LEARNER GUIDE

ACCOUNTING 31

LEASES (IFRS 16)

(from the viewpoint of the lessee only)
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INTRODUCTION OF THE TOPIC

IFRS 16 Leases is a relatively new standard that has been published by the IASB (International
Accounting Standards Board). The standard on leases has been changed (from IAS 17 to IFRS 16) as
part of the project in the Improvements to International Accounting Standards. The overriding
motivation for the change in the accounting treatment for leases was to ensure that all leases appear
on an entity’s statement of financial position, thereby eliminating lease related ‘off-balance sheet’
items. The standard was issued on 1 January 2016 with an effective date of 1 January 2019 (early
adoption is allowable). The standard deals with the accounting treatment of leases from the viewpoint
of the lessee as well as the lessor, however only the viewpoint of the lessee is discussed in
Accounting 3AB.

Critical to your success in understanding leases is the ability to:

 Identify a lease
 Measure it according to the principles in the standard.
 Present and disclose leases from the viewpoint of the lessee in the financial statements
 Account for Tax implications and VAT relating to leases.

It is essential that you master the accounting treatment and disclosure in Accounting 3. Also pay
particular attention to the accounting entries (journals and ledger accounts).

NB
- As the standard is relatively new, old versions of the textbook should not be used.

PRIOR KNOWLEDGE

Basic understanding of leases, to identify, present and disclose in financial statements. Although you
will not be required to prepare an amortisation table, the understanding of a supplied amortization
table is CRITICAL to the topic of leases. In REK3AB, you will build on your basic knowledge of leases
and also learn to account for Tax and VAT implications of lease transactions.

RESOURCES

In order to master this topic you should make use of the following resources (and in the stated
order):

3.1 Class notes and slides.

3.3 Question bank questions and additional questions in this document.

3.5 Introduction to IFRS 9th Edition

Koppeschaar
Rossouw
Van Wyk
Gaie-Booysen
Papageorgiou
Van der Merwe
Schmulian
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LEARNING OUTCOMES

By the end of this topic, you should be able to:

• discuss the objective and scope of the standard on leases from the viewpoint of the lessee;
• identify, recognise, measure, present and disclose leases in an appropriate manner in the
financial statements of the lessee.
• integrate leases with other standards of IFRS e.g. PPE.
• recognise and measure tax implications (including VAT) for the aspects mentioned above by
means of the correct accounting procedure.
• apply the disclosure requirements of leases as prescribed by IFRS 16 to practical situations by
presenting and disclosing them correctly in a set of financial statements and
• discuss all aspects of IFRS in discussion questions from the perspective of a lessee.

ASSESSMENT POSSIBILITIES

Learners will be competent if they can:

• correctly identify, recognise, measure, present and disclose leases and the tax effects thereof in
the financial statements
• correctly integrate leases with other standards of IFRS.

LITERATURE

• IFRS 16: Leases

A guide through IFRS (South African Institute of Chartered Accountants)
Not the following paragraphs:
61 – 103 Lessor Accounting

• Learner guide and class notes

NB!!

- As the standard is relatively new, old versions of textbooks should not be used!
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IFRS 16 - Leases

1. Identification of a lease

In order to assess if the asset can be classified as a lease the following needs to be applied:

 At inception of a contract, an entity shall assess whether the contract is, or contains, a lease.
o A contract is, or contains, a lease if the contract conveys the right to control the use of an
identified asset for a period of time in exchange for consideration

o To determine whether a contract conveys the right to control the use of an identified
asset for a period of time, an entity shall assess whether, throughout the period of use,
the customer has both of the following:

a) The right to obtain substantially all of the economic benefits from the use of the
identified asset and
b) The right to direct the use of the identified asset.

2. Identified asset

 An asset is identified when it has been explicitly specified in a contract.

2.1 Substantive substitution rights

 Even if an asset is specified, a customer does not have the right to use an identified asset if the
supplier has the substantive right to substitute the asset throughout the period of use. A
supplier’s right to substitute an asset is substantive only if both of the following conditions exist:

a) The supplier has the practical ability to substitute alternative assets throughout the period of use
(for example, the customer cannot prevent the supplier from substituting the asset and
alternative assets are readily available to the supplier or could be sourced by the supplier within
a reasonable period of time) and
b) The supplier would benefit economically from the exercise of its right to substitute the asset (i.e.
the economic benefits associated with substituting the asset are expected to exceed the costs
associated with substituting the asset).

