Example 1: Separating lease/non-lease elements

Transcription

1 List of Examples N. Title Example 1 Example 2 Example 3 Example 4 Example 5 Example 6 Example 7 Example 8 Example 9 Example 1 Example 11 Example 12 Example 13 Example 14 Separating the lease element from the non-lease element Accounting for the lease by the lessee with incremental borrowing rate Accounting for the lease by the lessee with interest rate implicit in the lease Variable lease payments Lease remeasurement I. - updating the lease payments Lease remeasurement II. - change in the lease term Lease modifications I. - separate contract Lease modifications II. - change in the existing contract Lessors: Classification of leases Lessors: land and building elements in the lease Accounting for finance lease by the lessor Manufacturer / dealer lessors and finance lease Accounting for operating lease by the lessor Sale and leaseback

2 Example 1: Separating lease/non-lease elements On 1 January 2X1, Worker Corp. enters into a lease contract with Rentor, for the rent of 3 printers, a cutting system and a copy machine for 2 years. It is assumed that the machines will be returned back to Rentor. The economic life of all machines is 5 years. Worker will pay monthly payments of CU 5 for the following services: - CU 4 7 for the rent of all machines, - CU 2 for the maintenance of all machines, - CU 1 to reimburse Rentor's admin costs associated with the contract. Worker could have bought one printer for CU 6, a cutting system for CU 4 and a copy machine for CU 45 when paying cash. The third party company provides similar maintenance services for CU 3 per machine per month. Advise Worker and Rentor how to account for the contract under IFRS Assessment of leases Worker Rentor needs to account for a right-of-use asset (no classification) classifies a lease as operating 2. Allocation of a consideration Total consideration: 12 Item Stand-alone Allocated Proportion selling price consideration Printer 1 6, 21.9% 26, Printer 2 6, 21.9% 26, Printer 3 6, 21.9% 26, Cutting system 4, 14.6% 17, Copy machine 45, 16.42% 19,78.3 Maintenance 9, 3.28% 3, TOTAL 274, 1.% 12,. 3. Accounting Worker can either: - account for the whole contract as for the lease (i.e. total consideration of CU 12 = lease payments) - separate, and in this case: - printers, cutting system and copy machine: recognize a right-of-use asset and a lease liability for every machine (CU for 1 printer, etc.) - maintenance: recognize CU 164 (3 942/24 months) in profit or loss every month Rentor: - as a lessor, he has no choice. He needs to separate contracts and account for: - maintenance: recognize CU 164 as revenue in profit or loss every month - rent of machines: Rentor needs to classify the leases and account for them based on the classification (operating or finance)

3 Example 2: Accounting for the lease by the lessee with incremental borrowing rate On 1 January 2X1 Worker rents a car under the lease contract. The lease term is for 1 year, with the option to extend the lease with the same lease payments for another year. At the lease commencement date, Worker concludes that the option will not be exercised, because for the same rentals, the new car can be leased and also it's been Worker's practice to change the cars after 1 year. Monthly lease payments are CU 1 and Worker incurred the legal cost of CU 1 2 associated with negotiating the lease contract. How would this transaction appear in the financial statements of Worker at 31 December 2X1? 1. Assessment at the lease commencement The lease term = 1 year Reasons: - option to extend is at market rentals - common practice of Worker Short-term lease - exemption can be applied 2. Journal entries: 2.1 Transaction cost: Debit Prepayments Credit Cash Debit P/L - Lease expenses Credit Prepayments 1,2-1,2 1 on a monthly basis Monthly rentals: Debit P/L - Lease expenses Credit Cash 1, -1,

4 Example 2: Accounting for the lease by the lessee with incremental borrowing rate The same situation as above, but this time, Worker has an option to extend the lease term for CU 5 per month (1/2 of market rentals). Due to this favorable condition, Worker expects to extend the lease term. Monthly lease payments are CU 1 in arrears and Worker incurred the legal cost of CU 1 2 associated with negotiating the lease contract. How would this transaction appear in the financial statements of Worker at 31 December 2X1? Assume incremental borrowing rate = 3% p.a., the fair value of the car is CU Assessment at the lease commencement The lease term = 2 years Reasons: - option to extend is at below market rentals Regular lease (extended lease term) 4. Initial measurement: Annual discount rate: 3.% Monthly discount rate:.25% Monthly discount rate: Formula used: =(1+annual rate)^(1/12)-1 Total Month Lease payment Discount factor Present value of lease payment 1-1,.998-9, ,.995-9, ,.993-9, ,.99-9,92 5-1,.988-9, ,.985-9, ,.983-9, ,.98-9,85 9-1,.978-9, ,.976-9, ,.973-9, ,.971-9, ,.968-4, ,.966-4, ,.964-4, ,.961-4, ,.959-4, ,.957-4, ,.954-4, ,.952-4, ,.95-4, ,.947-4, ,.945-4, ,.943-4, ,427 = lease liability at the commencement date

5 Example 2: Accounting for the lease by the lessee with incremental borrowing rate Discount factor = 1/(1+rate)^month 5. Journal entries - initial recognition Debit Right-of-use asset Credit Lease liability Credit Cash 176, ,427-1,2 6. Subsequent measurement Month Lease liability Lease Decrease in Lease Interest b/f payment lease liability liability c/f 1 175,427-1, , , ,86-1, -49-9, , ,269-1, , , ,655-1, , , ,16-1, , , ,354-1, , , ,668-1, -29-9,71 17, ,959-1, ,734 98, ,225-1, ,758 88, ,467-1, ,782 78, ,685-1, ,86 68, ,879-1, -17-9,83 59, ,49-5, ,854 54, ,195-5, ,866 49, ,328-5, ,878 44, ,45-5, -11-4,89 39, ,56-5, -98-4,92 34, ,657-5, -85-4,915 29, ,743-5, -73-4,927 24, ,816-5, -61-4,939 19, ,877-5, -49-4,951 14, ,926-5, -37-4,963 9, ,963-5, -25-4,975 4, ,988-5, -12-4,988 Total -175,427

6 Example 2: Accounting for the lease by the lessee with incremental borrowing rate 7. Journal entries - subsequent measurement 1st monthly payment: Debit P/L - Interest expense Debit Lease liability Credit Cash 433 9,567-1, Total for the year 2X1: Debit P/L - Interest expense Debit Lease liability Credit Cash 3, ,378-12, Depreciation of right-of-use asset: Debit P/L - Depreciation Credit Right-of-use asset (depr.) 88,314-88,314

