IFRS 16, Leases

for industry SPECIFIC application training and application click link 


IFRS 16, LEASES.

IFRS 16. Leases was brought in to remedy to non-recognition of liabilities for assets held under operation leases.
A lease is a contract, or part of contract, that conveys the right to use an asset, the underlying asset for a period of time in exchange of consideration.
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 of consideration. The contract may contain other elements which are not leases, such as a service contract. These other components must be separated out from the lease and separately accounted for, allocating the consideration on the basis of the stand-alone prices of the lease and non-lease components.
The right ot control the use of an identified asset depends on the lessee having.
(a) The right to obtain substantially all the economic benefits from use of the identified asset; and
(b) The right to direct the use of the identified asset (IFRS 16). This arises if either:
(i) The customer has the right to direct how and for what purpose the asset is used during the whole of its period of the use, or
(ii) The relevant decisions about use are pre-determined and the customer can operate the asset without the supplier having the right to change those operating instructions.
A lessee does not control the use of an identified asset if the lessor can substitute the underlying asset for another asset during the lease term and would benefit economically from doing so.
Identifying a lease: examples
The following flowchart, taken from IFRS 16, Leases may assist you in determining whether a lease may be identified in the examples that follow:
Is there an identified asset?
1.Does the customer have the right to obtain substantially all of the economic benefits from use of the assets throughout the period of use?
2. Does the customer, the supplier or neither party have the right to direct how and for what purpose the asset is used throughout the period of use?
Neither; how and for what purpose the asset will be used is predetermined.
3. Does the customer have the right to operate the asset throughout the period of use, without the supplier having the right to change those operating instructions?
4. Did the customer design the asset in a way that predetermines how and for what purpose the asset will be used throughout the period of use?
The contract contains a lease
The contract does not contain a lease.
Is it a lease (1)?.
Coketown Council has entered into a five-year contract with Carefleet Co, under which Carefleet Co supplies the council with ten vehicles to for the purposes of community transport. Carefleet Co owns the relevant vehicles, all ten of which are specified in the contract. Coketown Council determines the routes taken for community transport and the charges and eligibility for discounts. The council can choose to use the vehicles for purposes other than community transport. When the vehicles are not being use, they are kept at the council’s offices and connot be retrieved by Carefleet unless Caketown Council defaults on payment. If a vehicle needs to be serviced or repaired, Carefleet is obliged to provide a temporary replacement vehicle of the same type.
Conclusion: this is a lease. There is an identifiable asset, the ten vehicles specified in the contract. The council has a right to use the vehicles for the period of the contract. Carefleet Co does not have the right to substitute any of the vehicles unless they are being serviced or repaired. Therefore Coketown Council would need to recognize an asset and liability in its statement of financial position.
Is it a lease (2)?.
Broketown Council has recently make substantial cuts to its community transport service. It will now provide such services only in cases of great need, assessed on a case by case basis. It has entered in to a two-year contract with Fleetcar Co for the use of one of its minibuses for this purpose. The minibus must seat ten people, but Fleetcar Co can use any of its ten-seater minibuses when requited.
Conclusion: this is not a lease. There is no identifiable asset. Fleetcar can exchange one minibus for another. Therefore Broketown council should account for the rental payments as an expense in profit or loss.
Is it a lease (3)?.
This example is taken from I FRS 16 Illustrative example 3.
Kabel enters into a ten year contract with a utilities company (Telenew) for the right to use three specified, physically distinct dark fibres within a larger cable connecting North Town to South Town, Kabal makes the decisions about the use of the fibres by connecting each end of the fibres to its electronic equipment (ie Kabal ‘lights’ the fibres and decides what data, and how much data, those fibres will transport). If the fibres are damaged, Telenew is responsible for the repairs and maintenance. Telenew owns extra fibres, but can substitute those for Kabal’s fibres only for reasons of repairs, maintenance or malfunction (and is obliged to substitute the fibres in these cases).
Conclusion: this is a lease. The contract contains a lease of dark fibres. Kabal has the right to use the three dark fibres for ten years.
There are three identified fibres. The fibres are explicitly specified in the contract ad are physically distinct from other fibres within the cable. Telenew cannot substitute the fibres other than for reasons of repairs, maintenance or malfunction .
