M3: Liabilities (IFRS 16 Leases) Flashcards
(24 cards)
What is a lease?
A contract is a lease if it conveys the right to control the use of an identified asset for a period of
time in exchange for consideration.
What do we consider when considering the total lease term of a lease?
Length prescribed in the contract
PLUS:
Periods covered by an option to extend the lease, if the lessee is reasonably certain to exercise the option
Periods covered by an option to terminate the lease, if the lessee is reasonably certain not to exercise the option
Rent-free periods provided by the lessor to the lessee
What are the four key things that need to be shown to be a lease?
& describe
1) Right to control - Direct the use of the asset, Obtain substantially all economic benefits from the use of the asset
2) Identified asset - It is the subject of the lease, for which the right of use has been given
3) Period of time - Weeks, months, years or for use e.g. 10,000 miles etc
4) Consideration - Specified in the contract, Usually a cash amount, paid in instalments
If there is a lease term and a useful life, what should we use if its not explicitly stated in the question?
The shorter of the two.
What is a Lessor?
Provides the right to use an underlying asset
for a period of time in exchange for
consideration (also referred to as a
‘supplier’)
What is a Lessee?
Obtains the right to use the underlying asset
for a period of time in exchange for
consideration (also referred to as a
‘customer’)
What does IFRS 16 Leases not apply to?
Leases to explore minerals, oil, etc. (Not within the scope of RP2)
Leases of biological assets, covered by IAS 41 Agriculture. (Not within the scope of RP2)
Licences of intellectual property, covered by IFRS 15 Revenue from Contracts with Customers, in Module 4
Certain intangible assets, covered by IAS 38 Intangible Assets, in Module 2. A lessee may
opt to apply IFRS 16 to other intangible assets, but is not required to.
When can a lessee may elect not to
apply IFRS 16?
Short-term, low value leases where they can expense the lease payments, apportioned over the term of the lease.
What does Short-term mean in terms of leases?
‘Short term’ is likely to be less than 12 months and cannot be a lease with a purchase option.
What does Low value mean in terms of leases?
Low value’ is undefined and is a matter of judgement. It is based on the value of the asset when new. IFRS 16 Basis for Conclusions suggested a benchmark of $5,000 in 2015. Materiality to the lessee is irrelevant. The asset cannot be dependent or highly related to
another asset (eg a large asset broken down into smaller parts to avoid capitalising the right-of-use asset).
In order for an entity to control the use of an asset, what must be met?
1) Obtain substantially all economic benefits from the use of the asset
2) Direct the use of the asset
How do we determine if the lessee is reasonably certain to extend a lease?
We assess the financial implications of the options.
e.g. , if the lease extension is for a very small
‘token’ rental (eg £1 for five years), it is assumed the lessee will extend. If the termination and
purchase is cheaper than extending, it is assumed that termination and purchase will be
exercised
How do we value the RoU asset?
Initial measurement of lease liability
PLUS lease payments made at or before the commencement of the lease
PLUS direct costs of the lease (incremental costs of obtaining the lease that would not have been incurred if the lease had not been obtained, e.g. legal fees) XX
PLUS estimated dismantling or restoration costs (as with PPE in Module 2) XX
LESS incentives or reimbursements received from lessor (XX)
Total RoU Asset COST = XXX
What is the journal entry for the capitalisation of a RoU Asset?
DR RoU asset – cost
DR Bank (Reimbursements/Discounts)
CR Bank (initial and direct costs)
CR Lease liability
CR Provision (for dismantling)
How do we value the initial liability?
The lease liability will be measured as the present value of the FUTURE lease payments.
Lease liability = annuity factor x lease payments
What do we have to watch when calculating initial liability of a lease (Arrears/Advance)?
Whether we are paying in arrears or in advance.
If in arrears, the number of years for the annuity factor will be based on the number of payments.
However, if the payments are made in advance, the first payment is made on the inception of the
lease, meaning that the FUTURE PAYMENTS are the number of payments, less one.
What’s the difference between valuing the lease liability and the RoU Asset?
Lease liability = Annuity factor x Lease payments
RoU Assets = Lease liability + Direct costs - Incentives
What do we do with the RoU asset in subsequent years?
(& what rule means we always use useful life?)
We must depreciate the ROU Asset to the shorter of the lease term or the useful life.
It is always over the USEFUL LIFE if the lease transfers ownership to the lessee at end of the lease. This
may give rise to a residual value, which the lessee will benefit from on disposal, so this should be
incorporated into the depreciation calculation.
What happens at the end of the lease term?
At the end of the lease term, the asset should have a carrying value of zero, unless the ownership
transfers, in which case, at the end of the useful life, the asset value will be the residual value.
What is a sale-and-leaseback transaction?
A sale-and-leaseback transaction is when an organisation sells their asset and leases back
immediately.
What is the main rule to consider in a sale and leaseback transaction?
If the lease term is for a small part of the asset’s useful life, you can assume a sale has taken place.
If the lease term is for the majority of the asset’s useful life, you can assume a sale has NOT taken place.
How do we unwind the lease liability (in arrears vs advance for NCL and CL and Payment)
Open bal. + Int - Payment = Closing total liability
In Arrears: Payment is at end of year so interest included. Current is Difference between Closing Y1 and Y2. Non- current is Y2 Closing.
In Advance: Payment is before interest as it hasn’t accrued for year YET. CL is the lease payment. NCL is Y2 Closing.
Payments:
In Arrears:
In Advance: CL is the lease payments. NCL is the balance after Closing Y1 minus Payment.
What is the formula to work out the Gain on a sold portion on an underlying asset?
(Total Gain/FV total asset) x (Proceeds - Lease liability)
What is the formula to work out the Right of Use asset amount on the SoFP?
- We work out the Lease liability first (PV of future lease payments)
- We do the CA / FV underlying asset x Lease liability to get what should be on the SoFP