7 Example 3: Accounting for the lease by the lessee with interest rate implicit in the lease On 1 January 2X1 Stamper Co, producer of metal casts, enters into a lease contract to lease the stamping machine. Cash price of machine was 5 EUR and Stamper incurred additional costs of 2 EUR for arranging the lease contract. The lessors initial direct costs were CU 3. Economic life of stamping machine is 6 years. Lease term is 5 years, annual lease payments are 11 EUR payable 31 December each year. At the end of the lease term, Stamper has an obligation to purchase the machine for 1 EUR. There is no unguaranteed residual value of the lessor. How would this transaction appear in the financial statements of Stamper Co. at 31 December 2X1? 1. Initial recognition 1.1 Interest rate implicit in the lease: - put lease payments in the table - at the lease commencement, put FV of an asset plus lessor's initial direct costs. - lease commencement = year. If the lease payments are in advance, then deduct the 1st payment from the FV of an asset + lessor's initial direct costs - to the last period, add unguaranteed residual value of the lessor (it's in this case), - don't forget to add any price of exercising the option, etc. (here: 1 added to the last lease payment) Year Cash flow Lease commencement 53, 2X1 1-11, 2X2 2-11, 2X3 3-11, 2X4 4-11, 2X , 3.11% 1.2 Present value of the lease payments: - you don't have to calculate it again - it's 53, isn't it? But, let me prove it you in the table below: Year Lease payment Discount factor Present value of lease payments 1-11,.97-16, , , ,.912-1, , , , ,225 Total -53, 1.3 Right-of-use asset: PV of the minimum lease payments: 53, Initial direct costs of the lessee: 2, 55, 1.4 Journal entry Recognition of asset / lease liability: Interest rate implicit in the lease = IRR(D2:D25) Debit Right-of-use asset Credit Cash Credit Lease liability 55, -2, -53, 2. Subsequent measurement

8 Example 3: Accounting for the lease by the lessee with interest rate implicit in the lease 2.1 Allocation of the lease payments Year Lease liability Lease Decrease in Lease Interest b/f payment lease liability liability c/f 1-53, -11, -15,66-94,34-48, ,66-11, -12,723-97, , ,383-11, -9,694-1,36-211, ,77-11, -6,571-13,429-17, , , -3,351-17,649-53, 2.2 Calculation of depreciation Cost of right-of-use asset: 55, Useful life in years: 6 Annual depreciation charge (55 / 6): 84, Journal entries Depreciation of ROU: Debit Depreciation expenses Credit Accum. dep. - ROU Annual payment in the 1st year: 84,167 Debit Interest expense 15,66-84,167 Debit Finance lease liability 94,34 Credit Cash -11,

9 Example 4: Variable lease payments On 1 February 2X1 Worker enters into a 4-year lease of the office space. The information about the contract is as follows: - Monthly payment is CU 2 at the time of the lease commencement. - Every 2 years on 1 February, the monthly payments are adjusted for the annual inflation rate prevalent at the time of adjustment. - If Worker installs new window blinds, then the lease payments decrease by CU 2 per month for the period of 1 year. Worker incurred the following expenditures related to the contract: - Legal fees associated with the contract: CU 5 - Salary of an employee who negotiated the contract: CU 1 (allocated based on the hourly wage) The property owner (lessor) provided a 3-month rent-free period to Worker as an initial bonus. Worker took the office space on 1 March 2X1, but due to unexpected events, Worker moved in the office space on 1 May 2X1. Inflation rates: in 2X1-2%, 2X2-2.3%, 2X3-2.1%. Incremental borrowing rate is 4% p.a. How would this transaction appear in the financial statements of Worker at 31 December 2X1?

10 Example 4: Variable lease payments 1. Initial measurement: Annual discount rate: 4.% Monthly discount rate:.33% Monthly discount rate: Formula used: =(1+annual rate)^(1/12)-1 Month 1 = lease commencement = 1 March 2X1 Month Lease payment Discount factor Present value of lease payment 3/2X /2X /2X /2X1 4-2,.987-1,974 7/2X1 5-2,.984-1,968 8/2X1 6-2,.981-1,961 9/2X1 7-2,.977-1,955 1/2X1 8-2,.974-1,948 11/2X1 9-2,.971-1,942 12/2X1 1-2,.968-1,936 1/2X2 11-2,.965-1,929 2/2X2 12-2,.962-1,923 3/2X2 13-2,.958-1,917 4/2X2 14-2,.955-1,911 5/2X2 15-2,.952-1,94 6/2X2 16-2,.949-1,898 7/2X2 17-2,.946-1,892 8/2X2 18-2,.943-1,886 9/2X2 19-2,.94-1,88 1/2X2 2-2,.937-1,873 11/2X2 21-2,.934-1,867 12/2X2 22-2,.931-1,861 1/2X3 23-2,.928-1,855 2/2X3 24-2,.925-1,849 3/2X3 25-2,.922-1,843 4/2X3 26-2,.919-1,837 5/2X3 27-2,.916-1,831 6/2X3 28-2,.913-1,825 7/2X3 29-2,.91-1,819 8/2X3 3-2,.97-1,813 9/2X3 31-2,.94-1,87 1/2X3 32-2,.91-1,81 11/2X3 33-2,.898-1,796 12/2X3 34-2,.895-1,79 1/2X4 35-2,.892-1,784 2/2X4 36-2,.889-1,778 3/2X4 37-2,.886-1,772 4/2X4 38-2,.883-1,766 5/2X4 39-2,.88-1,761 6/2X4 4-2,.877-1,755 7/2X4 41-2,.875-1,749 8/2X4 42-2,.872-1,743 9/2X4 43-2,.869-1,738 1/2X4 44-2,.866-1,732 11/2X4 45-2,.863-1,726 12/2X4 46-2,.86-1,721 1/2X5 47-2,.858-1,715 2/2X5 48-2,.855-1,71 Total -82,742 = lease liability at the commencement date Discount factor = 1/(1+rate)^month