Kabal has the right to control the use of the4 fibres throughout the ten-year period of use because:
(a). Kabal has the right to obtain substantially all of the economic benefits from use of the fibres over the ten-year period of use and Kabal has excluysive use of the fibres throughout the period of use.
(b) Kabal has the right to direct the use of the fibres because IFRS 16: Para B24 applies:
(i) The customer has the right to direct how and for what purpose the asset is used during the whole of its period of use, or
(ii) The relevant decisions about use are pre-determined and the customer can operate the asset without the supplier having the right to change those operating instructions.
Kabal makes the relevant decisions about how and for what purpose the fibres are used by deciding (i) when and whether to light the fibres and (ii) when and hw much output the fibres will produce (ie what data, and how much data, those fibres will transport). Kabal has the right to change these decisions during the ten-year period of use.
Recognition exemptions
In the case of short-term leases and leases of low value assets, leases may elect to account for lease payments as an expense on a straight-line basis over the lease term instead of applying IFRS 16.
Instead of applying the recognition requirements of IFRS 16 described below, a lease may elect to account for lease payments as an expense on a straight-line basis over the lease term or another systematic basis for the following two types of leases IFRS 16.
(a) Short-term leases. These are leases with a lease term of twelve months or less. This election is made by class of underlying asset. A lease that contains a purchase option cannot be a short-term lease.
(b) Leases of low-value assets. These are leases where the underlying asset has a low value when new (such a tablet and personal computers or small items of office furniture and telephones.). This election can be made on a lease-by-lease basis. An underlying asset qualifies as low value only if two conditions apply:-
i. The lease can benefit from using the underlying asset.
ii. The underlying asset is not highly dependent on, or highly interrelated with, other assets.
Leases of low-value assets are leases of assets with a value when new of $5,000 or less (IFRS 16)
Example: leases of low-value assets and portfolio application
IFRS 16 illustrative Example 11 is of a lease in the pharmaceutical manufacturing and distribution industry, with leases including the following:
(a) Leases of IT equipment for use by individual employee (such as laptop computers, desktop computers, hand held computer devices, desktop printers and mobile phones)
(b) Leases of servers, including many individual modules that increase the storage capacity of those servers. The modules have been added to the mainframe servers over time as the lessee has needed to increase the storage capacity of the servers.
(c) Lease of office equipment:
i. Office furniture such as desks, chairs and partitions
ii. Water dispensers
Separating components of a contract.A contract may contain both a lease component and a non-lease component. In other words it may include an amount payable by the lessee for activities and costs that do not transfer goods or services to the lessee. These activities and costs might, for example, include maintenance, repairs or cleaning.
IFRS 16 requires entities to account for the lease component of the contract separately from the non-lease component. The entity must split the rental or lease payment and:
• Account for the lease component under IFRS 16, and
• Account for the service element separately, generally as an expense in profit or loss.
The consideration in the contract is allocated on the basis of the stand alone prices of the lease component(s).
Initial measurement of the right of use assets
At the commencement date the right of use asset is measured at cost. This comprises:
(a) The amount of the initial measurement of the lease liability
(b) Any lease payments made before the commencement date, less and lease incentives received
(c) Any initial direct costs incurred by the lessee
(d) Any costs which the lessee will incur for dismantling and removing the underlying asset or restoring the site at the end of the lease term
Subsequent measurement of the right of use asset
After the commencement date the right of use asset should be measured should be measured using the cost model in IAS 16, unless it is an investment property or belongings to a class of assets to which the revaluation model applies.
It the lease transfers ownership of the underlying asset at the end of the lease term or if the cost reflects a purchase option which the lease is expected to exercise, the right of use asset should be depreciated over the useful life of the underlying asset.
If there is no transfer of ownership and no purchase option, the right of use asset should be depreciated from the commencement date to the earlier of the end of the useful life and the end of the lease term.
Subsequent measurement of lease liability
After the commencement date the carrying amount of the lease liability is increased by interest charges on the outstanding liability and reduced by lease payments made.
Lessee accounting
