Is there an identified asset?

Yes

Does the customer have the right to obtain

substantially all the economic benefits from
use of the asset throughout the period of
use?

Yes

Does the customer, the supplier or neither

party have the right to direct how and for
Customer Supplier
what purpose the asset is used throughout
the period of use?
Neither, how and for what
purpsoe the asset will be used is
predetermined

Does the customer have the right to operate

the asset throughout the period of use,
Yes
without the supplier having the right to
change those operating instructions?

No

Did the customer design the asset in a way

that predetermines how and for what
NO
purpose the asset will be used throughout
the period of use?

Yes

The contract The contract does

contains the lease not contain the
lease
On 1 January 20X1, LessieCorp entered into a low value lease for new lorry under the following conditions:
1. Lease is non-cancellable for 4 years.
2. Rentals amounting to 9 200 EUR are to be paid annually, on 31 December, starting 20X1.
How would this transaction appear in the financial statements of LessieCorp at 31 December 20X1?

1. Accounting treatment

No asset is recognized under exception of IFRS 16. Rentals are included in expenses.

Debit Expenses - rentals 9,200

-9,200
Credit Cash
0

2. Disclosures

Future minimum lease payments under non-cancellable lease:

due not later than 1 year 9,200
due later than 1 year but not later than 5 years 18,400
due later than 5 years 0
Total 27,600
Example-1 A Lessor leases a bulldozer, a truck and a long-reach excavator to Lessee to be used in Lessee’s mining operations for four years. Lessor also agrees
to maintain each item of equipment throughout the lease term. The total consideration in the contract is CU600,000, payable in annual instalments
of CU150,000, and a variable amount that depends on the hours of work performed in maintaining the long-reach excavator. The variable payment
is capped at 2 per cent of the replacement cost of the long-reach excavator. The consideration includes the cost of maintenance services for each
item of equipment.

Several suppliers provide maintenance services for a similar bulldozer and a similar truck. Accordingly, there are observable standalone prices for
the maintenance services for those two items of leased equipment. Lessee is able to establish observable stand-alone prices for the maintenance
of the bulldozer and the truck of CU32,000 and CU16,000, respectively, assuming similar payment terms to those in the contract with Lessor.
The observable consideration for those four-year maintenance service contracts is a fixed amount of CU56,000, payable over four years, and a
variable amount that depends on the hours of work performed in maintaining the long-reach excavator.
Lessee is able to establish observable stand-alone prices for the leases of the bulldozer, the truck and the long-reach excavator of CU170,000,
CU102,000 and CU224,000, respectively.
Required: - Allocate the transaction price to lease and non-lease components?

Answer
Lessee concludes that there are three lease components and three non-lease components (maintenance services) in the contract. Lessee applies
the guidance IFRS 16 to allocate the consideration in the contract to the three lease components and the non-lease components.

Several suppliers provide maintenance services for a similar bulldozer and a similar truck. Accordingly, there are observable standalone prices for
the maintenance services for those two items of leased equipment. Lessee is able to establish observable stand-alone prices for the maintenance
of the bulldozer and the truck of CU32,000 and CU16,000, respectively, assuming similar payment terms to those in the contract with Lessor. The long-
reach excavator is highly specialized and, accordingly, other suppliers do not lease or provide maintenance services for similar excavators.
Nonetheless, Lessor provides four-year maintenance service contracts to customers that purchase similar long-reach excavators from Lessor. The
observable consideration for those four-year maintenance service contracts is a fixed amount of CU56,000, payable over four years, and a variable
amount that depends on the hours of work performed in maintaining the long-reach excavator. That variable payment is capped at 2 per cent of
the replacement cost of the long-reach excavator. Consequently, Lessee estimates the stand-alone price of the maintenance services for the long-
reach excavator to be CU56,000 plus any variable amounts. Lessee is able to establish observable stand-alone prices for the leases of the bulldozer,
the truck and the long-reach excavator of CU170,000, CU102,000 and CU224,000, respectively.