11 Example 4: Variable lease payments 2. Journal entries - initial recognition Debit Right-of-use asset Credit Lease liability Credit Cash 87,742-82,742-5, 3. Subsequent measurement Month Lease liability Lease Decrease in Lease Interest b/f payment lease liability liability c/f 3/2X1 1-82, ,13 4/2X1 2-83, ,285 5/2X1 3-83, ,558 6/2X1 4-83,558-2, ,726-81,831 7/2X1 5-81,831-2, ,732-8,99 8/2X1 6-8,99-2, ,738-78,361 9/2X1 7-78,361-2, ,743-76,618 1/2X1 8-76,618-2, ,749-74,869 11/2X1 9-74,869-2, ,755-73,114 12/2X1 1-73,114-2, ,761-71,353 1/2X ,353-2, ,766-69,587 2/2X ,587-2, ,772-67,815 3/2X ,815-2, ,778-66,37 4/2X ,37-2, ,784-64,253 5/2X ,253-2, -21-1,79-62,463 6/2X ,463-2, -24-1,796-6,668 7/2X2 17-6,668-2, ,81-58,866 8/2X ,866-2, ,87-57,59 9/2X ,59-2, ,813-55,246 1/2X2 2-55,246-2, ,819-53,427 11/2X ,427-2, ,825-51,61 12/2X ,61-2, ,831-49,77 1/2X ,77-2, ,837-47,933 2/2X ,933-2, ,843-46,9 3/2X ,9-2, ,849-44,241 4/2X ,241-2, ,855-42,386 5/2X ,386-2, ,861-4,525 6/2X3 28-4,525-2, ,867-38,657 7/2X ,657-2, ,873-36,784 8/2X3 3-36,784-2, -12-1,88-34,94 9/2X ,94-2, ,886-33,19 1/2X ,19-2, -18-1,892-31,127 11/2X ,127-2, -12-1,898-29,229 12/2X ,229-2, -96-1,94-27,324 1/2X ,324-2, -89-1,911-25,414 2/2X ,414-2, -83-1,917-23,497 3/2X ,497-2, -77-1,923-21,574 4/2X ,574-2, -71-1,929-19,645 5/2X ,645-2, -64-1,936-17,79 6/2X4 4-17,79-2, -58-1,942-15,767 7/2X ,767-2, -52-1,948-13,818 8/2X ,818-2, -45-1,955-11,864 9/2X ,864-2, -39-1,961-9,93 1/2X4 44-9,93-2, -32-1,968-7,935 11/2X4 45-7,935-2, -26-1,974-5,961 12/2X4 46-5,961-2, -2-1,98-3,98 1/2X5 47-3,98-2, -13-1,987-1,993 2/2X5 48-1,993-2, -7-1,993 Total -82,742

12 Example 4: Variable lease payments 4. Journal entries - subsequent measurement 1st month: Debit P/L - Interest expense Credit Lease liability Total for the year 2X1: Debit P/L - Interest expense Debit Lease liability Credit Cash 2,611 11,389-14, Depreciation of right-of-use asset: Debit P/L - Depreciation Credit Right-of-use asset (depr.) 18,28-18,28

13 Example 5: Lease remeasurement I. - updating the lease payments Example 4 continues: On 1 February 2X3, Worker completed the installation of new window blinds and as a result, the lease payments will decrease by CU 2 monthly for the next 12 months (starting in February 2X3). Also, the lease payments are adjusted by the inflation rate as agreed in the contract. How would these transactions appear in the financial statements of Worker at 31 December 2X3? 1. Remeasurement of the lease liability The new lease payment: 2,42 (CU 2 x 1,21) Discount rate:.33% Month Lease payment Discount factor Present value of lease payment 2/2X3 1-2, ,35 3/2X3 2-2, ,29 4/2X3 3-2, ,22 5/2X3 4-2, ,15 6/2X3 5-2, ,9 7/2X3 6-2, ,2 8/2X3 7-2, ,996 9/2X3 8-2, ,989 1/2X3 9-2, ,983 11/2X3 1-2, ,976 12/2X3 11-2, ,97 1/2X4 12-2, ,963 2/2X4 13-2, ,957 3/2X4 14-2, ,951 4/2X4 15-2, ,944 5/2X4 16-2, ,938 6/2X4 17-2, ,932 7/2X4 18-2, ,925 8/2X4 19-2, ,919 9/2X4 2-2, ,913 1/2X4 21-2, ,97 11/2X4 22-2, ,9 12/2X4 23-2, ,894 1/2X5 24-2, ,888 2/2X5 25-2, ,882 Total -48,94 = lease liability at the remeasurement date date Adjustment: Lease liability before remeasurement: -47,933 Lease liability at the remeasurement date: 48,94 Change: 96,873

14 Example 5: Lease remeasurement I. - updating the lease payments Right-of-use asset before the remeasurement: Cost: 87,742 Depreciation for 23 months: 42,43 Carrying amount: 45,699 New carrying amount: 142,572 New monthly depreciation (25 months) 5,73 2. Subsequent measurement: Month Lease liability Lease Decrease in Lease Interest b/f payment lease liability liability c/f 2/2X3 1-48,94-2, ,882-47,58 3/2X3 2-47,58-2, ,888-45,17 4/2X3 3-45,17-2, ,894-43,276 5/2X3 4-43,276-2, ,9-41,376 6/2X3 5-41,376-2, ,97-39,469 7/2X3 6-39,469-2, ,913-37,556 8/2X3 7-37,556-2, ,919-35,637 9/2X3 8-35,637-2, ,925-33,712 1/2X3 9-33,712-2, ,932-31,78 11/2X3 1-31,78-2, ,938-29,842 12/2X ,842-2, ,944-27,898 1/2X ,898-2, ,951-25,947 2/2X ,947-2, ,957-23,99 3/2X ,99-2, ,963-22,27 4/2X ,27-2, ,97-2,57 5/2X4 16-2,57-2, ,976-18,81 6/2X ,81-2, ,983-16,98 7/2X ,98-2, ,989-14,19 8/2X ,19-2, ,996-12,113 9/2X4 2-12,113-2, ,2-1,11 1/2X4 21-1,11-2, ,9-8,12 11/2X4 22-8,12-2, ,15-6,86 12/2X4 23-6,86-2, ,22-4,64 1/2X5 24-4,64-2, ,29-2,35 2/2X5 25-2,35-2, ,35 Total -48,94 3. Journal entries: Remeasurement: Debit Right-of-use asset Credit Lease liability 96,873-96,873 Lease payment - Feb 2X3: Debit P/L - Interest expense Debit Lease liability Credit Cash Credit P/L Variab.lease p 16 1,882-1,842-2 Depreciation of right-of-use asset (monthly) Debit P/L - Depreciation Credit Right-of-use asset (depr.) 5,73-5,73

