use of observable
information
Lease of Multiple Assets
• Right to use each asset is considered separate
lease if:
a. The lessee can benefit from the use of the
asset either on its own or with other
resources that are readily available to the
lessee
b. The underlying asset is neither highly
dependent on, nor highly interrelated with,
the other underlying assets in the contract
NOTE: If the criteria are not met, the right to use multiple assets is
considered a single lease component
Non-lease elements
• Considered a separate element if it transfers goods or
services to the lessee
• Examples:
a. Maintenance
b. Security Services
 c. Supply of utilities
GENERAL RECOGNITION
d. Supply of goods

e. Supply of operational services Lease Liability

• Payments for activities or costs that do not transfer

goods or services to the lessee are not separate
component of the contract

• Examples:

a. Administrative tasks
b. Real property taxes for which the lessor is liable
regardless of whether it has leased property
c. Insurance costs that protect the lessor’s investment
in the asset and, in which the lessor is the beneficiary

NOTE: The payments for these items are included in the total
consideration that is allocated to the separately identified component
of the contract
Right of Use Asset
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
Lease payments made to the lessor at or before
commencement
Advance Rent
• rentals are payable at the beginning of each
period Lease Bonus
• additional payment made by a lessee to a lessor to
induce granting of leasehold rights to the lessee
Reassessment of the lease liability
• 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
NOTE: Changes in the certainty and uncertainty of the lease 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 –
change in the amount payable under the purchase
option
NOTE: The revised discount rate is the interest rate implicit in the lease
for the remainder of the lease term. If that rate cannot be determined,
then use the incremental borrowing rate.

• 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
b. Change in the future lease payments resulting from
a change in an index or rate used to determine those
payments
Lease Modifications
• 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
• Example:
a. Adding or terminating the right to use one or more
underlying assets, or extending or shortening the
contractual lease term
• Accounted for as:
a. Separate lease
b. Remeasurement of the existing lease liability and
right of use asset
Separate Lease
• 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 in lease liability and right of use
asset
Not a Separate Lease
• Accounted for as a remeasurement of the existing lease
liability and right of use asset
• 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 • Interest expense on the lease liability is a component of
finance cost
• 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 asset are presented either:

a. Separately from other assets

b. Together with other assets as if they were

owned, with disclosure of the line items that
include the right of use assets

NOTE: Right of use asset that meet the definition of investment

property are presented as investment property

• Lease liabilities are presented either:

a. Separately from other liabilities

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

ACCOUNTING FOR LEASES BY LESSOR
Classification of lease by a lessor
1. Finance lease
• Transfers substantially all the risks and rewards
incidental to ownership of an underlying asset
2. Operating lease
• Does NOT transfer substantially all the risks and
rewards
NOTE: Risks includes:
• The possibility of losses from idle capacity and
technological obsolescence
• Variations in return because of changing economic
conditions
NOTE: Rewards may be represented by:
• The expectation of profitable operation
• Gain from appreciation in value or realization or
residual value
Indicators of a finance lease
a. The lease transfers ownership of the asset to the lessee
b. The lessee has the option to purchase the asset at a
price lower than the fair value at the date of the option
(bargain purchase option)
c. The lease term is for the major part of the economic life
of the asset even if title is not transferred
NOTE: Major part means at least 75% of the economic life of the
leased asset
d. The present value of the lease payments amounts to at
least substantially all of the fair value of the leased asset
at the inception date
NOTE: Substantially all means 990%of the fair value of the leased asset
e. The leased asset is of such specialized nature that only
the lessee can use it without major modifications
Other indicators of finance lease
a. If the lessee can cancel the lease, lessor’s losses
associated with the cancellation are borne by the lessee
b. Gain or loss from the fluctuation of fair value of the
residual accrue to the lessee
 c. The lessee has the ability to continue the lease for a
secondary period at a rent that is substantially lower
than market rent
Inception and commencement of lease
1. Inception date
• Earlier of the date of the lease agreement and
the date of commitment by the parties to the
principal provisions of the lease
• At this date:
a. A lease is classified as either finance or
operating lease
b. In case of a finance lease, the amounts to be
recognized at the commencement date are
determined
2. Commencement date
• The date on which a lessor makes an underlying
asset available for use by a lessee
• The date where the lessee is entitled to exercise
its right to use the leased asset
• Date of initial recognition
• Date of which journal entries are recorded
Finance Lease – Initial Measurement
• A lessor recognizes an asset from a finance lease as
receivable at an amount equal to the net investment in
the lease
NOTE: Net investment in the lease is the gross investment in the lease
discounted at the interest rate implicit in the lease
• The lessor derecognizes the leased asset and recognizes
finance lease receivable
NOTE: The receivable is treated as repayment of principal and finance
income to reimburse and reward the lessor for its investment and
services
Goss Investment in the lease
• Gross lease receivable
• The sum of:
a. The lease payments receivable by the lessor
b. Any unguaranteed residual value accruing to the
lessor
Unearned finance income
• Unearned interest income
• The difference between:
 a. The gross investment in the lease • Finance income (interest income) is computed using the
effective interest method and recognized in profit or loss
b. The net investment in the lease
• Lease payments are applied against the gross
Lease Payments investment in the lease to reduce both the principal and
the unearned finance income

