16 Leases (lessee) s19 final PDF

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Solution 16.a) Under IFRS 16, a lease is defined as a contract, or part of a contract, that conveys the right to use an underlying asset for a period of time in exchange for a consideration.A contract can be a lease (or contain a lease) only if  The underlying asset is identified  The entity can c...

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.1 a) Under IFRS 16, a lease is defined as a contract, or part of a contract, that conveys the right to use an underlying asset for a period of time in exchange for a consideration. A contract can be a lease (or contain a lease) only if  The underlying asset is identified  The entity can control the use of the identified asset by having the right to  Obtain all of the economic benefits from the use of the identified asset, and  Direct the use of the identified asset (IFRS 16.9; 16.B9 and Appendix A) b) An asset is identified if  it is explicitly specified in the contract , or  implicitly specified when made available to the customer An asset is not identified if the supplier has a substantive right to substitute another asset. A physically distinct portion of an asset can be identified (for example, part of a building) but a portion of an asset’s capacity cannot (for example, a capacity portion of a fibre optic cable). (IFRS 16.B13, 14 and 20) c) When assessing whether it has the right to obtain substantially all of the economic benefits from the use of an identified asset, a customer considers  The direct and indirect benefits from the use of the asset such as using, holding or sub-leasing the asset.  Only the economic benefits from the use of the asset within the defined scope of its right to use the asset (for example, if the use of a vehicle is limited to one territory, only the economic benefits from the vehicle in that territory are considered). (IFRS 16.B21 and 22) d) A customer has the right to direct the use of an identified asset only if  The customer has the right to decide how and for what purpose the asset is used, or  The relevant decisions about use of the asset are predetermined and the customer has  The right to operate the asset, or  Has designed the asset (or aspects of it) that predetermines its use. (IFRS 16.B24) e) A lessee may elect not to apply the lease accounting model to:  Short-term leases (i.e. leases of twelve months or less)  Leases for which the underlying asset is of low value when it is new (i.e a lease of a second-hand car would not qualify as a low value lease because a car, when new, would not be of low value). Examples could include personal computers, small items of equipment etc. (IFRS 16.5; B5 and 6)

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.1 continued . . . f) At the commencement date, a lessee measures the lease liability at the present value of the future lease payments.  The present value is determined by discounting the lease payments using the interest rate implicit in the lease, or if that cannot be readily determined, at the lessee’s incremental borrowing rate.  The future lease payments include  Fixed payments  Variable payments  Amounts expected to be payable under a residual value guarantee (only included if the lessee expects that the market value of the leased item will be less than residual value guarantee)  The exercise of a purchase option the lessee is reasonably certain to exercise  Payments for early termination. (IFRS 16.26 and 27) g) The lease term is the non-cancellable period of the lease, together with  Optional renewal periods if the lessee is reasonably certain to extend, or  Period after an optional termination date if the lessee is reasonably certain not to terminate early When determining the lease term, a lessee considers all the relevant facts and circumstances that create an economic incentive to exercise or forgo options to renew or terminate early. (IFRS 16.18; B37) h) The implicit interest rate is the rate that causes  The present value of the lease payments (includes guaranteed residual value), and  The present value of the unguaranteed residual value (if any) to equal  The fair value of the underlying asset, and  Any initial direct costs of the lessor. i)

The right of use asset is measured at cost, comprising  The amount of the initial measurement of the lease liability, plus  Any prepaid lease payments, plus  Any initial direct costs of the lessee, plus  Estimated costs to dismantle, remove or restore the underlying asset ito IAS 37. Note that if there are no prepaid lease payments, initial direct costs of lessee or costs to dismantle, then the right of use asset will equal the lease liability. In all other cases, the right of use asset will be greater than the lease liability. (IFRS 16.23 and 24)

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.1 continued . . . j)

A lessee depreciates the right of use asset ito IAS 16, implying that the depreciation method reflects the pattern in which the future economic benefits are consumed, most often on a straight-line basis. Depreciation starts at the commencement date of the lease and the period is determined as follows:  If ownership is transferred to the lessee, or the lessee is reasonably certain to exercise a purchase option, the depreciation period is equal to the useful life of the underlying asset  Otherwise, the depreciation period is equal the shorter of the useful life or the lease term. (IFRS 16.31 and 32)

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.2 Part A At the inception of a contract, an entity is required to assess whether the contract is a lease or contains a lease. This will be the case if the contract conveys the right to control the use of an identified asset for a period of time in exchange for a consideration. IFRS 16.9 A contract can be a lease (or contain a lease) only if  The underlying asset is identified  The entity can control the use of the identified asset by having the right to  Obtain all of the economic benefits from the use of the identified asset, and  Direct the use of the identified asset. IFRS16.B9 An asset can be either explicitly specified in a contract or implicitly specified at the time it is made available for use by the lessee. IFRS 16.B13 The vehicles here are explicitly specified as the contract specifies the model and capacity of the vehicles. Dark & White Limited has the right to obtain substantially all of the economic benefits throughout the period of use. It has the exclusive use of the vehicles, including when they are not being used to transport goods (such as for storage). Dark & White Limited also has the right to direct the use of the vehicles, including the transporting goods of other manufacturers. The arrangement thus does contain a lease. Big Deal Limited would recognise a right of use asset and a corresponding liability. Note that substitution rights are likely to be an important factor to consider in applying the lease definition. Some element of substitution is often allowed in the leases of certain items, such as fleets of vehicles, copiers and similar equipment.