15 Example 5: Lease remeasurement I. - updating the lease payments (depr.)

16 Example 6: Lease remeasurement II. - change in the lease term On 1 January 2X1, Delia enters into a 4-year lease of the office space. The information about the contract is as follows: - Annual payment is CU 25 payable in the beginning of each year; - After 4 years, Delia has an option to extend the lease for another 2 years for the annual rental payment of CU 25 adjusted by the inflation rate prevalent after 4 years. At the lease commencement, Delia assumes that this option will NOT be exercised, because of significant increase of new hires and the need to rent a bigger office space. - Delia paid CU 3 to the real estate agent for finding the right property and arranging the lease contract. Inflation rate in 2X5: 2.2% p.a., incremental borrowing rate: 4% p.a. How would this transaction appear in the financial statements of Delia at 31 December 2X1? 1. Initial recognition Annual discount rate: 4.% Year Lease payment Discount factor Present value of lease payment 2X1-25, , 2X2 1-25, ,38 2X3 2-25, ,114 2X4 3-25, ,225-94,377 Journal entry: Debit Right-of-use asset Credit Lease liability Credit Cash 97,377-94,377-3, 2. Subsequent measurement Year Lease liability b/f Lease payment Interest Decrease in lease liability Lease liability c/f 2X1-94,377-25, -25, -69,377 2X2 1-69,377-25, -2,775-22,225-47,152 2X3 2-47,152-25, -1,886-23,114-24,38 2X4 3-24,38-25, ,38-94,377 Journal entries in 2X1: Annual depreciation of right-of-use asset: Debit Depreciation expenses Credit Accum. dep. - ROU 24,344-24,344 Annual payment in the 1st year: Debit Lease liability Credit Cash 25, -25,

17 Example 6: Lease remeasurement II. - change in the lease term Interest accrual in 2X1: Debit P/L - Interest expenses Credit Accruals 2,775 Note: You need to do interest accruals only when payments are in advance (in the beginning of the period). -2,775 The reason is that in the second payment (1-Jan-2X2), you pay the interest for 2X1 in fact. Annual payment in the 2nd year: Debit Lease liability Debit Accruals Credit Cash 22,225 2,775-25, On 1 January 2X3, after the third payment was made, Delia's managers believe that no new employees will be hired due to the economic crisis. As a result, Delia's management changes its plan not to exercise the option to extend the lease and now they assume that the lease will be extended by another 2 years. How should Delia recognize these transactions in its financial statements? The incremental borrowing rate prevalent in 2X3 is 3.5% p.a. 3. Remeasurement of the lease liability Discount rate: 3.5% Year Lease payment Discount factor Present value of lease payments 2X4 1-25, ,155 2X5 2-25, ,338 2X6 3-25,.92-22,549 Total -7,41 Adjustment: Lease liability before remeasurement: -24,38 Lease liability at the remeasurement date: -7,41 Change: -46,2 Right-of-use asset before the remeasurement: Cost: 97,377 Depreciation for 2 years: 48,689 Carrying amount: 48,689 New carrying amount: 94,691 New annual depreciation (4 years) 23,673

18 Example 6: Lease remeasurement II. - change in the lease term Year Lease liability b/f Lease payment Interest Decrease in lease liability Lease liability c/f 2X3 1-7,41-7,41 2X4 2-7,41-25, -2,451-22,549-47,492 2X5 3-47,492-25, -1,662-23,338-24,155 2X6 4-24,155-25, ,155 Total -7,41 4. Journal entries: Remeasurement in 2X3: Debit Right-of-use asset Credit Lease liability 46,2-46,2 Interest accrued for 2X3: Debit P/L - Interest expenses Credit Accruals 2,451-2,451 Lease payment - Jan 2X3: Debit Accruals Debit Lease liability Credit Cash 1,886 23,114-25, Lease payment - Jan 2X4: Debit Accruals Debit Lease liability Credit Cash 2,451 22,549-25, TASK FOR YOU: If you got this far, I have a challenge for you. The contract says that Delia's lease payments will be adjusted after 4 years by the inflation rate prevalent at the time of adjustment - i.e. 1 Jan 2X5. Can you work out the remeasurement yourself and send me the solution to check?

19 Example 7: Lease modifications I. - separate contract On 1 January 2X1, Celia enters into an 8-year lease contract for 3 square meters of office space. Annual lease payment is CU 12 payable on 31 December each year. On 1 January 2X5, Celia and the property owner agree to amend the original lease for the remaining 4 years to include additional 4 square meters of office space. As a result, the lease payment increases to CU 26 per year. How should Celia account for the lease modification? Note: Celia's incremental borrowing rate is 5% in 2X1 and 6% in 2X5. 1. Assessment Does the modification add the right to use one or more assets? Does the consideration increase commensurate with the stand-alone price? Original consideration: Modified consideration: YES YES 4 per square meter per year 37 per square meter per year Separate Lease Discount (reasonable, reflecting the same lessee, no additional cost..) 2. Initial recognition Annual discount rate: 5.% Year Lease payment Discount factor Present value of lease payment 2X1 1-12, ,286 2X2 2-12,.97-18,844 2X3 3-12, ,661 2X4 4-12, ,724 2X5 5-12, ,23 2X6 6-12, ,546 2X7 7-12, ,282 2X8 8-12, , ,586 Journal entry: Debit Right-of-use asset Credit Lease liability 775, ,586

20 Example 7: Lease modifications I. - separate contract 2. Subsequent measurement Year Lease liability b/f Lease payment Interest Decrease in lease liability Lease liability c/f 2X ,586-12, -38,779-81, ,365 2X ,365-12, -34,718-85,282-69,83 2X3 3-69,83-12, -3,454-89, ,537 2X ,537-12, -25,977-94,23-425,514 2X ,514-12, -21,276-98, ,79 2X ,79-12, -16,339-13, ,129 2X ,129-12, -11,156-18, ,286 2X ,286-12, -5, , ,586 Journal entries in 2X1: Annual depreciation of right-of-use asset: Debit Depreciation expenses Credit Accum. dep. - ROU 96,948-96,948 Annual payment in the 1st year: Debit P/L-Interest paid Debit Lease liability Credit Cash 38,779 81,221-12, 3. Lease modification Discount rate: 6.% Year Lease payment Discount factor Present value of lease payments 2X5 1-14, ,75 2X6 2-14, ,6 2X7 3-14, ,547 2X8 4-14, ,893 Total -485,115 Journal entry: Debit Right-of-use asset Credit Lease liability 485, ,115

