IFRS 16 - LEASES

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 What is a lease?
A lease is a contract that conveys the right to
use an asset, the underlying asset, for a period
of time in exchange for a consideration.

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Lease Accounting by the Lessee
 Lessee reports lease assets and liabilities on
balance sheet,
Optional exceptions to exclude from balance sheet (rules):
 Short-term leases
– leases for which it is not ‘reasonably certain’ that
the term will be >12 months.
 Low-value asset leases
– Leases of assets with a value when new of $5,000
or less. Eg. Tablets, computers and small office
equipment
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IFRS 16: Identifying a Lease
 A lease is a contract , or part of a contract,
that conveys the right to use an asset, the
underlying asset, for a period of time in
exchange for consideration.
 Assess whether a contract contains a lease on
the basis of whether the customer has the
right to control the use of an identified asset
for a period of time.

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Assessing if a contract is a lease contract

 Is there an identified asset?

 Does the lessee obtain the economic benefits?
 Does the lessee have the right to direct use?
 If the contract does not contain a lease; apply
other applicable IFRSs

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 Identified asset-(Substitution Right)
 In many situations, it may be clear that a lease
contains an identified asset.
 In some contracts the lessors retain a substantive
right to substitute the asset throughout the period of
use.
 In such cases, the ‘specified asset’ criterion would not
be met and the contract would not contain a lease.
 A supplier’s right to substitute an asset would be
substantive if both of the following conditions are met:
 The supplier has the practical ability to substitute
alternative assets throughout the period of use; and
 The supplier would benefit economically from the
exercise of its right to substitute the asset.
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 Check Your Understanding
A sandwich company, Organic Subs, enters
into a contract with a property owner, Mallex,
to use a space in a mall.
The contract states the amount of space and
that the space may be located at any one of
several space allotments within the mall.
Mallex has the right to change the location of
the space allocated at any time during the
period of use, although it is required to
compensate Organic Subs for any costs of
relocation.
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Check Your Understanding
There are minimal costs to Mallex associated
with changing the location and Organic Subs
uses a kiosk (that it owns) that can be moved
easily.
There are several areas in the mall that are
available and that would meet the
specifications for the space in the contract.
Required:
a) Does Mallex have a substantive substitution
right in the contract?
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Test Your Understanding
b) Would the conclusion of Mallex’s
substantive substitution right change if
Organic Subs sold sandwiches from a retail
unit (rather than a kiosk) which had
undergone a custom refurbishment so that it
was the same as other Organic Sub
franchises?

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Identified asset- Portions of Assets
A capacity portion of an asset may be an identified
asset if it is physically distinct (e.g. a floor of a
building).
 A capacity portion of an asset that is not distinct is not
an identified asset, unless it represents substantially all
of the capacity of the asset.
 In this latter situation, the customer in essence has the
right to obtain substantially all of the benefit from the
underlying asset itself.
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Obtaining Economic Benefits
 Analyze whether the customer has the right to
obtain substantially all of the economic
benefits from use of the asset
 Ways that this may be demonstrated include
having exclusive use of the asset throughout
the period of the contract or by sub-leasing
the asset.
 Economic benefits from use of the asset
include its primary outputs (e.g. finished
goods for a manufacturer to sell) and
byproducts, including potential cash flows
that derive from these items.
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Right to Direct Use of the Asset
A customer has the right to direct how and for what
purpose an asset is used if, within the scope of its right
of use defined in the contract, it can change how and
for what purpose the asset is used throughout the period
of use.
 Examples of decision-making rights include:
 Rights to change the type of output that is produced by the asset
(e.g. What type of food certain food processing equipment
produces);
 Rights to change when the output is produced (e.g. the regular
operating hours);
 Rights to change where the output is produced (e.g. the physical
location of machinery); and
 Rights to change whether the output is produced, and the quantity

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Recognition & Measurement by Lessee

Recognition

At the commencement date a lessee shall recognize a right-of-

use asset and a lease liability.

 Measurement

Initial measurement of the right-of-use asset.

At the commencement date, a lessee shall measure the right-of-
use asset at cost.
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 Recognition

The Cost of the right-of-use asset comprises:

1. The amount of the initial measurement of the lease liability.

2. Any lease payments made at or before the commencement date,

less any lease incentives received.

