Lecture Notes on Leases and IFRS 16

Introduction to Leases

• Topic: Leases under IFRS 16
• New standard effective January 1, 2019, replacing older standards.
• Definition: Lease is a contract that conveys the right to use an underlying asset for a period of time in exchange for consideration (payment).

Key Concepts of IFRS 16

Rights Granted by Lease

• A lease must convey the right to control the use of an identified asset.
• Criteria for control:
  1. Economic Benefits: Lessee obtains substantially all economic benefits from the use of the asset.
  2. Direction of Use: Lessee has the right to direct how the asset is used.

Types of Leases

1. Operating Lease

• Does not transfer substantially all risks and rewards of ownership to the lessee.
• Owner remains the lessor.
• Considered a rent transaction.

2. Finance Lease

• Transfers substantially all risks and rewards of ownership to the lessee.
• In substance, it is a sale transaction with lease payments considered installment payments.
• Substance prevails over form in accounting.

Criteria for Finance Lease Classification

• According to paragraph 63 of IFRS 16:
  • T: Transfer of ownership at the end of the lease term.
  • O: Option to purchase the asset at a price lower than fair value.
  • M: Material lease term (generally 75% of the useful life).
  • S: Substantial present value of lease payments (at least 90% of fair value of the asset).

Lessee Accounting Under IFRS 16

• Lessor recognizes lease payments as income (rent income) on a straight-line basis or another systematic basis.
• Initial direct costs are added to the carrying amount of the asset and recognized over the lease term.

Executory Costs

• Costs incurred by the lessor for maintenance and repairs.
• These are expensed as incurred.

Refundable Security Deposits

• Not classified as income; recognized as a liability until refunded.

Lease Bonuses

• Additional payments made to obtain a lease, treated as unearned revenue and recognized over the lease term.

Illustrative Problems

Problem 1

• Lease Agreement: Pepper Company leases to Iana Company at a reduced rate for the first year.
• Required Rental Revenue: $2.4 million reported as rental income for the year.

Problem 2

• Lease Agreement: 5-year term with the first year discounted.
• Required Rental Income: $1.800 million.

Problem 3

• Lease Agreement: Monthly rentals over 4 years.
• Rent Receivable on December 31, 2018: $1.2 million.

Problem 4

• Lease Agreement: 10-year lease with initial direct costs and executory costs.
• Net Rent Income: $275,000.

Problem 5

• Lease Agreement: Annual rental and lease bonus.
• Required Rental Income: $1 million.

Conclusion

• Summary of key points on leases under IFRS 16.
• Encouragement to subscribe for further discussions on finance lease accounting.