1. Chapter 18
Leasing

2. By the end of this chapter, you should be able to:
understand IFRS 16
account for leases by the lessee

3. IFRS 16
The approach taken in IFRS 16 is to define a lease based upon economic substance rather than legal form.
A contract does not need to be legally established as a lease for the contract to be regarded as a lease for financial reporting purposes.

4. IFRS 16 defines a lease as
A contract, or part of a contract, that conveys the right to use an asset for a period of time in exchange for consideration’.
In order for such a contract to exist, IFRS 16 states that the customer (user of the ‘identified asset’) needs to have the right to:
Obtain substantially all of the economic benefits from the use of the asset
The right to direct the use of the asset.

5. Right to direct use IFRS 16 or
the customer has the right to direct how and for what purpose the asset is used throughout its period of use;
the relevant decisions about use are pre-determined
and the customer has the right to operate the asset throughout the period of use without the supplier having the right to change these operating instructions. or

6. Measuring a ‘right of use asset’ IFRS 16
A ‘right of use asset’ should initially be measured at the present value of the minimum lease payments.
The discount rate used to determine present value should be the rate of interest implicit in the lease. This is basically identical to the old ‘IAS 17 approach for finance leases.

7. Measuring a ‘right of use asset’ IFRS 16
However the ‘right of use asset’ would also include the following amounts, where relevant:
Any payments made to the lessor at, or before, the commencement date of the lease, less any lease incentives received.
Any initial direct costs incurred by the lessee.
An estimate of any costs to be incurred by the lessee in dismantling and removing the underlying asset, or restoring the site on which it is located if obligations are recognised under IAS 37 – Provisions, Contingent Liabilities and Contingent Assets.

9. Option 1
You will occupy a certain area of XY cubic meters, but the specific place will be determined by the owner of the warehouse, based on actual usage of the warehouse and free storage. Option 1 does not contain any lease, because no asset can be identified. The reason is that the supplier (warehouse owner) can exchange one place for another and you lease only certain capacity. Therefore, you would account for rental payments as for expenses in profit or loss.

10. Option 2 You will occupy the unit no. 13 of XY cubic meters
in the sector A of that warehouse.
This place is assigned to you and
no one can change it during the duration of the contract.
Option 2 does contain a lease, because an underlying asset can be identified– you are leasing the unit no. 13 of XY cubic meters in the sector A.
Therefore, you need to account for this contract as for the lease and it means recognizing some asset and a liability in your balance sheet.

11. Present value (PV) lease payments or
Fair value
Asset cost lowest of
Depreciation period
shortest of
Estimated useful life Or
Lease period
Carrying value = Asset cost – Acc. Depreciation
Liability at a lease date = Asset cost

12. Finance charge = Total minimun lease payments
Less Asset cost
Finance charge
allocated over
the term of the lease
Acturial
Sum of digits
Straight line
Liability reduced by (Payment - finance charge)

13. This spreads the finance charge equally over the period of the lease.
Acturial
This applies a constant periodic charge to the balance of the leasing obligation and is calculated by applying present value factors to the annual lease payments
Sum of the digits
This method (‘Rule of 78’) is much easier to apply than the actuarial method. The finance charge is apportioned to accounting periods on a reducing scale – method used by Elliott & Elliott
Straight line
This spreads the finance charge equally over the period of the lease.

14. Illustration Boonaloo Ltd entered into a lease on following terms:
Fair value of the leased asset 20,000
Term of the lease 5 years
Annual lease payments in arrears £4,500
Expected value of asset at lease end nil
Implicit rate of interest 4%

15. Boonaloo Ltd - Compare FV with PV of minimum lease payment
FV of lease £ 20,000 PV of instalments: 4500(PVIFA4%,5) = 4500 x = 20,034 Lowest of fair value and PV is 20,000.

16. Boonaloo Ltd – step approach
Step 1 Capitalise lease at FV = £20,000
Step 2 Straight-line depreciation = £4,000
Step 3 Asset in statement of financial position
Carrying Depreciation Carrying
Year 1 20, – 4,000 = £16,000
Year 2 16, – 4,000 = £12,000
Year 3 12,000 – 4,000 = £8,000
Year 4 8, – 4,000 = £4,000
Year 5 4, – 4,000 = 0

17. Boonaloo Ltd – step approach
Step 4 Obligation at inception £20,000
Step 5 Finance charge (sum of digits)
Sum of digits = = 15
Total to be paid (4,500 x 5) = £22,500
Fair value of asset -£20,000
Finance charge £2,500
Allocate as follows:
Year 1 5/(15) × 2, £833
Year 2 4/(15) × 2, £667
Year 3 3/(15) × 2, £500
Year 4 2/(15) × 2, £333
Year 5 1/(15) × 2, £167
Take note: If payments were made in advance, there would be only 4 years to be considered .

18. Boonaloo Ltd – step approach
Step 6 Reduce the obligation
Cost
payment
balance
finance charge
balance c/f
20000
4500
15500
833
16333
11833
667
12500
8000
500
8500
4000
333
4333
-167
167

19. Boonaloo Ltd– income statement
Year Year 2 Year 3 Year 4 Year 5
Depreciation 4, , , , ,000
Finance charge

20. Balance sheet presentation year 1 year 2 year 3 year 4 year 5
Non Current Asset right to use
Cost
20000
Accumulated depreciation
4000
8000
12000
16000
Carrying value
Current liability
3833
4167
4333
Non-current liability
12500
8500