Lessee allocates the fixed consideration in the contract (CU600,000) to the lease and non-lease components as follows:

Lease Non-lease Total

Bulldozer 170,000
Truck 102,000
Excavator 224,000 104,000
496,000 104,000 600,000
 Lessee enters into a 10-year lease of a floor of a building, with an option to extend for five years. Lease payments are CU50,000 per year
during the initial term and CU55,000 per year during the optional period, all payable at the beginning of each year. To obtain the lease,
Lessee incurs initial direct costs of CU20,000, of which CU15,000 relates to a payment to a former tenant occupying that floor of the building
Example-2

and CU5,000 relates to a commission paid to the real estate agent that arranged the lease. As an incentive to Lessee for entering into the
lease, Lessor agrees to reimburse to Lessee the real estate commission of CU5,000 and Lessee’s leasehold improvements of CU7,000.

At the commencement date, Lessee concludes that it is not reasonably certain to exercise the option to extend the lease and, therefore,
determines that the lease term is 10 years.
The interest rate implicit in the lease is not readily determinable. Lessee’s incremental borrowing rate is 5 per cent per annum, which reflects
the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a 10-year term,
and with similar collateral.

In the sixth year of the lease, Lessee acquires Entity A. Entity A has been leasing a floor in another building. The lease entered into by Entity A
contains a termination option that is exercisable by Entity A. Following the acquisition of Entity A, Lessee needs two floors in a building suitable
for the increased workforce. To minimize costs, Lessee (a) enters into a separate eight-year lease of another floor in the building leased that
will be available for use at the end of Year 7 and (b) terminates early the lease entered into by Entity A with effect from the beginning of Year
8.

Consequently, at the end of Year 6, Lessee concludes that it is now reasonably certain to exercise the option to extend its original lease as a
result of its acquisition and planned relocation of Entity A.
Lessee’s incremental borrowing rate at the end of Year 6 is 6 per cent per annum, which reflects the fixed rate at which Lessee could borrow
an amount similar to the value of the right-of-use asset, in the same currency, for a nine-year term, and with similar collateral. Lessee expects
to consume the right-of-use asset’s future economic benefits evenly over the lease term and, thus, depreciates the right-of-use asset on a
straight-line basis.
Required: -

a)           Measure the value at which lease will be initially recognized in the books of lessee and pass necessary journal entries?

b)           Provide accounting for the change in lease term and pass necessary journal entries?
c) Prepare lease repayment schedule for first six years and for seven and eighth year?
Answer

At the commencement date, Lessee makes the lease payment for the first year, incurs initial direct costs, receives lease incentives from Lessor
and measures the lease liability at the present value of the remaining nine payments of CU50,000, discounted at the interest rate of 5 per cent
per annum, which is CU355,391.
Lessee initially recognizes assets and liabilities in relation to the lease as follows.

Rs. Rs.
Right to use asset 405,391
Lease liability 355,391
Cash 50,000
Right to use asset 20,000
Cash (initial direct cost) 20,000
Cash (lease incentive) 5,000
Right to use asset 5,000
Lessee accounts for the reimbursement of leasehold improvements from Lessor applying other relevant Standards and not as a lease
incentive applying IFRS 16. This is because costs incurred on leasehold improvements by Lessee are not included within the cost of the right-of-
use asset.
The right-of-use asset and the lease liability from Year 1 to Year 6 are as follows.
Lease liability Right to use asset
Year Opening Lease Interest Ending Opneing Dep- for the Ending
balance payment expense balance balance year balance
1 355,391 - 17,770 373,161 420,391 42,039 378,352
2 373,161 50,000 16,158 339,319 378,352 42,039 336,313
3 339,319 50,000 14,466 303,785 336,313 42,039 294,274
4 303,785 50,000 12,689 266,474 294,274 42,039 252,235
5 266,474 50,000 10,824 227,297 252,235 42,039 210,196
6 227,297 50,000 8,865 186,162 210,196 42,039 168,156

At the end of the sixth year, before accounting for the change in the lease term, the lease liability is CU186,162 (the present value of four
remaining payments of CU50,000, discounted at the original interest rate of 5 per cent per annum). Interest expense of CU8,865 is recognized
in Year 6. Lessee’s right-of-use asset is CU168,157.

Lessee re-measures the lease liability at the present value of four payments of CU50,000 followed by five payments of CU55,000, all discounted
at the revised discount rate of 6 per cent per annum, which is CU378,174. Lessee increases the lease liability by CU192,012, which represents
the difference between the re-measured liability of CU378,174 and its previous carrying amount of CU186,162. The corresponding adjustment
is made to the right-of-use asset to reflect the cost of the additional right of use, recognized as follows.
Rs. Rs.
Right to use asset 192,012
Lease liability 192,012
Following the re-measurement, the carrying amount of Lessee’s right-of-use asset is CU360,169 (i.e. CU168,157 + CU192,012). From the
beginning of Year 7 Lessee calculates the interest expense on the lease liability at the revised discount rate of 6 per cent per annum.
The right-of-use asset and the lease liability from Year 7 to Year 15 are as follows.