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.2 continued . . . Part B At the inception of a contract, an entity is required to assess whether the contract is a lease or contains a lease. This will be the case if the contract conveys the right to control the use of an identified asset for a period of time in exchange for a consideration. IFRS 16.9 A contract can be a lease (or contain a lease) only if  The underlying asset is identified  The entity can control the use of the identified asset by having the right to  Obtain all of the economic benefits from the use of the identified asset, and  Direct the use of the identified asset. IFRS16.B9 An asset can be either explicitly specified in a contract or implicitly specified at the time it is made available for use by the lessee. IFRS 16.B13 The vehicles here are explicitly specified as the contract specifies the model and capacity of the vehicles. However, even if an asset is specified, a lessee does not control the use of an identified asset if the lessor has a substantive right to substitute the asset for an alternative asset during the lease term. IFRS 16.B14 A lessor’s substitution right is substantive if  the lessor has the practical ability to substitute the asset, and  the lessor would benefit economically from exercising its rights to substitute the asset. IFRS 16.B14

In this scenario, the benefits to Wheels Limited of substituting the vehicles are greater than the costs because  the vehicles are parked at Wheels Limited’s premises  Wheels Limited has a large pool of similar vehicles  the substitution costs are minimal. Wheels Limited’s substitution rights are substantive and the arrangement does not contain a lease. The payments made by Wheels Limited would be recognised as an expense in the statement of comprehensive income. No asset or related liability would be recognised. A discussion of the economic benefits from, and right to use the vehicles is not relevant here because of the substantive substitution rights. Note that substitution rights are likely to be an important factor to consider in applying the lease definition. Some element of substitution is often allowed in the leases of certain items, such as fleets of vehicles, copiers and similar equipment.

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.3 At the inception of a contract, an entity is required to assess whether the contract is a lease or contains a lease. This will be the case if the contract conveys the right to control the use of an identified asset for a period of time in exchange for a consideration. IFRS 16.9 A contract can be a lease (or contain a lease) only if  The underlying asset is identified  The entity can control the use of the identified asset by having the right to  Obtain all of the economic benefits from the use of the identified asset, and  Direct the use of the identified asset. IFRS16.B9 An asset can be either explicitly specified in a contract or implicitly specified at the time it is made available for use by the lessee. IFRS 16.B13 The aircraft here is explicitly specified as the contract specifies a particular model of jet, the Wizz 727 and its customisation. However, even if an asset is specified, a lessee does not control the use of an identified asset if the lessor has a substantive right to substitute the asset for an alternative asset during the lease term. IFRS 16.B14 A lessor’s substitution right is substantive if  the lessor has the practical ability to substitute the asset, and  the lessor would benefit economically from exercising its rights to substitute the asset. IFRS 16.B14 In this scenario, it would be uneconomical for Wings Limited to exercise its right to substitute the aircraft because of the substantial costs of customising another aircraft and Wings Limited’s substitution rights are thus not substantive. Big Deal Limited has the right to obtain substantially all of the economic benefits throughout the period of use and it has the right to direct the use of the aircraft by deciding, for example, which routes to fly. The contractual restrictions on where the aircraft can fly and the prohibition of carrying explosive cargo are protective rights of Wings Limited and define, but do not limit Big Deal’s ability to direct the use of the aircraft. IFRS 16.B30 The arrangement thus does contain a lease. Big Deal Limited would recognise a right of use asset and a corresponding liability.

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.4 Part A At the inception of a contract, an entity is required to assess whether the contract is a lease or contains a lease. This will be the case if the contract conveys the right to control the use of an identified asset for a period of time in exchange for a consideration. IFRS 16.9 A contract can be a lease (or contain a lease) only if  The underlying asset is identified  The entity can control the use of the identified asset by having the right to  Obtain all of the economic benefits from the use of the identified asset, and  Direct the use of the identified asset. IFRS16.B9 An asset can be either explicitly specified in a contract or implicitly specified at the time it is made available for use by the lessee. IFRS 16.B13 The strands are distinct and are specified in the contract and are separate from other strands within the cable. Interdata Limited cannot substitute the strands, other than for the purposes of repairs and maintenance. Hello Limited can control the use of the strands throughout the twenty year period because  It has the right to obtain substantially all of the economic benefits from the strands over the period of use.  It has the right to direct the use of the strands because it decides the type and quantity of data that will be transported and is responsible for the technical connections to its equipment. The arrangement thus does contain a lease. Hello Limited would recognise a right of use asset and a corresponding liability. Note that the requirement that a portion of an asset can meet the identifiability criterion can be seen as a potential ‘anti-avoidance’ provision of the standard. Without this, a contract could exclude a small portion of an asset’s capacity, and thus not meet the identifiability criterion.

