IFRS 16 Leases

Chapter 11
Definitions
 DEFINITIONS

1 Lease
A contract, or part of a contract, that conveys the
right to use an asset (an underlying asset) for a
period of time in exchange for consideration
2 Lessor
The entity that provides the right to use an underlying
asset in exchange for consideration

3 Lessee
4 Right-of-use asset
The entity that obtains the right to use an underlying Represents the lessee’s rights to use an underlying
asset in exchange for consideration asset for the lease term

Footnote 3
LESSEE ACCOUNTING

The lessee is the entity using the asset on

a day to day basis. It has the right-of-use

of the asset and the lessee will be paying

rentals,

At commencement, the lessee should

recognise:

• Lease liability

• Right-of-use asset

Footnote 4
Initial measurement
Lease liability

At present value of the lease payments that have not yet been
paid

Lease payments should include:

• Fixed payments over the lease term
• Amounts expected to be payable under residual value guarantees
• A residual value guarantee is provided by the lessee and states that the
underlying asset at the end of the lease term will not be worth less than a
specified amount.
• Options to purchase the asset that are reasonably certain to be exercised
• Termination penalties, if the lease term reflects the expectation that these will be
incurred.

Footnote 6
Right-of-use asset

At cost

The initial cost of the right-of-use asset comprises:

• The amount of the initial measurement of the lease liability
• Lease payments made at or before the commencement date
• Any initial direct cost
• The estimated cost of removing or dismantling the underlying asset, as per the
conditions of the lease.

Footnote 7
Lease term

The lease term is the length of time that the lessee has the right-of-use on an asset.

The lease term comprises:

• Non-cancellable period
• Periods covered by an option to extend the lease, if they are reasonably certain to
be exercised
• Periods covered by an option to terminate the lease, if these are reasonably
certain not to be exercised.

Footnote 8
ILLUSTRATION 1

Sadio leases a machine over a 5 year lease term from BH from 1 December 2015.
Rental payments of R75 000 are made in advance on 1 December each year and
the first instalment has just been paid.

The useful life of the asset is 7 years. A lease arrangement fee of R1 500 was
incurred by Sadio. The rate implicit on the lease cannot be readily determined but
the rate of incremental borrowing for Sadio is 8%.

Ownership of the asset is retained by the lessor at the end of the lease term.

Required
What would be the initial journal entry required to record the lease on 1 December
2015?

Footnote 9
ILLUSTRATION 1

Lease liability
PMT: 75 000
N: 4
I: 8%
PV: ?

PV = 248 410

Footnote 10
ILLUSTRATION 1

Right of use asset

Asset = lease liability + lease payments already made + initial direct costs

= 248 410 + 75 000 + 1 500

= 324 910

JOURNAL:
Dr Right of use asset 324 910
Cr Lease liability 248 410
Cr Cash 76 500

Footnote 11
EXERCISE 1

On 1 January 20X1, Dynamic entered into a two year lease for a truck. The contract
contains an option to extend the lease term for a further year. Dynamic believes that
it is reasonably certain to exercise his option. Trucks have a useful life of ten years.

Lease payments are R10 000 per year for the initial term and R15 000 per year for
the option period. All payments are due at the end of the year. To obtain the lease,
Dynamic incurs initial direct costs of R3 000. The lessor reimburses R1 000 of this
cost.
The interest rate for the lease is not readily determinable. Dynamic’s incremental
rate of borrowing is 5%.

REQUIRED:
Calculate the initial carrying amount of the lease liability and the right of use asset
and the provide the journal entries.
Footnote 12
EXERCISE 1

Lease liability
PMT: 10 000
N: 2
I: 5%
PV: 18 590

FV: 15 000
N: 3
I: 5
PV: 12 960

PV = 18 590 + 12 960 = 31 550

Footnote 13
EXERCISE 1

Right of use asset

Asset = lease liability + lease payments already made + initial direct costs -
reimbursement

= 31 550 + 3 0000 - 1 000

= 33 550

Footnote 14
EXERCISE 1

Journals:

Dr Right of use asset 31 550

Cr Lease liability 31 550

Dr Right of use asset 3 000

Cr Cash 3 000

Dr Cash 1 000
Cr Right of use asset 1 000

Footnote 15
Subsequent measurement
Lease liability

During the year, interest is charged in liabilities and payments

are made by the lessee. These transactions need to be taken
into account at year end.