Lease liability Right to use asset

Year Opening Lease Interest Ending Opneing Dep- for the Ending
balance payment expense balance balance year balance
7 378,174 50,000 19,690 347,864 360,169 40,019 320,150
8 347,864 50,000 17,872 315,736 320,150 40,019 280,131
9 315,736 50,000 15,944 281,680 280,131 40,019 240,113
10 281,680 50,000 13,901 245,581 240,113 40,019 200,094
11 245,581 55,000 11,435 202,016 200,094 40,019 160,075
12 202,016 55,000 8,821 155,837 160,075 40,019 120,056
13 155,837 55,000 6,050 106,887 120,056 40,019 80,038
14 106,887 55,000 3,113 55,001 80,038 40,019 40,019
15 55,001 55,000 0 1 40,019 40,019 -
Example - 3

Lessee enters into a 10-year lease of property with annual lease payments of CU50,000, payable at the beginning of each year. The
contract specifies that lease payments will increase every two years on the basis of the increase in the Consumer Price Index for the
preceding 24 months. The Consumer Price Index at the commencement date is 125. This example ignores any initial direct costs. The
rate implicit in the lease is not readily determinable. Lessee’s incremental borrowing rate is 5 per cent per annum, which reflects the fixed
rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a 10-year term, and
with similar collateral.

Lessee expects to consume the right-of-use asset’s future economic benefits evenly over the lease term and, thus, depreciates the right-
of-use asset on a straight-line basis.
At the beginning of the third year of the lease the Consumer Price Index is 135.
Required: - Prepare the journal entries of all the three years and prepare lease repayment schedule?
Answer

At the commencement date, Lessee makes the lease payment for the first year and measures the lease liability at the present value of
the remaining nine payments of CU50,000, discounted at the interest rate of 5 per cent per annum, which is CU355,391.

Lessee initially recognizes assets and liabilities in relation to the lease as follows.
Rs. Rs.
Right to use asset 405,391
Lease liability 355,391
Cash 50,000
During the first two years of the lease, Lessee recognizes in aggregate the following related to the lease.
Interest expense 33,928
Lease liability 33,928

Depreciation charge 81,078

Right to use asset 81,078
[405,391/10]x2

At the beginning of the second year, Lessee makes the lease payment for the second year and recognizes the following.
Lease liability 50,000
Cash 50,000

At the beginning of the third year, before accounting for the change in future lease payments resulting from a change in the Consumer
Price Index and making the lease payment for the third year, the lease liability is CU339,319 (the present value of eight payments of
CU50,000 discounted at the interest rate of 5 per cent per annum = CU355,391 + CU33,928 -CU50,000).

The payment for the third year, adjusted for the Consumer Price Index, is CU54,000 (CU50,000 × 135 ÷ 125). Because there is a change in
the future lease payments resulting from a change in the Consumer Price Index used to determine those payments, Lessee re-measures
the lease liability to reflect those revised lease payments, i.e. the lease liability now reflects eight annual lease payments of CU54,000.

At the beginning of the third year, Lessee re-measures the lease liability at the present value of eight payments of CU54,000 discounted at
an unchanged discount rate of 5 per cent per annum, which is CU366,464. Lessee increases the lease liability by CU27,145, which
represents the difference between the re-measured liability of CU366,464 and its previous carrying amount of CU339,319. The
corresponding adjustment is made to the right-of-use asset, recognized as follows.
Rs. Rs.
Right to use asset 27,145
Lease liability 27,145
At the beginning of the third year, Lessee makes the lease payment for the third year and recognizes the following.
Lease liability 54,000
Cash 54,000

Lease liability Right to use asset

Year Opening Lease Interest Ending Opneing Dep- for Ending
balance payment expense balance balance the year balance
1 355,391 - 17,770 373,161 405,391 40,539 364,852
2 373,161 50,000 16,158 339,319 364,852 40,539 324,313
3 366,464 54,000 15,623 328,087 351,458 43,932 307,526
4 328,087 54,000 13,704 287,791 307,526 43,932 263,593
 Example -3 Assume the same facts as Example 3 except that Lessee is also required to make variable lease payments for each year of the lease, which are determined as 1
per cent of Lessee’s sales generated from the leased property.