21 Example 7: Lease modifications I. - separate contract Subsequent measurement of the modification: Year Lease liability b/f Lease payment Interest Decrease in lease liability Lease liability c/f 2X ,115-14, -29,17-11, ,222 2X ,222-14, -22, , ,675 2X ,675-14, -15,4-124,6-132,75 2X ,75-14, -7, ,75 Total -485, Journal entries in 2X5 - total contract: Depreciation of the right-of-use assets: Debit P/L - Depreciation charge Credit Right-of-use asset Original lease Modification TOTAL 96, , ,227-96, , ,227 Lease payment - Dec 2X5 Debit P/L Interest expense Debit Lease liability Credit Cash 21,276 29,17 5,383 98,724 11,893 29,617-12, -14, -26,

22 Example 8: Lease modifications II. - change in the existing contract On 1 January 2X1, Melinda enters into an 8-year lease contract for 5 square meters of office space. Annual lease payment is CU 2 payable on 31 December each year.. On 1 January 2X5, Melinda and the property owner agree to amend the original lease for the remaining 4 years to decrease the leased office space to only 3 square meters. As a result, the lease payment decreases to CU 13 per year. How should Melinda account for the lease modification? Note: Melinda's incremental borrowing rate is 5% in 2X1 and 6% in 2X5. 1. Assessment Does the modification add the right to use one or more assets? NO Change in the original lease Not a separate lease 2. Initial recognition Annual discount rate: 5.% Year Lease payment Discount factor Present value of lease payment 2X1 1-2, ,476 2X2 2-2, ,46 2X3 3-2, ,768 2X4 4-2, ,54 2X5 5-2, ,75 2X6 6-2, ,243 2X7 7-2, ,136 2X8 8-2, ,368-1,292,643 Journal entry: Debit Right-of-use asset Credit Lease liability 1,292,643-1,292, Subsequent measurement Year Lease liability b/f Lease payment Interest Decrease in lease liability Lease liability c/f 2X1 1-1,292,643-2, -64, ,368-1,157,275 2X2 2-1,157,275-2, -57, ,136-1,15,138 2X3 3-1,15,138-2, -5, , ,895 2X ,895-2, -43, ,75-79,19 2X5 5-79,19-2, -35,46-164,54-544,65 2X ,65-2, -27, , ,882 2X ,882-2, -18, ,46-19,476 2X8 8-19,476-2, -9,524-19,476-1,292,643

23 Example 8: Lease modifications II. - change in the existing contract Journal entries in 2X1: Annual depreciation of right-of-use asset: Debit Depreciation expenses Credit Accum. dep. - ROU 161,58-161,58 Annual payment in the 1st year: Debit P/L-Interest paid Debit Lease liability Credit Cash 64, ,368-2, 3. Lease modification Discount rate: 6.% Year Lease payment Discount factor Present value of lease payments 2X5 1-13, ,642 2X6 2-13, ,7 2X7 3-13,.84-19,151 2X8 4-13, ,972 Total -45,464 The proportionate decrease in the lease liability / ROU: Original office space: 5, sq meters Modified office space: 3, sq meters %: 6.% Reduction of pre-modification ROU: Cost of ROU: 1,292,643 Accumulated depreciation: -646,321 Carrying amount before modification: 646,321 Reduced to 6%: 387,793 Difference: 258,529 Reduction of pre-modification lease liability: Lease Reduced to 6%: -425,514 Difference: -283,676 Reduced pre-modification lease liability: -425,514 Modified lease liability: -45,464 Difference: 24,95

24 Example 8: Lease modifications II. - change in the existing contract 4. Journal entries Modification adjustment - proportionate reduction in the lease liability+rou Debit Lease liability Credit ROU Credit P/L - Gain on the lease modification 283, ,529-25,148 Modification adjustment - difference between reduced and modified lease liability: Debit ROU Credit Lease liability 24,95-24,95 Depreciation charge of ROU in 2X5: Debit P/L - Depreciation charge Credit Right-of-use asset 13,186-13,186 Lease 31-Dec-2X5: Debit P/L Interest expense Debit Lease liability Credit Cash 27,28 12,972-13,

25 Example 9: Lessors: Classification of leases LorryCars, the leasing company, plans to enter into a lease contract with Lessie and there are 2 options of how the lease contract can be structured: General information: 1. Lorry would be leased for 4 years under the non-cancellable lease that starts 1 January 2X1. 2. Rentals are paid annually on 31 December starting year 2X1. 3. In these rentals, the insurance fee of 3 CU is included. 4. At the end of lease, lorry would have market value of 12 4 CU. 5. Normal economic life of lorry is 6 years. 6. LorryCars sells this type of lorries for 35 CU when paid cash. 7. LorryCar's incremental borrowing rate is 3% (and it is close to the rate implicit in the lease). Option 1: Lessie would pay annual rentals amounting to 6 8 CU. At the end of the lease term, Lessie has an option to buy lorry for its market value or lease it for additional 2 years with the same rental fees. Option 2: Lessie would pay annual rentals amounting to 9 5 CU. At the end of the lease term, Lessie has an option to buy lorry either for 2 CU, or lease it for another 2 years with rental fee of 1 CU per annum. Advise LorryCars on correct classification of above presented leases. 1. Present value of the lease payments Year Discount factor 1/(1+,3)^year Cash flow Option 1 Option 2 Present value (cash flow*df) Cash flow Present value (cash flow*df) ,5. 6, ,2. 8, ,5. 6, ,2. 8, ,5. 5, ,2. 8, ,5. 5, ,4. 8, Total 24, ,375. FV at inception: 35,. 35,. %: 69.3% 98.21% 2. Assessment of leases Option 1 Option 2 Transfer of ownership at the end of lease term no no Option to purchase asset for price < fair value no yes Lease term = major part of economic life no yes Present value of LP close to fair value no yes Leased asset - specialized nature no no Losses from cancellation borne by lessee?? Gains / losses from fluctuations to the lessee?? Option to continue rent for rental under market no yes Operating Finance