The transactions will be processed as follows:

For interest charges:
Dr Finance costs (I/S)
Cr Lease liability (B/S)

For payments made:

Dr Lease liability
Cr Cash

Footnote 17
Lease liability
Opening Interest Rental Closing
balance payment balance
Year 1 X X (X) X
Year 2 X X (X) X

Dr Right of use asset Dr Lease liability

Cr Lease liability Cr Cash

Dr P/L (finance cost)

SOFP
Cr Lease liability

Footnote 18
Lease liability – payments in arrears

Opening Interest Rental Closing

balance payment balance

Year 1 X X (X) A
Year 2 X X (X) B

Current liability = A – B
Non-current liability = B

Footnote 19
Lease liability – payments in advance

Opening Lease Sub-total Interest Closing

balance payments balance

Year 1 X (X) X A
Year 2 X (X) B

Current liability = A – B
Non-current liability = B

Footnote 20
Right-of-use asset

At cost – Measured at initial cost less accumulated depreciation and

impairments

Depreciation is calculated as follows:

• If ownership of the asset transfers to the lessee at the end of the lease term then
depreciation should be charged over the asset’s remaining useful life
• Otherwise, depreciation is charged over the shorter of the useful life and the lease
term
.

Footnote 21
 Now that you have the theory
and principles covered, let us
work through some
illustrations and examples

Footnote 22
ILLUSTRATION 1

Sadio leases a machine over a 5 year lease term from BH from 1 December 2015.
Rental payments of R75 000 are made in advance on 1 December each year and
the first instalment has just been paid.

The useful life of the asset is 7 years. A lease arrangement fee of R1 500 was
incurred by Sadio. The rate implicit on the lease cannot be readily determined but
the rate of incremental borrowing for Sadio is 8%.

Ownership of the asset is retained by the lessor at the end of the lease term.

Required
Prepare the extracts to the financial statements for the year ended 30 November
2016

Footnote 23
ILLUSTRATION 1

Lease liability
PMT: 75 000
N: 4
I: 8%
PV: ?

PV = 248 410

Footnote 24
ILLUSTRATION 1

Right of use asset

Asset = lease liability + lease payments already made + initial direct costs

= 248 410 + 75 000 + 1 500

= 324 910

JOURNAL:
Dr Right of use asset 324 910
Cr Lease liability 248 410
Cr Cash 76 500

Footnote 25
ILLUSTRATION 1

The lease liability is increased by finance charges and decreased by the lease
payments.

Period Liability Repayment Sub- Interest Closing

total @8% balance
2016 248 410 (already 248 410 19 872 268 282
made)
2017 268 282 (75 000) 193 282 15 462 208 744

Current liability: 268 282 – 193 282 = 75 000

Non-current liability: 193 282
Finance cost: 19 872 expensed in the statement of profit or loss

Footnote 26
ILLUSTRATION 1

The right of use asset uses the cost model as at the year end and should be
depreciated
Depreciation: 324 910 / 5 = 64 980

Statement of profit or loss

Finance cost 19 872
Depreciation 64 980

Statement of financial position

Right-of-use asset 259 920
Current lease liability 75000
Non-current lease liability 193 282

Footnote 27
EXERCISE 1

On 1 January 20X1, Dynamic entered into a two year lease for a truck. The contract
contains an option to extend the lease term for a further year. Dynamic believes that
it is reasonably certain to exercise his option. Trucks have a useful life of ten years.

Lease payments are R10 000 per year for the initial term and R15 000 per year for
the option period. All payments are due at the end of the year. To obtain the lease,
Dynamic incurs initial direct costs of R3 000. The lessor reimburses R1 000 of this
cost.
The interest rate for the lease is not readily determinable. Dynamic’s incremental
rate of borrowing is 5%.

REQUIRED:
Prepare extracts from Dynamic’s financial statements in respect of the lease
agreement for the year ended 31 December 20X1
Footnote 28
EXERCISE 1

Lease liability
PMT: 10 000
N: 2
I: 5%
PV: 18 590

FV: 15 000
N: 3
I: 5
PV: 12 960

PV = 18 590 + 12 960 = 31 550

Footnote 29
EXERCISE 1

Right of use asset

Asset = lease liability + lease payments already made + initial direct costs -
reimbursement

= 31 550 + 3 0000 - 1 000

= 33 550

Footnote 30
EXERCISE 1

Journals:

Dr Right of use asset 31 550

Cr Lease liability 31 550

Dr Right of use asset 3 000

Cr Cash 3 000

Dr Cash 1 000
Cr Right of use asset 1 000

Footnote 31
Exercise 1

Right of use asset:

Depreciated over the three year lease term, because it is shorter than the useful life.

= 33 550 / 3 = 11 183

Lease liability:

Year ended Opening Interest (5%) Payments Closing

31/12/x1 31 550 1 578 (10 000) 23 128
31/12/x2 23 128 1 156 (10 000) 14 284

Footnote 32
Exercise 1

Statement of profit or loss

Finance cost 1 578
Depreciation 11 182

Statement of financial position

Right-of-use asset (33 550 – 11 183) 22 367
Current lease liability 8 844
Non-current lease liability 14 284

Footnote 33