Lessee prepares financial statements on an annual basis. During the first year of the lease, Lessee generates sales of CU800,000 from the leased property.

Required: - Prepare the journal entries for the first year only?
Answer
Those payments are not included in the measurement of the asset and liability.
Rs. Rs.
Right to use asset 405,391
Lease liability 355,391
Cash 50,000

Lessee prepares financial statements on an annual basis. During the first year of the lease, Lessee generates sales of CU800,000 from the leased property. Lessee
incurs an additional expense related to the lease of CU8,000 (CU800,000 × 1 per cent), which Lessee recognizes in profit or loss in the first year of the lease.

Lease liability Right to use asset

Year Opening Lease Interest Opneing Dep- for
balance payment expense Ending balance balance the year Ending balance
1 355,391 - 17,770 373,161 420,391 42,039 378,352
2 373,161 50,000 16,158 339,319 378,352 42,039 336,313
3 339,319 50,000 14,466 303,785 336,313 42,039 294,274
4 303,785 50,000 12,689 266,474 294,274 42,039 252,235
5 266,474 50,000 10,824 227,297 252,235 42,039 210,196
6 227,297 50,000 8,865 186,162 210,196 42,039 168,156
7 186,162 50,000 6,808 142,970 168,156 42,039 126,117
8 142,970 50,000 4,649 97,619 126,117 42,039 84,078
9 97,619 50,000 2,381 50,000 84,078 42,039 42,039
10 50,000 50,000 (0) (0) 42,039 42,039 -
 Lessee enters into a 10-year lease for 2,000 square metres of office space. At the beginning of Year 6, Lessee and Lessor agree to
Example -5

amend the original lease for the remaining five years to include an additional 3,000 square metres of office space in the same
building. The additional space is made available for use by Lessee at the end of the second quarter of Year 6. The increase in total
consideration for the lease is
commensurate with the current market rate for the new 3,000 square metres of office space, adjusted for the discount that Lessee
receives reflecting that Lessor does not incur costs that it would otherwise have incurred if leasing the same space to a new tenant (for
example, marketing costs).
Required: - Discuss the accounting treatment of modification of lease?
Answer

Lessee accounts for the modification as a separate lease, separate from the original 10-year lease. This is because the modification
grants Lessee an additional right to use an underlying asset, and the increase in consideration for the lease is commensurate with the
stand-alone price of the additional right-of-use adjusted to reflect the circumstances of the contract. In his example, the additional
underlying asset is the new 3,000 square metres of office space. Accordingly, at the commencement date of the new lease (at the
end of the second quarter of Year 6), Lessee recognizes a right-of-use asset and a lease liability relating to the lease of the additional
3,000 square metres of office space. Lessee does not make any adjustments to the accounting for the original lease of 2,000 square
metres of office space as a result of this modification.
 Lessee enters into a 10-year lease for 5,000 square metres of office space. The annual lease payments are CU100,000 payable at the
Example -6

end of each year. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the
commencement date is 6 per cent per annum. At the beginning of Year 7, Lessee and Lessor agree to amend the original lease by
extending the contractual lease term by four years. The annual lease payments are unchanged (ie CU100,000 payable at the end of
each year from Year 7 to Year 14). Lessee’s incremental borrowing rate at the beginning of Year 7 is 7 per cent per annum.

Required: - Discuss the accounting treatment of modification of lease?

Answer

At the effective date of the modification (at the beginning of Year 7), Lessee re-measures the lease liability based on: (a) an eight-
year remaining lease term, (b) annual payments of CU100,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum.
The modified lease liability equals CU597,130. The lease liability immediately before the modification (including the recognition of the
interest expense until the end of Year 6) is CU346,511. Lessee recognizes the difference between the carrying amount of the modified
lease liability and the carrying amount of the lease liability immediately before the modification (CU250,619) as an adjustment to the
right-of-use asset.
 Lessee enters into a 10-year lease for 5,000 square metres of office space. The annual lease payments are CU50,000 payable at the
end of each year. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the
Example -7

commencement date is 6 per cent per annum. At the beginning of Year 6, Lessee and Lessor agree to amend the original lease to
reduce the space to only 2,500 square metres of the original space starting from the end of the first quarter of Year 6. The annual fixed
lease payments (from Year 6 to Year 10) are CU30,000. Lessee’s incremental borrowing rate at the beginning of Year 6 is 5 per cent
per annum.
Required: - Discuss the accounting treatment of modification of lease?

