IFRS16 Lessee Notes and class examples 2021 PDF

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FINANCIAL ACCOUNTING 300IFRS 16: LEASESNOTES AND CLASS EXAMPLESLEASES IN THE BOOKS OF THE LESSEEL KotzeDEPARTMENTOF ACCOUNTINGUPCONTENTSBACKGROUND ....................................................................................................................................... 2OUTLINE OF IFRS ...

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FINANCIAL ACCOUNTING 300 IFRS 16: LEASES NOTES AND CLASS EXAMPLES LEASES IN THE BOOKS OF THE LESSEE

DEPARTMENT OF ACCOUNTING UP

L Kotze

CONTENTS BACKGROUND ....................................................................................................................................... 2 OUTLINE OF IFRS 16 ............................................................................................................................. 3 FINANCIAL STATEMENTS LINE ITEMS AFFECTED BY LEASES ..................................................... 4 EXAMPLE 1 Revision example – Leases in the books of the lessee .............................................. 7 RE-MEASUREMENT / REASSESSMENT OF LEASE LIABILITY (IFRS 16.36 - 43) ......................... 20 EXAMPLE 2 Reassessment of lease liability - change in lease term ............................................ 21 EXAMPLE 3 Reassessment of lease liability - change in option to purchase ............................... 26 EXAMPLE 4 Reassessment of lease liability - change in the amount payable under a residual value guarantee ....................................................................................................................................... 29 EXAMPLE 5 Change in lease payments caused by change in an index or a rate used to determine lease payments .............................................................................................................................. 32 EXAMPLE 6 Change in lease payments caused by change in interest rate where lease has floating interest rate..................................................................................................................................... 35 PRESENTATION (IFRS 16.47 - .50 and IAS 1).................................................................................... 38 DISCLOSURE (IFRS 16.51 - 60)........................................................................................................... 39 INCOME TAX IMPLICATIONS .............................................................................................................. 44 EXAMPLE 7 Income tax implications of lease contract classified for income tax purposes as a lease ........................................................................................................................................................ 45

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BACKGROUND An entity requires the use of or access to certain assets for its business activities. Sometimes the acquisitions of these assets are financed out of available cash resources. If adequate cash resources are not available, it is not a sound business decision to finance long-term assets using short-term funds (such as bank overdraft or trade creditors). Therefore, an entity should finance long-term assets with long-term funds, such as long-term borrowings from financial institutions, or it may issue its own debentures or shares to raise the funds needed. Assets owned by the entity may also be used as security for the loans and debentures issued. Another form of financing that an entity can make use of is to enter into lease contracts with another party (lessor). By entering into such contracts, the entity will obtain use (and in some cases ownership) of the assets in exchange for making pre-determined payments to the lessor for a specified period of time. The need to have access to immediate funding for the total purchase price to acquire these assets is also overcome by entering into such contracts. Most of these types of contracts are classified as lease contracts. Whilst in some cases, ownership of the underlying assets is transferred to the lessee at the end of the lease term, this is not always so. IFRS 16, Leases, deals with the accounting for, presentation and disclosure related to lease contracts in the accounting records of both parties to these lease agreements, i.e.: the lessee and the lessor. The accounting for leases by each of these parties will be addressed in this material as follows: Accounting for leases in the books of the lessee Most of IFRS 16 with regard to accounting for leases in the books of the lessee has already been addressed in FRK201. It is assumed that you already know, understand and can apply all of the content covered by FRK201. None of the FRK201 content will be addressed again in FRK300 lectures, other than a brief revision. Some of the homework questions do address some of the issues already covered in FRK201. You should also refer to the material provided to you in FRK201 where necessary. Note that all of the content of FRK201 IFRS 16 content may be tested at any time in any FRK300 tests. For FRK300 the following additional content with regard to accounting for leases in the books of the lessee will be covered:  

Reassessment of the lease liability (IFRS 16.39 – 43); and The income tax implications of leases in the books of the lessee.

Accounting for leases in the books of the lessor The accounting for leases in the books of the lessor was not addressed in FRK201 and will, therefore, be addressed in FRK300 along with the tax implications thereof.