3. Any initial direct cost incurred by the lessee.

4. An estimate of costs to be incurred by the lessee in dismantling and

removing the underlying asset.

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 Recognition
Initial Measurement of the lease liability.
 At the commencement date, a lessee shall measure the lease
liability at the present value of the lease payments that are
not paid at that date.

 The lease payments shall be discounted using the interest rate

implicit in the lease, if that rate can be readily determined.

 If the implicit interest rate can not be readily determined, the

lessee shall use the lessee's incremental borrowing rate.

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Determining the Lease Term
 The lease term includes the following:
a) The non-cancellable period of the lease
b) Periods covered by an option to extend the lease if the
lessee is reasonably certain to exercise that option and
c) Periods covered by an option to terminate the lease if
the lessee is reasonably certain not to exercise that
option
 The lease term begins at the commencement date
(i.e. the date on which the lessor makes the
underlying asset(s) available for use by the lessee)
 The term includes any rent-free or reduced rent
periods provided to the lessee by the lessor.
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 Recognition and Measurement
 The components of future lease payments
include:
Fixed Payments
Certain Variable Payments
Residual Value Guaranteed
Purchase Options
Termination Costs
Less Payments Made Previously
 Allcomponents of the liability are added
together and discounted at an appropriate rate
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 Variable Lease Payments

 Payments that vary according to an index or rate.

Are included in the lease liability & asset at the
measurement date.
 The lease liability is re-measured when the index or rate
changes
 Payments that vary based on future usage of the leased asset
Are not included in the lease liability or asset

Are recognized as an expense in the period in which the

event or condition that triggers the payment takes place.

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Example 1: variable payment

Company W leases a production line. The lease

payment depend on the number of operating
hours of the production line i.e. W has to pay
Birr1000 per hour of use. The annual minimum
payment is Birr 1,000,000. Expected usage per
year is 1,500 hours.
Required:
Identify the amount of lease liability in the
initial measurement

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Example 2: variable payment
Company Y rents an office building. The lease term
is five years and the initial annual rental payments is
Birr 2,500,000. Payments are made at the end of
each year. The rent will be reviewed every year and
increased by the change in the consumer price index
(CPI). The discount rate is 5%. Assume during the
first year CPI increase by 5%,
a) what will be the initial measurement of the lease
liability?
b) What is the liability balance at the end of year 1?

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Subsequent Recognition
Subsequent Measurement of right-of-use asset
 After the commencement date a lessee shall measure the right-of-
use asset applying a cost model unless it applies either the fair value
model or the revaluation model.

Subsequent Measurement of lease liability

 After the commencement date, a lessee shall

measure the lease liability by:

A. Increasing the carrying amount to reflect the interest on the lease

liability.
B. Reducing the carrying amount to reflect the lease payment
made.
C. Remeasuring the carrying amount to reflect any reassessment or
lease modification.Tuesday, September 01, 20 24
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Example – Initial Recognition of a Lease
Entity Z (the lessee) enters into a 10-year lease of a
floor of a building, with an option to extend for 5
years. Lease payments are $50,000 a year during the
initial term and $ 55,000 per year during the
optional period, all payable at the beginning of each
year.
To obtain the lease, lessee incurs initial direct costs
of $15,000. At the commencement date, the lessee
concludes that it is not reasonably certain to exercise
the option to extend the lease. The rate implicit in
the lease is not readily determinable. The lessee’s
incremental rate of borrowing is 5% per annum.
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Example Cont…

To record the initial value of the lease asset

and liability:
Dr Right-of-use asset 420,391a
Cr Lease liability 355,391b
Cr Cash 65,000

aPV of 9 payments at 50,000, discounted at 5% + 50,000

+ 15,000
bPV of 9 payments at 50,000, discounted at 5%.