Answer

At the effective date of the modification (at the beginning of Year 6), Lessee re-measures the lease liability based on: (a) a five-year
remaining lease term, (b) annual payments of CU30,000 and (c) Lessee’s incremental borrowing rate of 5 per cent per annum. This
equals CU129,884. Lessee determines the proportionate decrease in the carrying amount of the right-of-use asset on the basis of the
remaining right-of-use asset (ie 2,500 square metres corresponding to 50 per cent of the original right-of-use asset).

50 per cent of the pre-modification right-of-use asset (CU184,002) is CU92,001. Fifty per cent of the pre-modification lease liability
(CU210,618) is CU105,309. Consequently, Lessee reduces the carrying amount of the right-of-use asset by CU92,001 and the carrying
amount of the lease liability by CU105,309. Lessee recognizes the difference between the decrease in the lease liability and the
decrease in the right-of-use asset (CU105,309 - CU92,001 = CU13,308) as a gain in profit or loss at the effective date of the modification
(at the beginning of Year 6).

Lessee recognizes the difference between the remaining lease liability of CU105,309 and the modified lease liability of CU129,884
(which equals CU24,575) as an adjustment to the right-of-use asset reflecting the change in the consideration paid for the lease and
the revised discount rate.
 Lessee enters into a 10-year lease for 2,000 square metres of office space. The annual lease payments are CU100,000 payable at the end of
each year. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the commencement
Example -8

date is 6 per cent per annum. At the beginning of Year 6, Lessee and Lessor agree to amend the original lease to (a) include an additional
1,500 square metres of space in the same building starting from the beginning of Year 6 and (b) reduce the lease term from 10 years to eight
years. The annual fixed payment for the 3,500 square metres is CU150,000 payable at the end of each year (from Year 6 to Year 8). Lessee’s
incremental borrowing rate at the beginning of Year 6 is 7 per cent per annum.

Required: - Discuss the accounting treatment of modification of lease?

Answer
The consideration for the increase in scope of 1,500 square metres of space is not commensurate with the stand-alone price for that increase
adjusted to reflect the circumstances of the contract. Consequently, Lessee does not account for the increase in scope that adds the right to
use an additional 1,500 square metres of space as a separate lease.
The pre-modification right-of-use asset and the pre-modification lease liability in relation to the lease are as follows.

Lease liability Right to use asset

Year Opening Lease Interest Ending Opneing Dep- for Ending
balance payment expense balance balance the year balance
1 736,009 100,000 44,161 680,170 736,009 73,601 662,408
2 680,170 100,000 40,810 620,980 662,408 73,601 588,807
3 620,980 100,000 37,259 558,238 588,807 73,601 515,206
4 558,238 100,000 33,494 491,733 515,206 73,601 441,605
5 491,733 100,000 29,504 421,237 441,605 73,601 368,005
6 421,237 421,237 368,005 - 368,005

At the effective date of the modificaion (at the beginning of Year 6), Lessee re-measures the lease liability on the basis of: (a) a three-year
remaining lease term, (b) annual payments of CU150,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum. The modified
liability equals CU393,647, of which (a) CU131,216 relates to the increase of CU50,000 in the annual lease payments from Year 6 to Year 8 and
(b) CU262,431 relates to the remaining three annual lease payments of CU100,000 from Year 6 to Year 8.
Decrease in the lease term
At the effective date of the modification (at the beginning of Year 6), the pre-modification right-of-use asset is CU368,004. Lessee determines
the proportionate decrease in the carrying amount of the right-of-use asset based on the remaining right-of-use asset for the original 2,000
square metres of office space (ie a remaining three-year lease term rather than the original five-year lease term). The remaining right-of-use
asset for the original 2,000 square metres of office space is CU220,802 (ie CU368,004 ÷ 5 × 3 years).

At the effective date of the modification (at the beginning of Year 6), the pre-modification lease liability is CU421,236. The remaining lease
liability for the original 2,000 square metres of office space is U267,301 (ie present value of three annual lease payments of CU100,000,
discounted at the original discount rate of 6 per cent per annum).