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OUTLINE OF IFRS 16 The table below is an outline of IFRS 16, referenced to the relevant paragraphs and B paragraphs of the standard. Please refer to your prescribed work document for paragraphs that are excluded from the FRK300 scope. Topic OBJECTIVE SCOPE RECOGNITION EXEMPTIONS (only applicable to the lessee) IDENTIFYING A LEASE Components of a lease contract LEASE TERM LESSEE Recognition Measurement Initial measurement Subsequent measurement

Paragraphs 1–2 3–4 5 – 8; B3 – B8

Notes Covered in FRK201 Covered in FRK201 Covered in FRK201

9 – 11 12 – 17; B32 – B33 18 – 21; B34 – B40 22 22 22 23 - 28; B42 29 - 43

Covered in FRK201 Covered in FRK201 Covered in FRK201

Presentation Disclosure LESSOR Classification of leases Finance leases Operating leases Disclosure

47 51 - 60; B48 – B51 61 61; B53 – B54 67 81 89

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Covered in FRK201 Covered in FRK201 Covered in FRK201 Par 39 - 43 will be covered in FRK300. All other paragraphs were covered in FRK201 Covered in FRK201 Covered in FRK201 Will be covered in FRK300 Will be covered in FRK300 Will be covered in FRK300 Will be covered in FRK300

FINANCIAL STATEMENTS LINE ITEMS AFFECTED BY LEASES Note: The impact on the line items of the statement of cash flows will be addressed in the lecture material of IAS 7, Statement of Cash Flows, later in the year. Example Limited Statement of financial position as at ……….. Assets Non-current assets Property, plant and equipment Investment property Goodwill Other intangible assets Right-of-use assets Financial assets Net investment in finance leases / Finance lease receivables Prepaid expenses related to lease agreements (if the simplified method of accounting is used) Accrued rental income related to operating lease agreements Deferred tax (if debit balance) Current assets Inventories Trade receivables Short-term portion of net investment in finance lease / Short-term portion of finance lease receivables Prepaid expense related to lease agreements (if the simplified method of accounting is used) Accrued rental income related to operating lease agreements Other current assets Cash and cash equivalents Current tax prepaid (if current tax owing by SARS) Total assets

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Lessee’s books R

Lessor’s books R

   

 

   

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Lessee’s books R Equity and liabilities Total equity Share capital Retained earnings/Accumulated loss Other components of equity Non-current liabilities Long-term borrowings Lease liabilities Income in advance related to operating lease Accrued expenses related to lease agreements (if the simplified method of accounting is used) Deferred tax (if credit balance) Long-term provisions Current liabilities Trade and other payables Short-term borrowings Short-term portion of long-term borrowings Short-term portion of lease liabilities Income in advance related to operating lease Accrued expenses related to lease agreements (if the simplified method of accounting is used) Current tax payable (if current tax owing to SARS) Short-term provisions Bank overdraft

Lessor’s books R

   

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   

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Total equity and liabilities

Example Limited Statement of changes in equity for the year ended ……….. Ordinary share capital R Balance at the beginning of the year Total comprehensive income for the year Profit for the year Other comprehensive income for the year Balance at the end of the year

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Retained earnings R

Example Limited Statement of profit or loss and other comprehensive income for the year ended on ……….. Revenue (refer 1 below) Cost of sales (refer 2 below) Gross profit Other income (refer 3 below) Distribution costs (refer 4 below) Administrative expenses (refer 4 below) Other expenses (refer 4 below) Finance costs (refer 5 below) Finance income using the effective interest method Other finance income (refer 6 below)

Lessee’s books R

Lessor’s books R



 

Profit before tax Income tax expense Profit for the year

      

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Lessee’s / lessor’s books R Other comprehensive income Items that will not be reclassified to profit or loss: Revaluation surplus on property, plant and equipment Gross amount Income tax expense Mark-to-market reserve for equity instruments Items that will be reclassified to profit or loss: Mark-to-market reserve for debt instruments Foreign currency translation reserve / Foreign currency differences arising on translation of foreign operations Total comprehensive income for the year (1)

Revenue of a manufacturer / dealer lessor related to a finance lease

(2)