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.4 continued . . . Part B At the inception of a contract, an entity is required to assess whether the contract is a lease or contains a lease. This will be the case if the contract conveys the right to control the use of an identified asset for a period of time in exchange for a consideration. IFRS 16.9 A contract can be a lease (or contain a lease) only if  The underlying asset is identified  The entity can control the use of the identified asset by having the right to  Obtain all of the economic benefits from the use of the identified asset, and  Direct the use of the identified asset. IFRS16.B9 An asset can be either explicitly specified in a contract or implicitly specified at the time it is made available for use by the lessee. IFRS 16.B13 The capacity portion of the network that is used by Hello Limited is not physically distinct from the remaining capacity of the cable and does not represent substantially all of the capacity of the cable. IFRS 16.B20 Further, Hello Limited cannot control the use of the strands throughout the twenty year period because Interdata Limited makes all decisions about the transmissions of its customers’ data. The arrangement thus does not contain a lease. Note that if the contract specified an amount of capacity equivalent to say 950 strands of fibre within the 1 000 strand cable, the contract would contain a lease as this represents substantially all of the cable’s capacity.

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.5 Part A A contract can be a lease (or contain a lease) only if  The underlying asset is identified  The entity can control the use of the identified asset by having the right to  Obtain all of the economic benefits from the use of the identified asset, and  Direct the use of the identified asset. IFRS16.B9 There is an identified asset as the ship is explicitly specified in the contract. Big Red Limited has the right to obtain substantially all of the economic benefits from the use of the ship. The cargo of apples will occupy substantially all of the ship’s capacity, thus preventing others from obtaining economic benefits from the use of the ship. A customer has the right to direct the use of an identified asset when  It has the right to decide how and for what purpose the asset is used, or  If relevant decisions about use of the asset are pre-determined,  the customer has the right to operate the asset, or  the customer designed the asset in a way that predetermines its use.

IFRS 16.B24

Big Red Limited does not have the right to direct the use of the ship as it does not have the right to direct how and for what purpose the ship is being used. The journey from Cape Town to Southhampton transporting the apples is predetermined in the contract. Big Red Limited also does not have the right to operate the ship and did not design the ship in a way that predetermined its use. In effect, Big Red has the same rights relating to the use of the shiop as if it were only one of a number of customers transporting cargo on the ship. The contract therefore does not contain a lease.

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.5 continued . . . Part B A contract can be a lease (or contain a lease) only if  The underlying asset is identified  The entity can control the use of the identified asset by having the right to  Obtain all of the economic benefits from the use of the identified asset, and  Direct the use of the identified asset. IFRS16.B9 There is an identified asset as the ship is explicitly specified in the contract. Big Red Limited has the right to obtain substantially all of the economic benefits from the use of the ship over the three year period. It also has exclusive use of the ship throughout the period of use, thus preventing others from obtaining economic benefits from the use of the ship. A customer has the right to direct the use of an identified asset when  It has the right to decide how and for what purpose the asset is used, or  If relevant decisions about use of the asset are pre-determined,  the customer has the right to operate the asset, or  the customer designed the asset in a way that predetermines its use.

IFRS 16.B24

Big Red Limited also has the right to direct the use of the ship as it has the right to direct how and for what purpose the ship is being used. It determines the quantity, grade and packaging of the apples and can use spare capacity for other produce and can decide on the departure and arrival ports. The contract therefore does contain a lease and will be recognised as a right of use asset with a corresponding liability.

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Solutions to GAAP : Graded Questions

Leases: lessee accounting

Solution 16.6 A lessee may elect not to apply the recognition requirements of IFRS 16 Leases (recognise a right to use asset and a corresponding lease liability) in respect of  Short-term leases  Low value asset leases IFRS 16.5 A short-term lease is defined as a lease that, at the commencement date has a lease term of 12 months or less. IFRS 16 (Appendix A) At the commencement of the lease, a lessee considers all the relevant facts and circumstances that create an economic incentive to exercise or forfeit options to renew the lease or terminate it early. IFRS 16.B37 As Point to Point Limited has the right to terminate the lease at the end of the first and second years, that right must be considered in determining the lease term. IFRS 16.B35 This lease will qualify for the short term election as  There is no termination penalty  The rentals in the second and third years are not below market  The changing market for airport transfers may result in the existing 25 seater busses not being suitable for the three year period. Point to Point Limited thus has an accounting policy choice – to apply the IFRS 16 recognition requirements or to recognise the lease payments as an expense on a straight line basis over ...