1. Fixed payments, including in-substance, less lease NOTE: The lessor does not recognize depreciation because the leased
incentives payable asset is already derecognized

2. Variable lease payments based on index or rate Initial Direct Cost

3. Guaranteed residual value • Included in the initial measurement of the net
investment in the lease and reduce the amount of
4. Exercise price of purchase option, if reasonably certain income recognized over the lease term

5. Termination penalty, if reasonably certain • Incremental costs of obtaining a lease that would not
have been incurred if the lease had not been obtained,
Discount rate except for such costs incurred by a manufacturer or
dealer lessor in connection with a finance lease.
• Net investment is measured using the interest rate
implicit in the lease NOTE: Initial direct costs that are capitalized except direct costs
incurred by a manufacturer or dealer lessor under a sales type, which
• Sublease – the intermediate lessor may use the discount are expensed immediately.
rate used for the head lease (adjusted for any initial
direct cost associated with the sublease) to measure the Classification of Finance Lease by the lessor
net investment in the sublease
1. Direct financing lease
Subsequent measurement
2. Sales type lease
• Net investment in the lease (net investment receivable)
is subsequently measured similar to an amortized cost
financial asset
Direct Financing Lease Cost of Sale

• A lessor acquires assets and leases them with the • Equal to cost, or carrying amount if different, less the
intention of generating income through interest. present value of the unguaranteed residual value

Sales Type Lease Gross Profit

• A lessor is the manufacturer or a dealer of the asset
being leased and uses leasing as a means of marketing
the products.
• Accounted for like a direct financing lease, except that
the manufacturer or dealer lessor recognizes the
following at the commencement date:
• The difference between revenue and cost of sale
Residual Value
• Lessors account for both guaranteed and unguaranteed
residual value, provided the leased asset reverts back to
the lessor at the end of the lease term

a. Sales revenue Residual Value is guaranteed if guaranteed by:

b. Cost of Sale a. The lessee

c. Gross Profit b. A party related to the lessee

Sales Revenue c. A third party unrelated to the lessor that is financially

capable of discharging the obligations under the
• Measured at lower of: guarantee

a. Present value of lease payments, discounted using a NOTE: If the residual value is guaranteed, the PV of guaranteed
market rate of interest residual value is added to sales

b. Fair value of the asset NOTE: If the residual value is unguaranteed, the PV of the
unguaranteed residual value is deducted from cost of sales
NOTE: Gross Profit is the same whether the residual value is consideration reflects the standalone price for the
guaranteed or unguaranteed increase in scope.
NOTE: If the residual value is guaranteed, the lessee pays the lessor
any deficiency in the residual value.

NOTE: If the residual value is unguaranteed, the decline in residual

value is recognized by the lessor as impairment loss.

If residual value is:

Guaranteed Unguaranteed
• Net investment is equal to
selling price
• The portion of the asset
pertaining to the residual
value is considered sold
• PV of guaranteed residual
value is included in
selling price
• Net investment is not
equal to selling price
• The portion of the asset
pertaining to the residual
value is not considered
sold
• PV of
unguaranteed
residual value is deducted
from cost of sales

Lease Modifications

Lease modification is accounted for as a:

a. Separate lease

b. Remeasurement or derecognition of the net investment

in the lease

Separate lease

• Both the scope and consideration in the lease are

increased due to the addition of a right of use one or
more underlying assets and the increase in the