26 Example 1: Lessors: land and building elements in the lease On 1 January 2X1, Belinda enters into a lease contract as a lessor to lease a specialized production hall with land. The lease contract has the following characteristics: 1. The lease term is 4 years (= remaining economic life of the hall). At the end, the hall has no residual value. 2. No ownership to the hall or land is transferred to the lessee after the end of the lease term. 3. Annual rentals are paid on 31 December each year amounting to CU. 4. Belinda's incremental borrowing rate is 3,1%. 5. At the end of 2X, the fair value of the hall and land was 8 CU and 2 CU respectively. Advise Belinda how to classify the lease. 1. Assessment of leases Land Building operating lease (indefinite life, no ownership transferred) needs to be assessed separately 2. Assessment of building element 2.1 Rentals related to building element Fair value of buildings: Total fair value (8 + 2 ): Percentage of building element: Total rentals: Rentals related to building element (8%*43 75) 8, A 1,, B 8% A/B 35, 2.2 Present value of the lease payments N. of payments: 4 Amount of 1 payment at the end of each year: 35, Present value: 796,97 Percentage of present value / fair value 99.51% ( / 8 ) Formula used: =PV(3,1%;4;35 ; )) 2.3 Assessment of buildings' lease Transfer of ownership at the end of lease term Option to purchase asset for price < fair value Lease term = major part of economic life Present value of LP close to fair value Leased asset - specialized nature no no yes yes yes Losses from cancellation borne by lessee? Gains / losses from fluctuations to the lessee? Option to continue rent for rental under market no Finance lease

27 Example 11: Accounting for finance lease by the lessor On 1 January 2X1 Belinda entered into a finance lease of used stamping machine as a lessor. The fair value of the machine was CU 5 and its carrying amount in Belinda's financial statements was CU 47. Belinda incurred additional costs of CU 3 for arranging the lease contract. Remaining economic life of the stamping machine is 6 years. Lease term is 5 years, annual lease payments are CU 11 payable 31 December each year. Belinda expects that at the end on the lease term, the machine can be sold for CU 5 and the lessee agrees to protect Belinda from the first CU 2 of loss for a sale at a price below the estimated residual value (i.e. CU 5 ). Belinda classifies the lease as finance. How would this transaction appear in Belinda's financial statements at 31 December 2X1? 1. Initial recognition 1.1 Asset - net investment in the lease Fair value of stamping machine: 5, Initial direct costs: 3, Net investment in the lease (5 + 3 ) 53, 1.2 Journal entry Recognition of net investment in the lease: Debit Assets - net investment in the lease Credit PPE - Stamping machine Credit Cash - paid for expenses Credit gain on sale of PPE 53, -47, -3, -3, 2. Subsequent measurement 2.1 Interest rate implicit in the lease: Year Cash flow Note: -53, Cash flows - FV of an underlying asset at the commencement: -5, 1 11, include: - lessor's initial direct costs: -3, 2 11, - 5x annual lease payments: 55, 3 11, - guaranteed residual value WITHIN the lease payments 2, included in year , - unguaranteed residual value 3, included in year , 5.84% Interest rate implicit in the lease, Formula used: =IRR(C37:C42) 2.2 Allocation of the lease payments Year Lease receivable b/f Lease payment Interest Decrease in lease receivable Lease receivable c/f 1 53, 11, 29,386 8, , ,386 11, 24,676 85, , ,62 11, 19,691 9,39 246, ,753 11, 14,416 95, , ,169 11, 8,831 11,169 5,

28 Example 11: Accounting for finance lease by the lessor 2.3 Journal entry Annual payment in the 1st year: Debit Cash Credit P/L - Finance income Credit Net investment in the lease 11, -29,386-8, Disclosures Gross investment in the lease: due not later than 1 year 11, due later than 1 year but not later than 2 years 11, due later than 2 years but not later than 3 years 11, due later than 3 years but not later than 4 years 13, due later than 4 years but not later than 5 years due later than 5 years Total 46, less unearned finance income -67,614 Present value of the lease payments: 392,386 Add unguaranteed residual value: 3, Net investment in the lease: 422,386 Check: Net investment in the lease at the commencement date: 53, Less the decrease in the first lease payment: -8,614 Net investment in the 422,386

29 Example 12: Manufacturer / dealer lessors and finance lease In January 2X1, CarProd, manufacturer of cars, offered the following finance lease related to the newest model of car produced: 1. The newest model of car has fair value equal to its selling price, that is CU 3. Cost of manufacture is CU The lease is non-cancellable for 4 years, with annual installments of CU 8 5 paid in arrears. 3. At the end of the lease term, the ownership of the car automatically passes to the client at no additional cost. CarProd incurred further cost of CU 1 related to negotiating contract. How would this transaction appear in the financial statements of CarProd at 31 December 2X1? 1. Initial recognition 1.1 Asset - net investment in the lease Fair value of new model: 3, Net investment in the lease: 3, 1.2 Accounting treatment Recognition of net investment in the lease / sale of asset: Debit Assets - net investment in the lease Credit Inventory - new model of car Credit Cash - paid for expenses Credit Profit on sale ( ) 3, -27, -1, -2, 2. Subsequent measurement 2.1 Allocation of minimum lease payments Year Lease receivable b/f Lease payment Interest Decrease in lease receivable Lease receivable c/f n/a -3, 3, 1 3, 8,5 1,56 6,94 23,6 2 23,6 8,5 1,2 7,3 15, ,76 8,5 82 7,68 8,8 4 8,8 8,5 42 8,8 5.2% Interest rate implicit in the lease, Formula used: =IRR(D32:D36) 2.2 Journal entries Annual payment in the 1st year: Debit Cash Credit Finance income Credit Net investment in the lease 8,5-1,56-6,94

30 Example 12: Manufacturer / dealer lessors and finance lease 3. Disclosures Lease payments to be received: due not later than 1 year 8,5 due later than 1 year but not later than 2 years 8,5 due later than 2 years but not later than 3 years 8,5 due later than 3 years but not later than 4 years due later than 4 years but not later than 5 years due later than 5 years Total 25,5 less unearned finance income -2,44 Present value of the lease payments: 23,6 Add unguaranteed residual value: Net investment in the lease: 23,6 Check: Net investment in the lease at the commencement date: 3, Less the decrease in the first lease payment: -6,94 Net investment in the 23,6

