IFRS 16

LEASES
P R E PA R E D B Y
D CHIMANGA

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Learning Outcome
By the end of the lecture students should be able to
Apply and discuss the treatment of non-current assets held for sale and discontinued
operations.

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 Introduction
Introduction:
An entity purchasing an asset acquires both legal title to the asset and risks and rewards of
ownership.
However, an entity may need a particular asset for its operations but cannot purchase the asset
outright.
The entity may elect to lease the asset, instead of outright purchase.
In substance, when an entity leases an asset, it is acquiring the right to use the asset.
IFRS 16, therefore, provides guidance for the recognition, measurement, presentation and
disclosure of leases.
The objective of the standard is to ensure that lessees and lessors provide relevant information in a
manner that faithfully represents those transactions

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 Definitions
What is a lease?
IFRS 16 defines a lease as a contract, or part of a contract, that conveys the right to use an
asset for a period of time in exchange for consideration.
The lessor is the entity that provides the right to use an underlying asset in exchange for
consideration.
The lessee is the entity that obtains the right to use an underlying asset in exchange for
consideration.
Right-of-use asset represents the lessees rights to use an underlying asset for the lease term.

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 Fundamental concepts
Contract:
A contract is an agreement between two or more parties that creates enforceable rights and
obligations.
IFRS 16 requires an entity to determine whether a contract is a lease or contains a lease at the
inception of a contract.
A contract is, or contains, a lease if the contract conveys the right to control the use of an identified
asset for a period of time in exchange for consideration.
A contract conveys the right to control the use of an identified asset, if throughout the period of use,
the lessee has both:
the right to obtain substantially all of the economic benefits from use of the identified asset, and
the right to direct the use of the identified asset.

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 Example
Coffee Bean enters into a contract with an airport operator to use some
space in the airport to sell its goods from portable kiosks for a threeyear
period. Coffee Bean owns the portable kiosks. The contract
stipulates the amount of space and states that the space may be
located at any one of several departure areas within the airport. The
airport operator can change the location of the space allocated to
Coffee Bean at any time during the period of use, and the costs that the
airport operator would incur to do this would be minimal. There are
many areas in the airport that are suitable for the portable kiosks.

Required:
Does the contract contain a lease?

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 Example
AFG enters into a contract with Splash, the supplier, to use a specified
ship for a five-year period. Splash has no substitution rights. During the
contract period, AFG decides what cargo will be transported, when the
ship will sail, and to which ports it will sail. However, there are some
restrictions specified in the contract. Those restrictions prevent AFG
from carrying hazardous materials as cargo or from sailing the ship into
waters where piracy is a risk.
Splash operates and maintains the ship and is responsible for the safe
passage of the cargo on board the ship. AFG is prohibited from hiring
another operator for the ship, and from operating the ship itself during
the term of the contract.
Required:
Does the contract contain a lease ?

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 Lease term
The lease term is the length of time that the lessee has the right-of-use of an asset or the total
period of time that an asset is used to fulfil a contract with a customer.
The lease term comprises:
Non-cancellable periods
Periods covered by an option to extend the lease, if they are reasonably certain to be
exercised.
Periods covered by an option to terminate the lease if they are reasonably certain not to be
exercised.

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 Lease Modifications
A firm may elect to be exempt from the recognition requirements of IFRS 16.22-.49 for short
term leases (IFRS 16.5(a)), which is a lease which, at commencement date, has a lease term of
12 months or less. (1)
The extension of the lease term will be regarded as a lease modification since this is a change in
the scope of the lease that was not part of the original terms and conditions of the lease (IFRS
16 Appendix A). (2)
The lease modification will be considered as a new lease (IFRS 16.7(a)). In this instance the new
lease also has a lease term of less than 12 months; hence this lease will also be a short term
lease. (2)
 the lease payments as an expense as it is incurred , since this

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 Lessee’s books
At the commencement of the lease, the lessee should recognise:
A lease liability, and
A right-of-use asset.

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 Initial measurement
Lease liability:
The lease liability is initially measured at the present value of the lease payments that have not yet
been paid.
Lease payments include the following:
Fixed payments over the lease term
Residual value guarantees –the lessee guarantees that the asset’s value will not fall below a
specified amount.
Options to purchase the asset that are reasonably certain to be exercised.
Termination penalties, if the lease term reflects the expectation that these will be incurred.
The discount rate is the rate implicit in the lease or the incremental borrowing rate