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Example : classifying leases payments
• On 1 January 2015 Entity enters as lessee into
a 5 year non‑cancellable lease over a machine
when the machine’s cash cost =
ETB1,000,000.
• Terms of the lease:
5 equal annual lease payments of ETB 263,797
starting on 31/12/2015. Implicit rate of return is
10%.
• Assume straight line depreciation method
• The lease amortisation table is set out on the
next slide…
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Example : classifying lease payments
  Liability at Finance Payment on Payment Liability at
1-Jan cost for the 31 of Lease 31-Dec
year December liability

2015
1,000,000 100,000 (263,797.49) 163,797.49 836,202.51
2016
836,202.51 83,620.25 (263,797.49) 180,177.24 656,025.27
2017
656,025.27 65,602.53 (263,797.49) 198,194.96 457,830.31
2018
457,830.31 45,783.03 (263,797.49) 218,014.46 239,815.85
2019
239,815.85 23,981.58 (263,797.49) 239,815.85 0.00
  318,987.39 1,318,987.39    
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Example : lessee accounting…

At what amount, if any, would the right of

use asset and lease liability be measured in
Entity’s 31/12/2016 financial statements: IFRS 16

Statement of Financial Position:

- Right of use asset (property, plant and equip) ?

- Lease liability: non-current ?

- Lease liability: current ?
Statement of Profit or Loss:
- Depreciation expense ?
- Finance costs ?
- Lease expense ?

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Example 2: classifying leases
 On 1 January 2015 Entity enters as lessee into a 5 year
non‑cancellable lease over a photocopier when the
photocopier’s cash cost = Br10,000.
 Terms of the lease:

◦ 5 equal annual lease payments of Br2,638 starting on

31/12/2015 (payment in arrears). The implied rate of return
is 10%.

◦ upon paying the final lease payment legal ownership of the

photocopier transfers from the lessor to Entity.
 The lease amortisation
Tuesday,table is01,set
September 20 out on the next slide… 30
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 Example 2: classifying leases
Liability at Finance Payment Liability at
1 January cost for on 31 31
the year December December

2015
10,000 1,000 (2,637.97) 8,362.03
2016
8,362.03 836.20 (2,637.97) 6,560.26
2017
6,560.26 656.03 (2,637.97) 4,578.32
2018
4,578.32 457.83 (2,637.97) 2,398.18
2019
2,398.18 239.82 (2,638.00) 0
3,189.88 13,189.88

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Example 2: lessee accounting
Assuming the amounts are material, at IFRS 16 if IFRS 16 if
what amount (if any) would the right of ‘small ticket ‘small ticket
use asset and lease liability (and changes item item exemption’
therein in the period) be measured in exemption’ used
Entity’s 31/12/2016 financial statements: not used

Statement of Financial Position:

Right of use asset (PPE) ? ?

- Lease liability: non-current ? ?

- Lease liability: current ? ?
Statement of Profit or Loss:
- Depreciation expense ? ?
- Finance costs ? ?
- Lease expense ? ?

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PRESENTATION
• Statement of Financial Position
– Right-of-use assets: separate from other assets or same line as
underlying asset type and disclose.
– Lease liabilities separate from other liabilities or disclose line
item.
• Statement of Profit and Loss
– Interest cost with other finance costs per IAS 1.
– Amortization of right-of-use assets.
• Statement of Cash Flows
– Cash payments of lease liabilities as financing activities.
– Cash payments for interest in accordance with IAS 7’s
requirements for interest paid.
– Short-term, low-value and variable lease payments within
operating activities.
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LEASE ACCOUNTING BY LESSOR
 IFRS 16 is substantially unchanged in most
respects from IAS 17 for lessor.
 Leases are classified as:
 Finance leases
 Operating leases
 Finance leases - Leases that transfer
substantially all of the risks and rewards
 Operating lease- Risks and rewards not
transferred
 For operating leases both the lessee and the
lessor will recognize an asset.
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 Risks and rewards of ownership

RISKS REWARDS

• Losses may arise from: • Gains may arise from:

 Idle capacity  Generation of profits from
use of asset
 Fall in asset value due to
technological  Future sale of asset which
obsolescence has increased in value

 Cost of maintenance and

repair

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Classification
Classification of
of Leases
Leases
Leases that DO NOT meet any of the four criteria are accounted for as
Operating Leases.

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 Accounting by the Lessor
Ex: ETHIO Company signs an agreement on January 1, 2018, to lease
equipment to Harar Company. The following information relates to this
agreement.

1. The term of the non-cancelable lease is 6 years with no

renewal option. The equipment has an estimated economic
life of 6 years.
2. The cost and fair value of the asset at January 1, 2010, is
£343,000.
3. The asset will revert to the lessor at the end of the lease term,
at which time the asset is expected to have a residual value of
£61,071, none of which is guaranteed.
4. The term involves equal annual rental payments of Br 64,400,
beginning on January 1, 2018.
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 Accounting by the Lessor
Amortization schedule that would be suitable for the lessor at a 10%
required return.

