LEASES

(PART 1) – ACCOUNTING BY LESSEES

1. 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
o Parties to a lease contract:
§ Lessee – the entity that obtains the right to use an underlying asset for a period of time in
exchange for a consideration
§ Lessor – the entity that obtains the right to use an underlying asset for a period of time in
exchange for a consideration
• Identifying a lease:
Essential elements Guidance
1. Identified asset • Identified explicitly or implicitly
• Not identified if the supplier has substantive substitution rights
• A portion of an asset that is:
a) Physically distinct can be an identified asset
b) Not physically distinct is not an identified asset
2. Right to obtain substantially • Consider direct and indirect benefits
all of the economic benefits • Consider only the economic benefits within the defined scope of a
customer’s rights to use an asset, and not beyond
3. Right to direct use • Customer has the right to decide 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 law or regulations.
• Lease term is the non-cancellable period of a lease, together with both:
o Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise the
option
o Periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise
the option

2. Lessee accounting
• Recognition of lease liability: a lessee recognizes a lease liability and a right-of-use asset at the commencement
date
• Initial measurement of lease liability: present value of the lease payments that are not yet paid as at the
commencement date
• Subsequent measurement of lease liability: similar to an amortized cost financial liability (but remeasure to
reflect any reassessments or lease modifications)
o Interest on the 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.
o Lease payments are apportioned between the interest and a reduction to the lease liability/
• Lease payments
Included Not included
1. Fixed payments, including in-substance fixed 1. Payments for non-lease elements (except when
payments, less any lease incentives receivable the entity elects apply the practical expedient)

2. Variable lease payments that depend on an 2. Payments in optional extension periods, unless
index or a rate, initially measured using the the extension is reasonably certain
index or rate as at the commencement date
3. Future changes in variable payments that depend
3. Amounts expected to be payable by the lessee on an index or rate
under residual value guarantees
Prepared by: Moneia Brae E. Casas (BSMA II)
 4. Variable payments linked to the lessee’s future
4. The exercise price of a purchase option if the sales or usage of the underlying asset
lessee is reasonably certain to exercise the
option

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

• Discount rate
o The lease payments are discounted using the interest rate implicit in the lease
o If indeterminable, the lessee’s incremental borrowing rate is used
• Initial measurement of right-of-use asset: at cost, which comprises the following:
o Amount of the initial measurement of the lease liability
o Any lease payments made at or before the commencement date, less any lease incentives received
o Any initial direct costs incurred by the lessee
o The present value of decommissioning and restoration costs for which the entity has incurred an
obligation, unless those costs are incurred to produce inventories
• Subsequent measurement of right-of-use asset: similar to a purchased asset;
o Cost model: measure at cost
§ Less any accumulated depreciation and any accumulated impairment losses
§ Adjusted for any remeasurement of the lease liability
o Exceptions:
§ 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
§ 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
• Recognition exemptions: a lessee may elect not to apply the recognition requirements (i.e., recognition of lease
liability and right-of-use asset) for short term leases (below 12 months) and leases for which the underlying
asset is of low value (based on the value of the asset when it is new)
• Separating the components of a contract
o Each lease component of a contract is accounted for separately form the non-lease components of that
contract.
o 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 stand-alone price of the non-lease
components.
§ Relative stand-alone price: the price that the lessor or similar supplier would charge for a
component separately. If a separate price is not readily available, the lessee shall estimate it,
maximizing the use of observable information.
• Lease of multiple assets
o For a contract that contains rights to use multiple assets, the right to use each asset is considered a
separate lease component if both of the following criteria are met:
a. The lessee can benefit from the use of the asset either on its own or together with other
resources that are readily available to the lessee
b. The underlying asset is neither highly dependent on, nor highly interrelated with, the other
underlying assets in the contract.

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.