Consequently, Lessee reduces the carrying amount of the right-of-use asset by CU147,202 (CU368,004 - CU220,802), and the carrying amount of
the lease liability by CU153,935 (CU421,236 - CU267,301). Lessee recognises the difference between the decrease in the lease liability and the
decrease in the right-of-use asset (CU153,935 - CU147,202 = CU6,733) as a gain in profit or loss at the effective date of the modification (at the
beginning of Year 6).
Rs. Rs.
Lease liability 153,935
Right to use 147,202
Profit or loss account 6,733
At the effective date of the modification (at the beginning of Year 6), Lessee recognizes the effect of the re-measurement of the remaining
lease liability reflecting the revised discount rate of 7 per cent per annum, which is CU4,870 (CU267,301 - CU262,431), as an adjustment to the
right-of-use asset.
Rs. Rs.
Lease liability 4,870
Right to use asset 4,870

Increase in the leased space

At the commencement date of the lease for the additional 1,500 square metres of space (at the beginning of Year 6), Lessee recognizes the
increase in the lease liability related to the increase in scope of CU131,216 (i.e. present value of three annual lease payments of CU50,000,
discounted at the revised interest rate of 7 per cent per annum) as an adjustment to the right-of-use asset.
The modified right-of-use asset and the modified lease liability in relation to the modified lease are as follows.
Lease liability Right to use asset
Year Opening Lease Interest Ending Opneing Dep- for Ending
balance payment expense balance balance the year balance
6 393,647 150,000 27,555 271,202 347,148 115,716 231,432
7 271,202 150,000 18,984 140,186 231,432 115,716 115,716
8 140,186 150,000 9,813 (0) 115,716 115,716 -
 Lessee enters into a 10-year lease for 5,000 square metres of office space. At the beginning of Year 6, Lessee and Lessor agree to
Example -9
amend the original lease for the remaining five years to reduce the lease payments from CU100,000 per year to CU95,000 per year.
The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the commencement date
is 6 per cent per annum. Lessee’s incremental borrowing rate at the beginning of Year 6 is 7 per cent per annum. The annual lease
payments are payable at the end of each year.
Required: - Discuss the accounting treatment of modification of lease?
Answer
At the effective date of the modification (at the beginning of Year 6), Lessee re-measures the lease liability based on:
(a) a five-year remaining lease term,
(b)
annual payments of CU95,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum. Lessee recognizes the
difference between the carrying amount of the modified liability (CU389,519) and the lease liability immediately before the
modification (CU421,236) of CU31,717 as an adjustment to the right-of-use asset.
LessieCorp plans to lease a new lorry from LorryCars . LorryCars made an offer to LessieCorp with 2 options:
General information:
1. Lorry would be leased for 4 years under non-cancellable lease that starts 1 January 20X1.
2. Rentals are paid annually on 31 December starting year 20X1.
3. In these rentals, insurance fee of 300 EUR is included.
4. At the end of lease, lorry would have market value of 12 400 EUR.
5. Normal economic life of lorry is 6 years.
6. LorryCars sells this type of lorry for 35 000 EUR when paid cash.
7. LessieCorp's incremental borrowing rate is 3% (and it is close to the rate implicit in the lease).
Option 1: LessieCorp would pay annual rentals amounting to 6 800 EUR. At the end of lease term, LessieCorp has an option to buy lorry for its market value or
lease it for additional 2 years with the same rental fees.
Option 2: LessieCorp would pay annual rentals amounting to 9 500 EUR. At the end of lease term, LessieCorp has an option to buy lorry either for
200 EUR, or lease it for another 2 years with rental fee of 100 EUR per annum.
Advise LessieCorp on correct classification of above presented leases.
1. Calculating present value of minimum lease payments

Option 1 Option 2
Discount factor Present value Present value
Year Cash flow Cash flow
1/(1+0,03)^year (cash flow*DF) (cash flow*DF)
1 0.971 6,500.00 6,310.68 9,200.00 8,932.04
2 0.943 6,500.00 6,126.87 9,200.00 8,671.88
3 0.915 6,500.00 5,948.42 9,200.00 8,419.30
4 0.888 6,500.00 5,775.17 9,400.00 8,351.78
Total 24,161.14 34,375.00

FV at inception: 35,000.00 35,000.00

%: 69.03% 98.21%

2. Assessment of leases

Option 1 Option 2
Transfer of ownership at the end of lease term no no

Option to purchase asset for price < fair value no yes

Lease term = major part of economic life no yes

Present value of MLP close to fair value no yes

Leased asset - specialized nature no no

Losses from cancellation borne by lessee ? ?