 If the supplier has a right or an obligation to substitute the asset only on or after either a particular
date or the occurrence of a specified event, the supplier’s substitution right is not substantive
because the supplier does not have the practical ability to substitute alternative assets throughout
the period of use.

 An entity will evaluate whether a supplier’s substitution right is substantive based on facts and
circumstances at inception of the contract.

 If the asset is located at the premises of the customer or elsewhere, the costs associated with
substitution are generally higher than when located at the supplier’s premises and, therefore, are
more likely to exceed the benefits associated with substituting the asset.

 The supplier’s right or obligation to substitute the asset for repairs and maintenance, if the asset is
not operating properly or if a technical upgrade becomes available does not preclude the customer
from having the right to use an identified asset

 If the customer cannot readily determine whether the supplier has a substantive substitution right,
the customer shall presume that any substitution right is not substantive.
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3. Right to obtain economic benefits from use

 To control the use of an identified asset, a customer is required to have the right to obtain
substantially all of the economic benefits from use of the asset throughout the period of use
 The economic benefits from use of an asset include its primary output (including potential cash
flows derived from these assets.

4. Right to direct the use

 A customer has the right to direct the use of an identified asset throughout the period of use
only if either:

a) The customer has the right to direct how and for what purpose the asset is used
throughout the period of use; OR
b) The relevant decisions about how and for what purpose the asset is used are
predetermine; and
c) The customer has the right to operate the asset (or to direct others to operate the asset in
a manner that it determines) throughout the period of use, without the supplier having the
right to change those operating instruction; OR
d) The customer designed the asset in a way that predetermines how and for what purpose
the asset will be used throughout the period of use.

4.1 How and for what purpose the asset is used

o A customer has the right to direct how and for what purpose the asset is used if the
customer can change how and for what purpose the asset is used throughout the period
of use.

o The following are examples that that the customer has the right to determine how and for
what purpose the asset is used:

a) Rights to change the type of output that is produced by the asset

b) Rights to change when the output is produced (for example, to decide when an item
of machinery or a power plant will be used)
c) Rights to change whether the output is produced, and the quantity of that output (for
example, to decide whether to produce energy from a power plant and how much
energy to produce from that power plant).

4.2 Decisions determined during and before the period of use

 The relevant decisions about how and for what purpose the asset is used can be
predetermined in a number of ways. For example, the relevant decisions can be
predetermined by the design of the asset or by contractual restrictions on the use of the
asset.
 In assessing whether a customer has the right to direct the use of an asset, an entity shall
consider only rights to make decisions about the use of the asset during the period of use,
unless the customer has designed the asset. Consequently, unless the customer
designed the asset an entity shall not consider decisions that are predetermined before
the period of use. For example, if a customer is able only to specify the output of an asset
before the period of use, the customer does not have the right to direct the use of that
asset. The ability to specify the output in a contract before the period of use, without any
other decision-making rights relating to the use of the asset, gives a customer the same
rights as any customer that purchases goods or services.
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5. Protective rights

 A contract may include terms and conditions designed to protect the supplier’s interest in the
asset or other assets, to protect its personnel, or to ensure the supplier’s compliance with laws or
regulations. These are examples of protective rights. For example a contract may:

a) Specify the maximum amount of use of an asset or limit where or when the customer can use
the asset;
b) Require a customer to follow particular operating practices; or
c) Require a customer to inform the supplier of changes in how an asset will be used.

 Protective rights typically define the scope of the customer’s right of use but do not, in isolation,
prevent the customer from having the right to direct the use of an asset.
 -7-
The following flowchart will assist you in making the assessment of whether a contract is, or contains, a
lease.

Is there an identified asset? No

Supplier has
Yes substitution rights?
Does the customer have the right to
obtain substantially all of the No
economic benefits from use of the
asset throughout the period of use?

Yes

Customer
Supplier
Does the customer, the supplier or
either party have the right to direct
how and for what purpose the asset
is used throughout the period of
use?
Neither; how and for what purpose the
asset will be used is predetermined

Does the customer have the right to

Yes operate the asset throughout the
period of use, without the supplier
having the right to change those
operating instructions?

No

No
Did the customer design the asset
in a way that predetermines how
and for what purpose the asset will
be used throughout the period of
use?

Yes

The contract contains The contract does not

a lease contain a lease
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When do we commence with the lease?

 Inception of the lease is the earlier of the date of the contract AND the date of commitment by the
parties to the principal provisions of the lease.
 The commencement of the lease term is the date from which the lessee is entitled to exercise its right
to use the leased asset. At this date the initial recognition of the lease takes place.

Lease Term

An entity shall determine the lease term as the non-cancellable period of a lease, together with both:
 Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise
that option; and
 Periods covered by an option to terminate the lease if the lessee is reasonably certain not to
exercise that option.

Accounting in the books of the LESSEE

1. Initial Recognition

 At the commencement date, a lessee shall recognise a right-of use asset and a lease liability.

Journal:

DR Right-of-use asset
CR Lease liability

2. Initial measurement

 Initial measurement of the right-of-use asset

At the commencement date, a lessee shall measure the right-of-use asset at a cost which
includes.
 The amount of the initial measurement of the lease liability;
 Any lease payments made at or before the commencement date;
 Any initial direct cost;
 An estimate of dismantling, removing or restoration costs.

 Initial measurement of the lease liability

 The lease liability will be measured at: the present value of the lease payments not yet
paid discounted at the interest rate implicit in the lease (or the lessee’s incremental
borrowing rate)
 The lease payments will include residual value guarantees and purchase options (that will
reasonably be exercised).
Note: The above will be given to you and you would not be required to calculate the lease
liability

 Subsequent measurement of right-of use asset

 The right-of-use asset will subsequently be measured by using the cost model (It is
therefore depreciated);
 The depreciation policy for depreciable leased assets shall be consistent with the
standard on property, plant and equipment (IAS 16).
 If ownership is acquired at the end of the lease term, depreciate the asset over the useful life.
 If ownership is not acquired, depreciate the asset over the shorter of the lease term and
its useful life.
  Subsequent measurement of lease liability

 The lease liability will subsequently be measured by Increasing the carrying amount to
reflect the interest on the lease and
 Reducing the carrying amount to reflect the lease payments

3. Lease exemptions

A lessee may elect not to apply the above requirements to

 Short-term leases; and

 Leases for which the underlying asset is of low value

Leases for which the underlying asset is of low value

 A lessee shall assess the value of an underlying asset based on the value of the asset
when it is new, regardless of the age of the asset being leased.
 The assessment of whether an underlying asset is of low value is performed on an
absolute basis. Leases of low-value assets qualify for the accounting exemption
regardless of whether those leases are material to the lessee
 If the above is applicable an entity shall recognise the lease payments associated with
those leases as an expense on either a straight-line basis over the lease term or another
systematic basis. The lessee shall apply another systematic basis if that basis is more
representative of the pattern of the lessee’s benefit.ie treated as a normal operating lease
ito the old IAS 17.

4. Disclosure

In the notes of the Statement of Financial Position

Asset (Part of IAS 16 note)

 Carrying amount per category (Beginning & end of period)

 Reconciliation of carrying amount
 Suitable description to indicate being a right-of-use asset

Liability (as long term loan note)

 Current and non-current portions

 Suitable description to indicate being a lease of a right-to-use asset
 Portion payable within one year transferred to current liabilities
 Appropriate details of repayment conditions of non-current portion
 Indication that it is secured
 Interest rate
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Commitments note
 Showing what is still payable on the lease

Example:

Minimum lease Future finance Present Value

payment payment
Payable:
Within 1 Year Xxx Xxx Xxx
Between 1 and 5 years Xxx Xxx Xxx
After 5 Years Xxx Xxx Xxx
xxx xxx xxx

Statement of comprehensive income

• Depreciation per category
• Profit/loss on sale of asset
• Interest as part of finance cost

Disclosure of short term lease or lease of asset with low value

Statement of financial position

 Commitments for future minimum lease payments:
< 1 year
1 <> 5 years Actual cash flows
> 5 years

Statement of comprehensive income

 Lease expenses per category e.g. office building, telephone system
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EXAMPLES

ACCOUNTING FOR LEASE – LESSEES PERSPECTIVE

1. Value added tax (VAT)

VAT is levied at the conclusion of the agreement and the lessee can immediately claim back all the
VAT as input tax. Installments include VAT.