Prepared by: Moneia Brae E. Casas (BSMA II)

 1. Maintenance (e.g. cleaning of common areas in a building, garbage collection, repairs, etc.)
2. Security services
3. Supply of utilities (e.g. water, heat, electricity, internet, air conditioning, etc.)
4. Supply of goods (e.g. consumable for a manufacturing equipment)
5. Supply of operational services (driver for a leased vehicle, a machine operator for a leased equipment,
etc.)
o Payments for activities or costs that do not transfer goods or services to the lessee are not a separate
component of the contract.
§ Examples:
1. Administrative tasks
2. Real property taxes for which the lessor is liable regardless
of whether it has leased the property.
3. Insurance costs that protect the lessor’s investment in the
asset and, in which the lessor is the beneficiary.
• Practical expedient
o PFRS 16 allows an entity to elect, by class of underlying asset, not to separate the lease and non-lease
components of a contract and instead account for them as a single lease component.
o Recognition exemption: A lessee may elect to recognize the lease payments as expense on a straight-
line basis if the lease is (a) short-term or (b) of low value
• In-substance fixed lease payments
o Payments that are variable in legal form but, in substance, are unavoidable.
o Examples:
1. Payments that must be made only if an asset is proven to be capable of operating during the
lease, or only if an event occurs that has no genuine possibility of not occurring.
2. Payments that are initially variable but for which the variability will be resolved in the future
(which become ‘in-substance fixed’ when resolved).
3. Arrangements in which there is more than one set of payments that a lessee could make, but
only one of those sets of payments is realistic. In this case, the lease payments are the realistic
set of payments.
• Lease incentives
o Payments made by a lessor to lessee associated with a lease, or the reimbursement or assumption by
a lessor of costs of a lessee
• Variable lease payments
o Portion of payments made by a lessee to a lessor for the right to use an underlying asset during the
lease term that varies because of changes in facts or circumstances occurring after the commencement
due date, other than the passage of time
Type of variable payment Initial accounting Subsequent accounting
1. Based on index or • Include in lease liability and • Adjust lease liability and
rate right-of-use asset based on right-of-use asset when the
the level of index or rate at revised index or rate changes
the commencement date the lease payments (using
original discount rate)
2. Others (e.g. based on • Exclude from lese liability • Recognized as expense when
sales or usage) and right-of-use asset event or condition that
triggers payment occurs
3. In-substance fixed • Treat as fixed lease payments • Treat as fixed lease payments
payments

• Residual value guarantee
o 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 tot the end of its useful life
o A lessee includes the residual value of an underlying asset in the lease payments (and consequently in
the measurement of lease liability and right-of-use asset) only if the residual value is guaranteed
Prepared by: Moneia Brae E. Casas (BSMA II)
 o Residual value guarantee – 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; a residual value is guaranteed if it is: (a) guaranteed by the lessee; (b) guaranteed by a party
related to the lessee
• Purchase option
o The exercise price of a purchase option is included in the lease payments if the exercise is reasonably
certain.
• Current and noncurrent portions of the lease liability
o Current portion of the lease liability in 20x1: Amortization in 20x2
o Noncurrent portion of the lease liability in 20x1: Present value on 12/31/20x2
• Initial direct costs
o Are incremental costs of obtaining a lease that would not have been incurred if the lease had not been
obtained, except for such costs incurred by a manufacturer or dealer lessor in connection with a
finance lease
o A lessee capitalizes initial direct costs as follows:
General recognition Recognition exemption
• Treat as part of the cost of the • Treat as prepaid rent and
right-of-use asset and include recognize as expense under
in depreciation the straight-line basis
• Lease payments made to lessor at or before commencement date
General recognition Recognition exemption
Advance rent • Arises when rentals are payable at • Treated as prepaid rent and
the beginning of each period recognized as expense under the
straight-line basis
• Excluded from the initial
measurement of lease liability but
included in the initial measurement
of right-of-use asset

Lease bonus • Is additional payment made by a • Treated as prepaid expense and
lessee to a lessor to induce granting recognized as expense under the
of leasehold rights to the lessee straight-line basis

• Opposite of lease incentive

• Excluded from the initial
measurement of lease liability but
included in the initial measurement
of right-of-use asset

• Security deposits
o Another form of payment made to the lessor at or before commencement date
o Intended to compensate for any damages caused to the leased property
o If no damage is made the lessor returns the security deposit to the lessee at the end of the lease term
o The lessee accounts for a security deposit as a receivable measured at amortized cost
o Security deposits do not affect the lessee’s lease ability and right-of-use asset
o Deposits to be applied as rental payment at the end of the lease term are not security deposits but
rather advance rent
• Reassessment of the lease liability
o A lessee remeasure the lease liability (and adjust the right-of-use asset) if there are subsequent
changes to the lease payments. However, if the carrying amount of the right-of-use asset is reduced to
zero and there is a further reduction, the excess adjustment is charged to profit or loss.
o The lease liability is remeasured by discounting the revised lease payments using a revised discount
rate if there is a:
Prepared by: Moneia Brae E. Casas (BSMA II)
 a. Change in the lease term – the revised lease payments are determined based on the revised
lease term. Changes in the certainty or uncertainty of the lessee exercising an extension
option, or not exercising a termination option, result to a change in the lease term.

b. Change in the assessment of a purchase option – the revised lease payments shall reflect
the change in the amount payable under the purchase option

The revised discount rate is the interest rate implicit in the lease for the remainder of the lease
term. If that rate is indeterminable, the revised discount rate is the lessee’s incremental borrowing
at the date of reassessment.
o The lease liability is remeasured by discounting the revised lease payments using an unchanged
discount rate if there is a:
a. Change in the residual value guarantee – the revised lease payments shall reflect the change
in the amount expected to be payable under the residual value guarantee.

b. Change in the future lease payments resulting from a change in an index or a rate used to
determine those payments – the revised lease payments shall reflect the change in the
contractual cash flows resulting from the occurrence of the specified event or condition.

• 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 the conditions of the lease
o Separate lease
§ A lease modification is accounted for as a separate lease if both the scope and consideration
in the lease are increased due to the addition of a right to use on or more underlying assets
and the increase in the consideration reflects the stand-alone price for the increase in scope
§ No adjustment is made on the existing lease liability and right-of-use asset from the original
contract
o Not a separate lease
§ A lease modification does not result in a separate lease is accounted for as a remeasurement
of the existing lease liability and right-of-use asset
§ The 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
• Leasehold improvements
o Are recognized as asset, separate from the right-of-use asset, and depreciated over the shorter of the
life of the improvements and the remaining lease term
o Presentation
§ Statement of financial position
• Right-of-use assets are presented either:
a. Separately from other assets
b. Together with other assets as if they were owned, with disclosure of the line
items that include the right-of-use assets
• Lease liabilities are presented either:
a. Separately from other liabilities
b. Together with other liabilities, with disclosure of the line items that include
the lease liabilities
§ Statement of profit or loss and other comprehensive income
• Depreciation and interest expense are presented separately
• Interest expense on the lease liability is a component of finance cost

Prepared by: Moneia Brae E. Casas (BSMA II)

LEASES (PART 1) – ACCOUNTING BY LESSEES
Problem and Solution

Problem
On January 1, 2019, Scofield and Burrows Company negotiated a 15-year lease or a building. The building has a useful
life of 20 years.
Before occupancy, the lessee incurred leasehold improvement of P600,000 with useful life of 5 years.
The lessee is required to restore the building upon expiration of the lease. The estimated cost of restoration is
P644,000.
Annual payments of P1,000,000 are payable to the lessor on December 31 every year for 15 years of the lease term.
The lease was negotiated to assure the a lessor a 10% rate of return.
PV of an ordinary annuity of 1 at 10% for 15 periods 7.606
PV of an annuity of 1 in advance at 10% for 15 periods 8.367

Requirement: Prepare journal entries on the books of Scofield and Burrows Company for 2019.

Solution:
Jan 1, 2019 Building (1,000,000 x 7.606) P7,606,000
Lease liability P7,606,000

Dec 31, 2019 Depreciation expense (7,606,000 / 15) 507,067
Accumulated depreciation 507,067

Theory: The term of the lease is at least 75% of the life of the
asset (15/20). Since this is the basis of the finance lease, the
depreciation is computed using the term of the lease, which
is shorter than the life of the asset.

Dec 31, 2019 Interest expense (7,606,000 x 10%) 760,600
Lease liability 239,400
Cash 1,000,000




Reference: Financial Accounting Volume II 2019 Edition (Valix, Peralta, Valix)

Prepared by: Moneia Brae E. Casas (BSMA II)