Depreciation of right-of-use asset if this asset is part of manufacturing activity OR Cost of sale of a manufacturer / dealer lessor for a finance lease

(3)

Operating lease income for a lessor

(4)

Depreciation of a right-of-use asset not used in a manufacturing activity OR lease expense if simplified accounting method used OR costs related to the service component of lease agreements of lessee

(5)

Finance costs incurred related to leases of lessee

(6)

Finance income earned related to finance lease of lessor

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On 1 January 20X16 (commencement date), ZINFANDEL LIMITED entered into a lease agreement with Nebbiolo Limited to lease a new factory building from Nebbiolo Limited for a non-cancellable period of 15 years. The lease does not include any options to extend or terminate the lease and ownership of the factory building does not transfer to Zinfandel Limited at the end of the lease term. The following information has been extracted from the lease contract: 

The lease payments payable annually in arrears are calculated at R1 500 per unit of finished goods manufactured in the factory.



A minimum amount of R3 050 000 is payable annually in arrears.



If the fair value of the factory building at the end of the lease term is less than R4,5 million, then Zinfandel Limited must pay to Nebbiolo Limited an amount calculated as the difference between that fair value and the amount of R4,5 million.

Nebbiolo Limited, as an incentive to encourage Zinfandel Limited to enter into this lease agreement, paid an amount of R28 750 to Zinfandel Limited on 1 January 20X16. On 1 January 20X16, Zinfandel Limited paid R300 000 as a deposit to secure the lease agreement with Nebbiolo Limited. On the commencement date of the lease, Zinfandel Limited expects that the fair value of the factory building at the end of the 15 year lease term will be R3,2 million. Zinfandel Limited expects that 2 200 units of finished product will be manufactured per year in the factory building. The interest rate implicit in the lease is not readily determinable. The incremental borrowing rate of Zinfandel Limited on 1 January 20X16 is 12,25% per annum. Zinfandel Limited incurred initial direct costs of R35 000 related to this lease agreement that were paid to the company’s external legal advisor on 1 January 20X16. The company also has an employee that is actively involved in the negotiation and arrangement of all of its lease agreements and the total cost to company of this employee is R40 000 per month (assume each month has four weeks). This employee was involved in the negotiation and arrangement of this lease agreement for a week. 

Zinfandel Limited had to modify some parts of the factory building to meet its specific requirements and incurred total costs of R1,8 million in this regard that it paid in cash on 30 June 20X16. The lease agreement made provision for leasehold improvements to be made by the lessee, but also requires that at the end of the lease term, the lessee must return the factory building to the lessor in its original condition. On 1 January 20X16, Zinfandel Limited estimated that the costs related to the restoration of the factory building would amount to R2 501 635 at the end of the lease term. An appropriate pre-tax discount rate on 1 January 20X16, is 12,5% per annum. Assume that the criteria for the recognition of a provision for these costs in terms of IAS 37, Provisions, Contingent Liabilities and Contingent Assets have been met on 1 January 20X16.

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Additional information: 

The reporting date of Zinfandel Limited is 31 December.



Zinfandel Limited does have another factory building that it owns. It accounts for this factory building in accordance with the cost model. Depreciation is calculated in accordance with the straight-line method over the estimated useful life of the factory building.



The estimated economic life of the underlying asset is 25 years.



During the years ended 31 December 20X16 and 31 December 20X17, Zinfandel Limited manufactured 2 020 units and 2 580 units of finished products respectively.



All lease payments were paid on 31 December of each year.

Required: a) Prepare the journal entries (cash transactions included) in the books of Zinfandel Limited for all of the transactions entered into by Zinfandel Limited related to the initial recognition of the lease contract with Nebbiolo Limited in accordance with IFRS 16, Leases. Note:

- Round calculated amounts to the nearest Rand. - Journal narrations are required. - The journal entries must be dated.

b) Prepare the journal entry in the books of Zinfandel Limited for the subsequent measurement of the lease contract with Nebbiolo Limited in accordance with IFRS 16, Leases for the year ended 31 December 20X16 and 31 December 20X17. Note:

- Round calculated amounts to the nearest Rand. - Journal narrations are required. - The journal entries must be dated.

c) Present the information on the statement of financial position and the statement of profit or loss and other comprehensive income of Zinfandel Limited for the year ended 31 December 20X17, in accordance with IFRS 16, Leases and IAS 1, Presentation of Financial Statements. Note:

- Round calculated amounts to the nearest Rand.

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d) Assume that Zinfandel Limited has recognised the following lease expenses related to: 

Short-term leases for desk top computers: R125 400 for each of the years ended 31 December 20X16 and 20X17. The actual cash outflows for these leases during both reporting periods was also R125 400. The portfolio of short-term leases to which the company is committed at each of the reporting dates is similar to the portfolio for which the short-term leases expense was recognised during each of the periods; and



Low-value lease for office furniture: R15 000 and R30 000 for the years ended 31 December 20X16 and 20X17 respectively. The actual cash outflows for these leases amounted to R18 000 for the year ended 31 December 20X16 and R33 000 for the year ended 31 December 20X17.

Zinfandel Limited uses the following time bands to disclose its lease liabilities: - Not later than 1 year - Later than 1 year but not later than 5 years - Later than 5 years Required: Disclose the information related to the leases entered into by Zinfandel Limited for the year ended 31 December 20X17, in accordance with IFRS 16, Leases and IAS 1, Presentation of Financial Statements. Zinfandel Limited chooses to disclose all matters related to leases in which it is the lessee in a single note. 

Note:

- Round calculated amounts to the nearest Rand.

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Suggested solution: a) Journal entries in books of Zinfandel Limited (lessee) Dr R

Cr R

1 January 20X16 1.

2.

Bank (SFP) Right-of-use asset – factory building (SFP) Lease incentive received from lessor

28 750

Right-of-use asset – factory building (SFP) Lease liability (SFP) (calc 1)

20 728 505

28 750

20 728 505

Recognition of right-of-use asset at initial measurement of lease liability 3.

4.

5.

Right-of-use asset – factory building (SFP) Bank (SFP) Lease deposit allocated to right-of-use asset

300 000

Right-of-use asset – factory building (SFP) Provision for restoration costs (SFP) Initial recognition of restoration costs provision

427 500

Right-of-use asset – factory building (SFP) Bank (SFP) Fees paid to external legal advisors recognised as initial direct costs

300 000

427 500 35 000 35 000

30 June 20X16 6.

Leasehold improvements to factory building (SFP) (see comment below) Bank (SFP) Leasehold improvements recognised

1 800 000 1 800 000

Comment:  The leasehold improvements to the factory building is a property, plant and equipment item and would be accounted for in accordance with IAS 16, Property, Plant and Equipment. 

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10 

b) Suggested solution: Cr R

Dr R 31 December 20X16 7.

8.

9.

Depreciation (P/L) Right-of-use asset - factory building (SFP) Depreciation for year ended 31/12/20X16 (R21 462 255 (calc 2) / 15 years)

1 430 817

Interest expense / Finance costs (P/L) Lease liability (SFP) Interest for year on lease liability (AMORT 1 INT = R2 539 242)

2 539 242

Lease liability (SFP) Bank ( SFP) Payment of lease liability made for year

3 050 000

10. Lease expense (P/L) Bank ( SFP) Variable lease payment based on finished goods manufactured for the year not included in lease liability ([2 020 units x R1 500] = R3 030 000 compared to R3 050 000 minimum amount, thus no additional amount payable)

1 430 817

2 539 242

3 050 000 -

31 December 20X17 11. Depreciation (P/L) Right-of-use asset - factory building (SFP) Depreciation for year ended 31/12/20X17 (R21 462 255 (calc 2) / 15 years)

1 430 817

12. Interest expense / Finance costs (P/L) Lease liability (SFP) Interest for year on lease liability (AMORT 2 INT = R2 476 674)

2 476 674

13. Lease liability (SFP) Bank ( SFP) Payment of lease liability made for year

3 050 000

14. Lease expense (P/L) Bank ( SFP) Variable lease payment based on finished goods manufactured for the year ([2 580 units x R1 500] = R3 870 000 compared to R3 050 000 minimum amount,...