Example:

Cost price R114 000(14% VAT included).

Three annual instalments of R50 000 each
Effective interest rate 15,09%
Tax rate 28%

In terms of SARS Rules, VAT may be claimed upfront

Accounting treatment:
Journals

Dr Right of use asset 100 000

Dr VAT-input account 14 000
Cr Lease obligation 114 000

The annual installment would then be divided between the capital and interest components according
to the applicable amortisation schedule.

Amortisation schedule:

Instalment Interest Capital Balance

- - - 114 000
Year 1 50 000 17 200 32 800 81 200
Year 2 50 000 12 250 37 750 43 450
Year 3 50 000 6 550 43 450 -
150 000 36 000 114 000

Journals

Year 1 Year 2 Year 3

Dr Finance charges 17 200 12 250 6 550
Cr Lease Obligation 17 200 12 250 6 550

Years 1 – 3

Lease Obligation 50 000

Bank 50 000
 -12-

2. Taxation (SA Normal Tax)

Temporary differences result between the lease instalment claimed for tax purposes and the
depreciation and interest expense recognised for accounting purposes.
Asset:
Carrying amount = Cost price less accumulated depreciation
Tax base = Amount deductible in future
Liability:
Carrying amount = Outstanding lease obligation
Tax base = CA - amount deductible in future

Example: See VAT above

Add the following: Depreciation 15% p.a. straight line

Amortisation schedule: See VAT above

Asset CA TB TD

1/1/.1 100 000 - 100 000

For .1 (15 000) - (15 000)
31/12/.1 85 000 - 85 000
For .2 (15 000) - (15 000)
31/12/.2 70 000 - 70 000
For .3 (15 000) - (15 000)
31/12/.3 55 000 - 55 000
For .4 (15 000) - (15 000)
31/12/.4 40 000 - 40 000
For .5 (15 000) - (15 000)
31/12/.5 25 000 - 25 000
For .6 (15 000) - (15 000)
31/12/.6 10 000 - 10 000
For .7 (10 000) - (10 000)
31/12/.7 - - -

Liability CA TB TD

1/1/.1 114 000 14 000 100 000

For .1 (32 800) (4 667) (28 133)
31/12/.1 81 200 9 333 71 867
For .2 (37 750) (4 667) (33 083)
31/12/.2 43 450 4 666 38 784
For .3 (43 450) (4 666) (38 784)
31/12/.3 - - -
 -13-

TD Asset TD Liability Net TD DTL (28%)

1/1/.1 100 000 100 000 - -

For .1 (15 000) (28 133) 13 133 3 677.24
31/12/.1 85 000 71 867 13 133 T 3 677.24
For .2 (15 000) (33 083) 18 083 5 063.24
31/12/.2 70 000 38 784 31 216 T 8 740.48
For .3 (15 000) 38 784 23 784 6 659.52
31/12/.3 55 000 - 55 000 T 15 400
For .4 (15 000) - (15 000) (4 200)
31/12/.4 40 000 - 40 000 T 11 200
For .5 (15 000) - (15 000) (4 200)
31/12/.5 25 000 - 25 000 T 7 000
For .6 (15 000) - (15 000) (4 200)
31/12/.6 10 000 - 10 000 T 2 800
For .7 (10 000) - (10 000) (2 800)
31/12/.7 - - - -

Journals
Year 1 Year 2 Year 3
Dr Tax expense 3 677.24 5 063.24 6 659.52
Cr DT account 3 677.24 5 063.24 6 659.52
Provide DT
Year 4 Year 5 Year 6 Year 7