Gains / losses from fluctuations to the lessee ? ?

Option to continue rent for rental under market no yes

Operating lease Finance lease

On 1 January 20X1 FinanceLease Co. entered into finance lease of stamping machine as a lessor. Cash price of machine was 500 000 EUR. FinanceLease Co.
incurred additional costs of 3 000 EUR for arranging lease contract. Economic life of stamping machine is 6 years. Lease term is 5 years, annual lease
payments are 110 000 EUR payable 31 December each year. At the end of lease term, machine has an unguaranteed residual value of 1 000 EUR.
How would this transaction appear in the financial statements of FinanceLease Co. at 31 December 20X1?

1. Initial recognition

1.1 Asset - net investment in the lease

Cash price of stamping machine: 500,000
Directly attributable expenses: 3,000
Net investment in the lease (500 000 + 3 000) 503,000

1.2 Accounting treatment

Recognition of net investment in the lease:

Debit Assets - net investment in the lease 503,000

Credit Cash - paid for machine -3,000
Credit Cash - paid for expenses -500,000
0

2. Subsequent measurement

2.1 Allocation of minimum lease payments

Lease Ending balance of

Year Cash flow Interest
receivable FL receivable
0 -503,000 503,000
1 110,000 15,660 94,340 408,660
2 110,000 12,723 97,277 311,383
3 110,000 9,694 100,306 211,077
4 110,000 6,571 103,429 107,649
5 111,000 3,351 106,649 1,000
3.11%

Interest rate implicit in the lease,

Formula used: =IRR(C32:C37)

2.2 Accounting treatment

Annual payment in the 1st year:

Debit Cash 110,000

Credit Finance income -15,660
-94,340
Credit Net investment in the lease
0
3. Disclosures

Gross investment in the lease:

due not later than 1 year 110,000
due later than 1 year but not later than 5 years 331,000
due later than 5 years 0
Total 441,000
less unearned finance income -32,340
Present value of minimum lease payments: 408,660

Present value of minimum lease payments:

due not later than 1 year 97,277
due later than 1 year but not later than 5 years 311,383
due later than 5 years
Total 408,660

Unearned finance income in respect of finance leases: 32,340

Unguaranteed residual value accruing to the lessor: 1,000
In January 20X1, CarProd, manufacturer of cars, offered the following finance lease related to the newest model of car produced:
1. Newest model of car has fair value equal to its selling price, that is 30 000 EUR. Cost of manufacture is 27 000 EUR.
2. Lease would be non-cancellable for 4 years, with annual installments of 8 500 EUR paid in arrears.
3. At the end of lease term, ownership of the car automatically passes to the client at no additional cost.
CarProd incurred further cost of 1 000 EUR related to negotiating contract. How would this transaction appear in the financial statements of CarProd at 31
December 20X1?

1. Initial recognition

1.1 Asset - net investment in the lease

Cash price of new model: 30,000
Net investment in the lease: 30,000

1.2 Accounting treatment

Recognition of net investment in the lease / sale of asset:

Debit Assets - net investment in the lease 30,000

Credit Inventory - new model of car -27,000
Credit Cash - paid for expenses -1,000
-2,000 Note: This is simplified accounting. CarProd would probably show
Credit Profit on sale (30 000 - 27 000 - 1000)
0 30 000 EUR as revenues, 27 000 EUR as costs of sales and 1 000
EUR as marketing or other expenses.

2. Subsequent measurement

2.1 Allocation of minimum lease payments

Ending balance
Year Cash flow Interest Lease asset
of FL asset
0 -30,000 30,000
1 8,500 1,560 6,940 23,060
2 8,500 1,200 7,300 15,760
3 8,500 820 7,680 8,080
4 8,500 420 8,080 0
5.20%

Interest rate implicit in the lease,

Formula used: =IRR(C32:C36)

2.2 Accounting treatment

Annual payment in the 1st year:

Debit Cash 8,500

Credit Finance income -1,560
-6,940
Credit Net investment in the lease
0
3. