PFRS 16 Leases - Lecture notes 1 PDF

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lecture notes for leases...

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PFRS 16 Leases Lease 

A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.

Parties to a Lease Contract 1. Lessee – entity that obtains the right to use an underlying asset 2. Lessor – entity that provides the right to use an underlying asset

An entity has the right to control an underlying asset when it has both of the following: 1. Right to obtain substantially all the economic benefits from the use of the asset 2. Right to direct the use of the identified asset

An asset can be identified by being: (identified asset)

Portions of assets 

A portion of an asset is an identified asset if it is physically distinct



If not physically distinct, it is not an identified asset, unless it represents substantially all of the capacity of the asset

Substantive substitution rights 

An asset is not an identified asset if the supplier has the substantive right to substitute it throughout the period of use

Supplier’s right to substitute an asset is substantive if the following conditions exist: 1. The supplier has the practical ability to substitute alternative assets throughout the period of use 2. The supplier would benefit economically from the exercise of its right to substitute the asset

Supplier’s right to substitute an asset is not substantive when substitution is made:

a. Explicitly stated in the contract

1. Only on a particular date or upon the occurrence of a specified event

b. Implicitly specified at the time it is made available for use

2. Only during repairs, maintenance or upgrading

b. Rights to change when the output is produced

NOTE: A supplier’s substitution right is presumed not substantive if it is not readily determinable as substantive

c. Rights to change where the output is produced

Right to obtain economic benefits from use 

Economic benefits include potential inflows from the asset’s output which can be obtained directly or indirectly from using, holding or sub-leasing the asset



An entity considers only the economic benefits within the defined scope of its rights to use the asset



A stipulation in a contract requiring the customer to pay additional consideration based on a portion of the cash flows derived from use of an asset does not prevent the customer from having the right to obtain substantially all of the economic benefits from use of the asset

Right to direct the use 



d. Rights to change whether the output is produced, and the quantity of the output NOTE: Rights to operate or maintain the asset do not necessarily grant the right to direct how and for what purpose the asset is used.

Protective Rights 

Include contractual restrictions designed to protect the supplier’s interest in the asset or its personnel, or to ensure compliance with laws or regulation



Examples: a. Specify the maximum amount of use

A customer has the right to direct the use of the asset if:

b. Limit when or where the customer can use the asset

a. The customer has the right to direct how and for what purpose the asset is used

c. Require customer to follow certain operating procedures

b. Asset’s use is predetermined and the supplier is precluded from changing that use

d. Require customer to inform the supplier of changes on how asset will be used

The following may signify the existence of right to change how and for what purpose the asset is used: a. Rights to change the type of output

Flowchart: Identifying a Lease Lease Term 

The non-cancellable period of lease



Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option



Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option

NOTE: Includes any rent-free periods provided by the lessor to the lessee.

Non-cancellable Period 

The period which the contract is enforceable



A lease is no longer enforceable when both the lessee and lessor can terminate the lease without permission from each other



If only the lessee has the right to terminate the lease, the lessee should consider whether it is reasonably certain or not



If only the lessor has the right to terminate the lease, the non-cancellable period of the lease includes the period covered by the option to terminate the lease

The lessee may be reasonably certain to exercise an option to extend if: a. Lease payments on the extended period are expected to be below market value b. The lessee made significant leasehold improvements with useful life longer than the original lease term

The lessee may be reasonably certain NOT to exercise an option to terminate if: a. The cost of terminating the lease are significant b. The leased asset is important to the lessee’s operations

Discount Rate 

Lease payments are discounted using the interest rate implicit in the lease or the lessee’s incremental borrowing rate if the former is not readily determinable

Incremental Borrowing Rate 

The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment

ACCOUNTING FOR LEASES BY LESSEE

NOTE:

Recognition 

e. Payment of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease

A lessee recognizes a. Lease liability

Lease payments do not include:

b. Right of use asset

a. Payments for non-lease elements (except when the entity elects to apply the ‘practical expedient’)

Initial measurement of Lease Liability 

Initially measured at the present value of the lease payments that are not yet paid as at the commencement date

Lease payments include the following: a. Fixed payments, including in-substance payments, less any lease incentives receivable

d. The exercise price of a purchase option if the lessee is reasonably certain to exercise that option

fixed

NOTE: Lease incentives are payments made by a lessor to a lessee associated with a lease, or the reimbursement or assumption by a lessor of costs of a lessee.

b. Variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date c. Amounts expected to be payable by the lessee under residual value guarantees

NOTE: Practical expedient, according to PFRS 16, allows an entity to elect not to separate the lease and non-lease component of a contract and instead account for them as a single lease component NOTE: Applying the practical expedient simplifies accounting but it would increase the amounts recognized for the lease liability and right-of-use asset and this could have implications for impairment

b. Payments in optional extension periods, unless the extension is ‘reasonably certain’ c. Future changes in variable payments that depend on an index or rate d. Variable payments linked to the lessee’s future sales or usage of the underlying asset

Fixed Payments

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Payments made by the lessee to the lessor for the rent to use the underlying asset during the lease term



In-substance fixed payments – variable in legal form but fixed in substance

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Examples:



The lease liability is remeasured when the index or interest rate changes and the lease payments are revised

Residual Value 

The estimated amount that an entity would currently obtain from disposal of an asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life



A lessee includes the residual value in the lease payments (and consequently in the measurement of lease liability and right of use asset) only if the residual value is guaranteed

a. Payments that must be made only if an asset is proven to be capable of operating during the lease b. Payments that must be made only if an event occurs with no genuine possibility of not occurring c. Payments that are initially variable but for which the variability will be resolved at some point and the payments become in-substance fixed when resolved d. When there is more than one set of payments only the realistic set of payments should be considered

Variable Payments 

Are payments made by the lessee for the right to use the underlying asset during the lease term that vary because of changes in facts or circumstances occurring after the commencement date other than passage of time



Payments that are based on an index or interest rate, foe example, payments linked to consumer price index or benchmark interest rate are included in the lease payments

Residual Value Guaranteed 

A guarantee made to a lessor by a party unrelated to the lessor that the value (or part of the value) of an underlying asset at the end of a lease will be at least a specified amount

NOTE: The guaranteed residual value is not taken into account when computing for the depreciation because the residual value inures to the benefit of the lessor. NOTE: Any subsequent change in the amount expected to be payable on the guarantee is treated as a reassessment of the lease liability and an adjustment to the carrying amount of the right of use asset (and consequently, the depreciation)

Unguaranteed Residual Value



b. Any lease payments made at or before the commencement date, less any lease incentives received

The portion of the residual value of the underlying asset, the realization of which by the lessor is not assured or is guaranteed solely by a party related to the lessor

As to the lessee, a residual value is guaranteed if it is:

NOTE: Lease incentives are payments made by a lessor to a lessee associated with a lease, or the reimbursement or assumption by a lessor of costs of a lessee.

c. Any initial direct costs incurred by the lessee 1. Guaranteed by the lessee d. The present value of any decommissioning and restoration costs for which the entity has incurred an obligation, unless those costs are incurred to produce inventories

2. Guaranteed by a party related to the lessee NOTE: When a lessee accounts for residual value, it means that the asset will revert back to the lessor. If the asset will not revert back to the lessor, for instance ownership will be transferred to the lessee, it indicates that the residual value is not guaranteed because it inures to the benefit of the lessee rather than the lessor

Subsequent Measurement of Lease Liability 

Subsequently measured similar to an amortized cost financial liability (but remeasured to reflect any reassessments or lease modifications



Interest on lease liability is computed using the effective interest method and recognized in profit or loss, unless it forms part of the carrying amount of another asset

Right of Use Asset 

An asset that represents the right of a lessee to use an underlying asset over the lease term in a finance lease

Initial Measurement of Right of Use Asset 

Right of use asset is initially measured at cost



The cost comprises the following:

NOTE: Interest in each period reflects a constant periodic rate of interest on the remaining balance of the lease liability

 a. The amount of the initial measurement of lease liability or the present value of the lease payments

Lease payments are apportioned between the interest and a reduction to the lease liability

b. There is a reasonable certainty that the lessee will exercise a purchase option

Subsequent Measurement of Right to Use Asset 

Subsequently measured in cost model



Exception: a. It relates to a class of PPE that is measured under the revaluation model, in which case, the asset may be measured under the revaluation model b. It meets the definition of an investment property and the entity uses the fair value model, in which case, the asset is measured under the fair value model



NOTE: Depreciation starts from the commencement date of the lease.

Recognition exemptions 

b. Adjusted for any remeasurement of the lease liability

Depreciation 

b. Leases for which the underlying asset is of low value

The right of use asset is measured at COST: a. Less any accumulated depreciation and any accumulated impairment losses

Depreciate over its useful life if: a. The contract provides for the transfer of ownership to the lessee by the end of the lease term

A lessee may elect not to apply the recognition of lease liability and right of use asset for: a. Short-term leases

Cost Model 

If the abovementioned conditions are not met, the underlying asset shall be depreciated over the shorter of the asset’s useful life and the lease term.

Short-term lease 

A lease that has a term of 12 months or less at the commencement date

NOTE: A lease that contains a purchase option is NOT a short-term lease



The election for short-term lease shall be made by class of underlying asset

Low Valued Asset



The assessment of low value asset is based on the value of the asset when it is new, regardless of the age of the asset being leased

NOTE: If the leased asset is subleased, the head lease does not qualify as a lease of a low-value asset



If a separate price is not readily available, the lessee shall estimate it, maximizing the use of observable information

Lease of Multiple Assets  Right to use each asset is considered separate lease if:

Accounting for short-term lease and low valued asset 

a. The lessee can benefit from the use of the asset either on its own or with other resources that are readily available to the lessee

The lessee may elect to recognize the lease payments as an expense on a straight line basis over the lease term, unless another systematic basis is more representative of the pattern of the lessee’s benefit

b. The underlying asset is neither highly dependent on, nor highly interrelated with, the other underlying assets in the contract

Separating the Components of a Contract 

An entity accounts for each lease component of a contract separately from the non-lease components of that contract



A lessee allocates the consideration in the contract to each lease component based on the relative stand-alone price of the lease component and the aggregate standalone price of the non-lease component



Relative stand-alone price is the price that the lessor or similar supplier would charge for a component separately

NOTE: If the criteria are not met, the right to use multiple assets is considered a single lease component

Non-lease elements 

Considered a separate element if it transfers goods or services to the lessee



Examples: a. Maintenance b. Security Services

c. Supply of utilities d. Supply of goods e. Supply of operational services 

Payments for activities or costs that do not transfer goods or services to the lessee are not separate component of the contract



Examples: a. Administrative tasks b. Real property taxes for which the lessor is liable regardless of whether it has leased property c. Insurance costs that protect the lessor’s investment in the asset and, in which the lessor is the beneficiary

NOTE: The payments for these items are included in the total consideration that is allocated to the separately identified component of the contract

GENERAL RECOGNITION Lease Liability

Right of Use Asset

Lease payments made to the lessor at or before commencement Advance Rent 

rentals are payable at the beginning of each period

Lease Bonus 

additional payment made by a lessee to a lessor to induce granting of leasehold rights to the lessee

Reassessment of the lease liability 

the lease liability is remeasured by discounting the revised lease payments using a revised discount rate if there is a: a. change in the lease term

NOTE: Changes in the certainty and uncertainty of the lease exercising an extension option, or not exercising a termination option, result to a change in the lease term

RECOGNITION expedient

EXEMPTION

–

practical

A lessee may elect to recognize the lease payments as expense on a straight line basis (or another more appropriate basis) if the lease is (a) shortterm or (b) of low value

b. change in the assessment of a purchase option – change in the amount payable under the purchase option NOTE: The revised discount rate is the interest rate implicit in the lease for the remainder of the lease term. If that rate cannot be determined, then use the incremental borrowing rate.



The lease liability is remeasured by discounting the revised lease payments using an unchanged discount rate if there is a:

Separate Lease 

Both the scope and consideration in the lease are increased due to the addition of a right to use one or more underlying assets and the increase in the consideration reflects the stand-alone price for the increase in scope



No adjustment is made in lease liability and right of use asset

a. Change in the residual value guarantee b. Change in the future lease payments resulting from a change in an index or rate used to determine those payments

Lease Modifications 

A change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease



Example: a. Adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term



Not a Separate Lease 

Accounted for as a remeasurement of the existing lease liability and right of use asset



Lease liability is remeasured by discounting the revised lease payments using a revised discount rate



For lease modifications that decrease the scope of the lease, the carrying amount of the right of use asset is decreased to reflect the partial or full termination of the lease. Any gain or loss is recognized in profit or loss.



For all other lease modifications, a corresponding adjustment to the right of use asset is made

Accounted for as: a. Separate lease b. Remeasurement of the existing lease liability and right of use asset

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