Dr DT account 4 200 4 200 4 200 2 800

Cr Tax expense 4 200 4 200 4 200 2 800
Appropriation of DT account
 -14-
SHORT TERM/ LOW VALUE LEASES

1. Value added tax (VAT)

SHORT TERM/LOW VALUE LEASE

VAT is levied on each individual lease payment. A lease payment includes VAT. Lease expenses
(statement of comprehensive income) excludes VAT. Assume the lease meets the criteria for the
practical expedient for low value leases offered by IFRS 16.
1.1 Even lease
Example:
Annual installment R11 400 (14% VAT included) for four years
Tax rate 28%
Accounting treatment:
Journals
Years 1 – 4

a) Lease expense (P/L) 10 000

VAT-input account
1 400
Bank 11 400

1.2 Uneven lease

With an uneven lease VAT can only be claimed when the lessee becomes liable for the lease
instalment. In other words, VAT cannot be claimed when applying the matching concept.
A. Pre-paid
Example:
Annual instalment year 1 & 2 R10 000 p.a. (excl. 14% VAT)
Annual instalment year 3 & 4 R8 000 p.a. (excl. 14% VAT)
Tax rate 28%
Accounting treatment:
Average instalment = [(2 x 10 000) + (2 x 8 000)]/4 = 9 000 p.a.
Journals
Year 1 & 2

a) As above
b) Dr Pre-paid Lease (F/P) 1 000
Cr Lease expense (P/L) 1 000
(NB! No VAT written back)

Year 3 & 4

a) Dr Lease expense (P/L) 8 000

Dr VAT - input account 1 120
Cr Bank 9 120

b) Dr Lease expense (P/L) 1 000

Cr Pre-paid expense (F/P) 1 000
 (NB! No extra VAT claimed)

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B. Provision made
Example:

Annual instalment year 1 & 2 R8 000 p.a. (excl. 14% VAT)

Annual instalment year 3 & 4 R10 000 p.a. (excl. 14% VAT)

Accounting treatment:

Average instalment = R9 000

Journals
Year 1 & 2

a) Dr Lease expense (P/L) 8 000

Dr VAT - input account 1 120
Cr Bank 9 120

b) Dr Lease expense (P/L) 1 000

Cr Provision for Lase (F/P) 1 000
(NB! No extra VAT claimed)

Year 3 & 4

a) Dr Lease expense (P/L) 10 000

Dr VAT - input account 1 400
Cr Bank 11 400

b) Dr Provision Lease (F/P) 1 000

Cr Lease expense (P/L) 1 000
(NB! No VAT written back)

2. Taxation (SA Normal Tax)

1.1 Even lease

Temporary differences will not result from an even lease because the lease expense
(accounting) is equal to the lease payment (tax).

1.2 Uneven lease

Temporary difference result only from uneven leases where lease instalments are paid in
advance or when provision is made for instalments in arrears.

A. Pre-paid lease
Carrying amount = Pre-paid amount
Tax base = Amount that is deductible in future periods
= nil (would be like this because the full amount paid would be
deducted, for tax purposes, in the year of actual payment).
 Example: See VAT 1.2 (A)
Year 1 & 2 Year 3 & 4
Paid 10 000 8 000
Expense 9 000 9 000
Pre-paid 1 000
Underpaid 1 000

CA TB TD DTL (28%)
1/1/.1 - - - -
For .1 1 000 - 1 000 280
31/12/.1 1 000 - 1 000 T 280
For .2 1 000 - 1 000 280
31/12/.2 2 000 - 2 000 T 560
For .3 (1 000) - (1 000) (280)
31/12/.3 1 000 - 1 000 T 280
For .4 (1 000) - (1 000) (280)
31/12/.4 - - - -

Journals
Year 1 & 2
Dr Tax expense 280
Cr DT account 280
Provide DT
Year 3 & 4
Dr DT account 280
Cr Tax expense 280
Appropriation of DT account

B. Provision made on an lease

Carrying amount = Amount provided

Tax base = Carrying amount less the amount that will be deductible in
future periods
= nil (would be like this because only the amount actually paid, would be
deducted for tax).