31 Example 13: Accounting for operating lease by the lessor On 1 January 2X1, Lessor Co. made a following offer for operating lease to one of its biggest clients: 1. Lease relates to machinery in total fair value of CU Lease is non-cancellable for 6 years, whereas machines have an economic life of 1 years. 3. Annual rentals of CU 17 are payable in arrears on 31 December each year. Lessor paid CU 5 of commission to an agent for mediating the lease. How would this transaction appear in the financial statements of Lessor Co. at 31 December 2X1? 1. Journal entries 1.1 Asset related entries: Recognition of assets at commencement: Debit PPE - machinery Credit Cash Initial direct costs: Debit PPE - machinery Credit Cash 1,, -1,, 5, -5, Depreciation charge of PPE for 2X1 (w/o initial direct costs) Debit Depreciation expenses (1 / 1) Credit PPE - cummulated depreciation 1, -1, Depreciation charge of PPE for 2X1 (initial direct costs) Debit Depreciation expenses (5 / 6) Credit PPE - cummulated depreciation 8,333-8, Rentals related entries: Cash received on 31 December 2X1: Debit Cash Credit Rental income 17, -17, 2. Disclosures Lease payments to be received: due not later than 1 year 17, due later than 1 year but not later than 2 years 17, due later than 2 years but not later than 3 years 17, due later than 3 years but not later than 4 years 17, due later than 4 years but not later than 5 years 17, due later than 5 years Total 85,

32 Example 14: Sale and leaseback On 1 January 2X1, Relia sells an administrative building to FinanceMaster for CU 6 and at the same time, Relia leases the same building back for 15 years for an annual payment of CU 5 due 31 December each year. Additional info: - the fair value of the building at the time of the sale is CU 5, - the carrying amount of the building in Relia's books right before the sale is CU 48, - the transaction meets the definition of a sale under IFRS 15, - the interest rate implicit in the lease is 4% p.a. - FinanceMaster classifies the lease as operating How should Relia and FinanceMaster account for the transaction? 1. Relia = seller = lessee Selling price 6, Fair value 5, Difference 1, => additional financing to be repaid in the lease payments Present value of the lease payments: N. of payments: 15 Amount of 1 payment at the end of each ye 5, Discount rate: 4% Present value: 555,919 thereof: "Loan" (financing): 1, Lease - payments for ROU asset 455,919 ROU asset = proportion of the previous carrying amount of the building that relates to the ROU retained Carrying amount of the building: 48, Fair value of the building: 5, => total rights Discounted lease payments: 455,919 => the rights transferred ROU asset: 437,683 Gain related to the rights transferred to FinanceMaster: FV of the building: 5, Carrying amount: 48, Gain on sale: 2, thereof: related to ROU retained by the seller: 18,237 related to rights transferred to the buyer: 1,763 Journal entries: At the commencement: Debit Cash Debit ROU asset Credit PPE - building Credit Financial Liability Credit Gain on the rights transferred 6, 437,683-48, -555,919-1,763

33 Example 14: Sale and leaseback transferred After the commencement: Debit P/L Depreciation of ROU asset Credit ROU asset (accum. dep.) Debit P/L Interest expense Debit Financial liability Credit Cash 29,179 over 15 years -29,179 22,237 27,763-5, 2. FinanceMaster = buyer = lessor At the commencement: Debit PPE - Building Debit Financial asset (loan) Credit Cash 5, 1, -6, Annual lease payment: thereof: for the ROU asset transferred: 41,6 for the repayment of a loan: 8,994 Debit Cash Credit P/L - Lease income Credit P/L - Interest income Credit P/L = Financial liability 5, -41,6-4, -4,994

34 Is there an identified asset? Yes Does the customer have the right to obtain substantially all the economic benefits from use of the asset throughout the period of use? Yes Customer Yes Does the customer, the supplier or neither 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 purpsoe the asset will be used is predetermined Does the customer have the right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions? Supplier 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? NO Yes The contract contains the lease The contract does not contain the lease

35 On 1 January 2X1, LessieCorp entered into a low value lease for new lorry under the following conditions: 1. Lease is non-cancellable for 4 years. 2. Rentals amounting to 9 2 EUR are to be paid annually, on 31 December, starting 2X1. How would this transaction appear in the financial statements of LessieCorp at 31 December 2X1? 1. Accounting treatment No asset is recognized under exception of IFRS 16. Rentals are included in expenses. Debit Expenses - rentals Credit Cash 9,2-9,2 2. Disclosures Future minimum lease payments under non-cancellable lease: due not later than 1 year 9,2 due later than 1 year but not later than 5 years 18,4 due later than 5 years Total 27,6

36 Example-1 A Lessor leases a bulldozer, a truck and a long-reach excavator to Lessee to be used in Lessee s mining operations for four years. Lessor also agrees to maintain each item of equipment throughout the lease term. The total consideration in the contract is CU6,, payable in annual instalments of CU15,, and a variable amount that depends on the hours of work performed in maintaining the long-reach excavator. The variable payment is capped at 2 per cent of the replacement cost of the long-reach excavator. The consideration includes the cost of maintenance services for each item of equipment. Several suppliers provide maintenance services for a similar bulldozer and a similar truck. Accordingly, there are observable standalone prices for the maintenance services for those two items of leased equipment. Lessee is able to establish observable stand-alone prices for the maintenance of the bulldozer and the truck of CU32, and CU16,, respectively, assuming similar payment terms to those in the contract with Lessor. The observable consideration for those four-year maintenance service contracts is a fixed amount of CU56,, payable over four years, and a variable amount that depends on the hours of work performed in maintaining the long-reach excavator. Lessee is able to establish observable stand-alone prices for the leases of the bulldozer, the truck and the long-reach excavator of CU17,, CU12, and CU224,, respectively. Required: - Allocate the transaction price to lease and non-lease components? Answer Lessee concludes that there are three lease components and three non-lease components (maintenance services) in the contract. Lessee applies the guidance IFRS 16 to allocate the consideration in the contract to the three lease components and the non-lease components. Several suppliers provide maintenance services for a similar bulldozer and a similar truck. Accordingly, there are observable standalone prices for the maintenance services for those two items of leased equipment. Lessee is able to establish observable stand-alone prices for the maintenance of the bulldozer and the truck of CU32, and CU16,, respectively, assuming similar payment terms to those in the contract with Lessor. The long-reach excavator is highly specialized and, accordingly, other suppliers do not lease or provide maintenance services for similar excavators. Nonetheless, Lessor provides four-year maintenance service contracts to customers that purchase similar long-reach excavators from Lessor. The observable consideration for those four-year maintenance service contracts is a fixed amount of CU56,, payable over four years, and a variable amount that depends on the hours of work performed in maintaining the long-reach excavator. That variable payment is capped at 2 per cent of the replacement cost of the long-reach excavator. Consequently, Lessee estimates the stand-alone price of the maintenance services for the long-reach excavator to be CU56, plus any variable amounts. Lessee is able to establish observable standalone prices for the leases of the bulldozer, the truck and the long-reach excavator of CU17,, CU12, and CU224,, respectively. Lessee allocates the fixed consideration in the contract (CU6,) to the lease and non-lease components as follows: Lease Non-lease Total Bulldozer 17, Truck 12, Excavator 224, 14, 496, 14, 6,