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 Accounting by the Lessor

Prepare all of the journal entries for the lessor for 2018.

1/1/10 Lease Receivable 343,000

Equipment
343,000

1/1/10 Cash 64,400

Lease Receivable
64,400

12/31/10 Interest Receivable 27,860

Interest Revenue
27,860
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 Accounting by the Lessor
Prepare all of the journal entries for the lessor for 2011.
1/1/11 Cash 64,400

Lease Receivable
36,540

Interest Receivable
27,860

12/31/11 Interest Receivable 24,206

Interest Revenue
24,206

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 Case Study 1
 Alpha Co. enters into a contract with Supplier for the use of a
truck for one week to transport cargo from Port Mombassa to
Addis Ababa. Supplier does not have substitution rights.
 Only cargo specified in the contract is permitted to be
transported on this truck for the period of the contract. The
contract specifies a maximum distance that the truck can be
driven. Alpha Co. is able to choose the details of the journey
(speed, route, rest stops, etc.) within the parameters of the
contract. Alpha Co. does not have the right to continue using
the truck after the specified trip is complete.
 The cargo to be transported, and the timing and location of
pick-up in Mobassa and delivery in Addis Ababa, are specified
in the contract.
 Alpha Co. is responsible for driving the truck from Mombassa to
Addis Ababa.
Does the contract constitute a lease?
Questions/ Suggestions

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 Case Study 1
 Alpha Co. enters into a contract with Supplier for the use of a
truck for one week to transport cargo from Port Mombassa to
Addis Ababa. Supplier does not have substitution rights.
 Only cargo specified in the contract is permitted to be
transported on this truck for the period of the contract. The
contract specifies a maximum distance that the truck can be
driven. Alpha Co. is able to choose the details of the journey
(speed, route, rest stops, etc.) within the parameters of the
contract. Alpha Co. does not have the right to continue using
the truck after the specified trip is complete.
 The cargo to be transported, and the timing and location of
pick-up in Mobassa and delivery in Addis Ababa, are specified
in the contract.
 Alpha Co. is responsible for driving the truck from Mombassa to
Addis Ababa.
Does the contract constitute a lease?
 Case Study 2
Facts
 Entity A is a large, multi-national technology company
with approximately 10 billion birr in its annual
operating budget. It enters into a contract to lease one
floor of an office building in Addis Ababa for total lease
cost of Br 50,000 per annum for two years. The
operations of the facility and the lease cost are
immaterial to Entity A.

 Determine If the floor can be assessed as low value

 Case Study 3
 Facts

Entity Z (the lessee) enters into a 5-year lease of a floor of a

building, with an option to extend the lease for a further 5
years. Lease payments are CU 50,000 per annum during the
initial term and CU 55,000 per annum during the optional
period, all payable at the beginning of each year. To obtain the
lease, Entity Z incurs initial direct costs of CU 25,000.
At the commencement date, Entity Z concludes that it is
reasonably certain to exercise the option to extend the lease.
Therefore the lease term is 10 years.
The rate implicit in the lease is not readily determinable.
Entity Z’s incremental borrowing rate is 5% per annum.

Assessment
Show the entries required to record the transaction
 Case Study 2
Facts
 Entity A is a large, multi-national technology company
with approximately 10 billion birr in its annual
operating budget. It enters into a contract to lease one
floor of an office building in Addis Ababa for total lease
cost of Br 50,000 per annum for two years. The
operations of the facility and the lease cost are
immaterial to Entity A.

 Determine If the floor can be assessed as low value

 Case Study 3
 Facts

Entity Z (the lessee) enters into a 5-year lease of a floor of a

building, with an option to extend the lease for a further 5
years. Lease payments are CU 50,000 per annum during the
initial term and CU 55,000 per annum during the optional
period, all payable at the beginning of each year. To obtain the
lease, Entity Z incurs initial direct costs of CU 25,000.
At the commencement date, Entity Z concludes that it is
reasonably certain to exercise the option to extend the lease.
Therefore the lease term is 10 years.
The rate implicit in the lease is not readily determinable.
Entity Z’s incremental borrowing rate is 5% per annum.

Assessment
Show the entries required to record the transaction