For lessees, IFRS 16 removes the distinction between finance leases and operating leases which was a feature of IAS 17.
All leases result in a company, the lessee obtaining:
• The right to use an asset at the start of the lease, and
• Financing, if lease payments are made over time.
Apportionment of rental payments
When the lessee makes a rental payment it will comprise two elements.
(a) An interest charge on the finance provided by the lessor. This proportion of each payment is interest payable in the statement of profit or loss of the lessee.
(b) A repayment of part of the capital cost of the asset. In the lessee’s books this proportion of each rental payment must be debited to the lessor’s account to reduce the outstanding liability.
The accounting problem is to decide what proportion of each installment paid by the lessee represents interest, and what proportion represents a repayment of the capital advanced by the lessor. This is done by the actuarial method, using the interest rate implicit in the lease.
Lessor accounting
Finance leases
A finance lease is a lease that lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset. It can be considered, to be, like hire purchase, a form of installment credit.
When we talk of risks here, we specifically mean that risks of ownership, not other types of risk, Risks of ownership include the possibility of losses from idle capability or technological obsolescence, or variations in return due to changing economic conditions. The rewards are represented by the expectation of profitable operation over the asset’s economic life, and also any gain from appreciation in value or realization of a residual value.
For lessor, but not lessees, finance leases are distinguished from operating leases.
Accounting treatment
IAS 16 requires the amount due from the lessee under a finance lease to be recorded in the statement of financial position of a lessor as a receivable at the amount of the net investment in the lease.
The recognition of finance income under a finance lease should normally be based on a pattern to give a constant periodic rate of return on the lessor’s net investment outstanding in respect of the finance lease in each period. In arriving at the constant periodic rate of return, a reasonable approximation may be made.
The lease payments (excluding costs for services) relating to the accounting period should be applied against the gross investment in the lease, so as to reduce both the principal and the unearned finance income.
Operating leases
Definition
An Operating lease is a lease that does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset. Its useful life. The distinction between finance and operation leases applies only to lessors, not lessees.
Accounting treatment
An asset held for use in operating leases by a lessor should be recorded as a long-term asset and depreciated over its useful life. The basis for depreciation should be consistent with the lessor’s policy on similar non-lease assets and follow the guidance in IAS 16.
Income from an operating lease, excluding charges for services such as insurance and maintenance, should be recognised on a straight-line basis over the period of the lease (even if the receipts are not on such a basis), unless another systematic and rational basis is more representative of the time pattern in which the benefit from the leased asset is receivable.
Initial direct costs incurred by lessors in negotiating and arranging an operating lease should be added to the carrying amount of the leased asset and recognised as an expense over the lease term on the same basis as lease income, ie capitalised and amortised over the lease term.
Sale and leaseback
A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset.
IFRS 16 requires an initial assessment to be made regarding whether or not the transfer constitutes a sale. This is does by determining when the performance obligation is satisfied in accordance with IFRS 15 Revenue from Contracts with Customers .
Transfer is a sale
If the transfer satisfies the IFRS 15 requirement to be accounted for as a sale:
• The seller/lessee measures the right of use asset arising from the leaseback at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller / lessee.
• The seller / lessee only recognizes the amount of any gain or loss on the sale that relates to the rights transferred to the buyer .
If the fair value of the consideration for the sale does not equal the fair value of the asset or if the lease payments are not at market rates, the following adjustments should be made:
• Any below market terms should be accounted for as a prepayment of lease payments (the shortfall in consideration received from the lessor is treated as a lease payment made by the lessee)
• Any above market terms are accounted for as additional financing provided by the buyer / lessor (the additional amount paid by the lessor is treated as additional liability, not as gain on the sale).
Transfer is not a sale
If the transfer does not satisfy the IFRS 15 requirements to be accounted for as a sale, the seller continues to recognize the transferred asset and the transfer proceeds are treated a as financial liability, accounted for in accordance with IFRS 9. The transaction is more in the nature of a secured loan.

Comments

Popular posts from this blog

IFRS 15, Revenue from contract with customers