Example: See VAT 1.2 (B)

Year 1 & 2 Year 3 & 4

Paid 8 000 10 000

Expense 9 000 9 000
Underpaid 1 000
Pre-paid 1 000

CA TB TD DTA (28%)

1/1/.1 - - - -
For .1 1 000 - 1 000 280
31/12/.1 1 000 - 1 000 D 280
For .2 1 000 - 1 000 280
31/12/.2 2 000 - 2 000 D 540
For .3 (1 000) - (1 000) (280)
31/12/.3 1 000 - 1 000 D 280
For .4 (1 000) - (1 000) (280)
 31/12/.4 - - - -

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Journals
Year 1 & 2

Dr DT account 280
Cr Tax expense 280
Establish a DT account
Year 3 & 4

Dr Tax expense 280

Cr DT account 280
Appropriation of DT account

INSTALMENT SALE AGREEMENT

Accounting treatment of instalment sale agreements

- IAS 17 handles this in par 1 and 6.

- Definition: par 6.
- Accounting treatment same as lease. It is a purchase transaction, not a rental agreement. However, tax
treatment differs as ownership passes upfront and thus SARS recognizes the asset and corresponding
wear and tear allowance will be allowed as a deduction, not the repayments.

INSTALMENT SALE AGREEMENT E.G. HIRE PURCHASE CONTRACTS

1. Value added tax (VAT)

VAT is levied at the conclusion of the agreement and therefore the lessee can claim it immediately as
input tax. Installments (cheque) exclude VAT.

Example:

Cost price R114 000 (14% VAT included).

VAT payable immediately
Deposit R20 000 (immediately payable)

Three annual instalments of R45 000 each

Effective interest rate 31,53%
Tax rate 28%
Accounting treatment:

Journals
Year 1
Dr PPE 100 000
Cr ISA Installment liability 100 000

Dr VAT-input account 14 000

Dr ISA Installment liability 20 000
Cr Bank 34 000

Years 1 – 3
Dr ISA installment Liability 45 000
 Cr Bank 45 000

The annual installment would then be divided between the capital and interest components according
to the applicable amortisation schedule.

Amortisation schedule:

Instalment Interest Capital Balance

- - - 80 000
Year 1 45 000 25 224 19 776 60 224
Year 2 45 000 18 988 26 012 34 212
Year 3 45 000 10 788 34 212 -
135 000 55 000 80 000

Journals
Year 1 Year 2 Year 3
Dr Finance charges 25 224 18 988 10 788
Cr ISA Liability 25 224 18 988 10 788

Years 1 - 3
DR ISA Liability 45 000
CR Bank 45 000

2. Taxation (SA Normal Tax)

Temporary differences may result because a wear and tear allowance and interest paid can be claimed
for tax purposes while depreciation and interest expense are recognised for accounting purposes.
Asset:
Carrying amount = Cost price less accumulated depreciation
Tax base = Cost price less wear and tear allowance
Liability:
Carrying amount = Outstanding ICA amount
Tax base = Carrying amount

Example: See VAT above

Add the following: Depreciation 15% p.a. straight line

Wear & tear 20% p.a. straight line
Tax rate 28%
 -19-

Asset CA TB TD DTL (28%)

1/1/.1 100 000 100 000 - -

For .1 (15 000) (20 000) 5 000 1 400
31/12/.1 85 000 80 000 5 000 T 1 400
For .2 (15 000) (20 000) 5 000 1 400
31/12/.2 70 000 60 000 10 000 T 2 800
For .3 (15 000) (20 000) 5 000 1 400
31/12/.3 55 000 40 000 15 000 T 4 200
For .4 (15 000) (20 000) 5 000 1 400
31/12/.4 40 000 20 000 20 000 T 5 600
For .5 (15 000) (20 000) 5 000 1 400
31/12/.5 25 000 - 25 000 T 7 000
For .6 (15 000) - (15 000) (4 200)
31/12/.6 10 000 - 10 000 T 2 800
For .7 (10 000) - (10 000) (2 800)
31/12/.7 - - - -

Journals

Years 1 - 5

Dr Tax expense 1 400

Cr DT account 1 400
Provide DT

Year 6 Year 7

Dr DT account 4 200 2 800

Cr Tax expense 4 200 2 800
Appropriation of DT account