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 Example 1
On 1 January 20X1, Dynamic entered into a two year lease for a lorry. The contract contains an
option to extend the lease term for a further year. Dynamic believes that it is reasonably certain
to exercise this option. Lorries have a useful life of ten years.
Lease payments are $10,000 per year for the initial term and $15,000 per year for the option
period. All payments are due at the end of the year. To obtain the lease, Dynamic incurs initial
direct costs of $3,000. The interest rate within the lease is not readily determinable. Dynamic’s
incremental rate of borrowing is 5%.
Required:
Calculate the initial carrying amount of the lease liability

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 Example 2
Sadio leases a machine over a 5 year lease term from BH from 1 December 20X5. Rental
payments of $75,000 are made in advance on 1 December each year and the first instalment has
just been paid. The useful life of the asset is 7 years. A lease arrangement fee of $1,500 was
incurred by Sadio. The rate implicit on the lease cannot be readily determined but the rate of
incremental borrowing for Sadio is 8%. Ownership of the asset is retained by the lessor at the end
of the lease term.
Required:
Calculate the initial carrying amount of the liability

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 Right-of-use asset:
The lessee initially measures the right-of-use asset at cost, which consists of all of the following:
The amount of the initial measurement of the lease liability.
Any lease payments made to the lessor at or before the commencement date, less any lease
incentives received from the lessor.
Any initial direct costs incurred by the lessee.
An estimate of the costs to be incurred by the lessee in dismantling and removing the
underlying asset, restoring the site on which the underlying asset is located or restoring the
underlying asset to the condition required by the terms and conditions of the lease.
The liability associated with dismantling, removal and restoration costs is recognised and
measured in accordance with IAS 37.

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 Example
On 1 January 20X1, Dynamic entered into a two year lease for a lorry.
The contract contains an option to extend the lease term for a further
year. Dynamic believes that it is reasonably certain to exercise this
option. Lorries have a useful life of ten years.
Lease payments are $10,000 per year for the initial term and $15,000
per year for the option period. All payments are due at the end of the
year. To obtain the lease, Dynamic incurs initial direct costs of $3,000.
The lessor immediately reimburses $1,000 of these costs.
The interest rate within the lease is not readily determinable. Dynamic’s
incremental rate of borrowing is 5%.
Required:
Calculate the initial carrying amount of the lease liability and the
right-of-use asset and provide the double entries needed to record
these amounts in Dynamic's financial records

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 Example
On 31 March 20-7, an entity with a June 30 financial year-end decided to dispose of an
individual asset which was correctly classified as held for sale and had a carrying amount of$7
500 000.This recorded amount incorporates the following: original cost $13 900 000,
accumulated depreciation $4 300 000 and previously recognized impairment losses of $2 100
000. The
asset's estimated fair value less costs to sell when it was classified as held for sale was $6 800000.
On 30 June 20-7, the asset was remeasured, and its fair value l
as costs to sell was estimated at$9 750 000.
Calculate the amounts which should be recognized in the entity's financial statements in relation
to the asset.

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 Subsequent measurement
Lease liability:
The carrying amount of the lease liability is increased by the interest charge.

DR Finance cost(Interest expense) -SOPL

The carrying amount of the lease liability is reduced by cash payments.

DR Lease liability
CR Bank

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 Subsequent measurement
cont…
Right-of-use asset:
The right-of use asset is measured using the cost model, i.e. it is measured at its initial cost less
accumulated depreciation and impairment losses.
Other measurement models include the revaluation method and fair value method.

Depreciation expense:
Depreciation is calculated as follows:
If ownership of the asset transfers to the lessee at the end of the lease term then depreciation is
charged over the asset’s useful life.
Otherwise, depreciation is charged over the shorter of the useful life and the lease term.

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 Example
On 1 January 20X1, Dynamic entered into a two year lease for a lorry. The contract
contains an option to extend the lease term for a further year. Dynamic believes that it
is reasonably certain to exercise this option. Lorries have a useful life of ten years.
Lease payments are $10,000 per year for the initial term and $15,000 per year for the
option period. All payments are due at the end of the year. To obtain the lease,
Dynamic incurs initial direct costs of $3,000. The interest rate within the lease is not
readily determinable. Dynamic’s incremental rate of borrowing is 5%.
Required:
Prepare extracts from Dynamic's financial statements in respect of the lease
agreement for each of the years ended 31 December.

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Short-life and low value assets
If the lease term is less than a year at the inception date the contract is a short-term
lease, and the following are low value assets:
Tablets,
small personal computers
Small items of furniture
Telephones.
The lessee uses a simplified treatment, i.e. lease payments are recognised in the
profit or loss on a straight line basis.

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 Accounting treatment
shall recognise the lease payments associated with leases of low value items as an expense on
either a straight-line basis over the lease term or another systematic basis if that basis is more
representative of the pattern of the lessee’s benefit (IFRS 16.6)

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