37 Example-2 Lessee enters into a 1-year lease of a floor of a building, with an option to extend for five years. Lease payments are CU5, per year during the initial term and CU55, per year during the optional period, all payable at the beginning of each year. To obtain the lease, Lessee incurs initial direct costs of CU2,, of which CU15, relates to a payment to a former tenant occupying that floor of the building and CU5, relates to a commission paid to the real estate agent that arranged the lease. As an incentive to Lessee for entering into the lease, Lessor agrees to reimburse to Lessee the real estate commission of CU5, and Lessee s leasehold improvements of CU7,. At the commencement date, Lessee concludes that it is not reasonably certain to exercise the option to extend the lease and, therefore, determines that the lease term is 1 years. The interest rate implicit in the lease is not readily determinable. Lessee s incremental borrowing rate is 5 per cent per annum, which reflects the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a 1- year term, and with similar collateral. In the sixth year of the lease, Lessee acquires Entity A. Entity A has been leasing a floor in another building. The lease entered into by Entity A contains a termination option that is exercisable by Entity A. Following the acquisition of Entity A, Lessee needs two floors in a building suitable for the increased workforce. To minimize costs, Lessee (a) enters into a separate eight-year lease of another floor in the building leased that will be available for use at the end of Year 7 and (b) terminates early the lease entered into by Entity A with effect from the beginning of Year 8. Consequently, at the end of Year 6, Lessee concludes that it is now reasonably certain to exercise the option to extend its original lease as a result of its acquisition and planned relocation of Entity A. Lessee s incremental borrowing rate at the end of Year 6 is 6 per cent per annum, which reflects the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a nine-year term, and with similar collateral. Lessee expects to consume the right-of-use asset s future economic benefits evenly over the lease term and, thus, depreciates the right-ofuse asset on a straight-line basis. Required: - a) Measure the value at which lease will be initially recognized in the books of lessee and pass necessary journal entries? Answer b) Provide accounting for the change in lease term and pass necessary journal entries? c) Prepare lease repayment schedule for first six years and for seven and eighth year? At the commencement date, Lessee makes the lease payment for the first year, incurs initial direct costs, receives lease incentives from Lessor and measures the lease liability at the present value of the remaining nine payments of CU5,, discounted at the interest rate of 5 per cent per annum, which is CU355,391. Lessee initially recognizes assets and liabilities in relation to the lease as follows. Rs. Rs. Right to use asset 45,391 Lease liability 355,391 Cash 5, Right to use asset 2, Cash (initial direct cost) 2, Cash (lease incentive) 5, Right to use asset 5,

38 Lessee accounts for the reimbursement of leasehold improvements from Lessor applying other relevant Standards and not as a lease incentive applying IFRS 16. This is because costs incurred on leasehold improvements by Lessee are not included within the cost of the rightof-use asset. The right-of-use asset and the lease liability from Year 1 to Year 6 are as follows. Year Lease liability Right to use asset Opening Lease Interest Ending Opneing Dep- for the Ending balance payment expense balance balance year balance 1 355,391-17,77 373,161 42,391 42,39 378, ,161 5, 16, , ,352 42,39 336, ,319 5, 14,466 33, ,313 42,39 294, ,785 5, 12, , ,274 42,39 252, ,474 5, 1, , ,235 42,39 21, ,297 5, 8, ,162 21,196 42,39 168,156 At the end of the sixth year, before accounting for the change in the lease term, the lease liability is CU186,162 (the present value of four remaining payments of CU5,, discounted at the original interest rate of 5 per cent per annum). Interest expense of CU8,865 is recognized in Year 6. Lessee s right-of-use asset is CU168,157. Lessee re-measures the lease liability at the present value of four payments of CU5, followed by five payments of CU55,, all discounted at the revised discount rate of 6 per cent per annum, which is CU378,174. Lessee increases the lease liability by CU192,12, which represents the difference between the re-measured liability of CU378,174 and its previous carrying amount of CU186,162. The corresponding adjustment is made to the right-of-use asset to reflect the cost of the additional right of use, recognized as follows. Right to use asset 192,12 Lease liability 192,12 Following the re-measurement, the carrying amount of Lessee s right-of-use asset is CU36,169 (i.e. CU168,157 + CU192,12). From the beginning of Year 7 Lessee calculates the interest expense on the lease liability at the revised discount rate of 6 per cent per annum. The right-of-use asset and the lease liability from Year 7 to Year 15 are as follows. Rs. Rs. Year Lease liability Right to use asset Opening balance Lease payment Interest expense Ending balance Opneing balance Dep- for the year Ending balance 7 378,174 5, 19,69 347,864 36,169 4,19 32, ,864 5, 17, ,736 32,15 4,19 28, ,736 5, 15, ,68 28,131 4,19 24, ,68 5, 13,91 245,581 24,113 4,19 2, ,581 55, 11,435 22,16 2,94 4,19 16, ,16 55, 8, ,837 16,75 4,19 12, ,837 55, 6,5 16,887 12,56 4,19 8, ,887 55, 3,113 55,1 8,38 4,19 4, ,1 55, 1 4,19 4,19 -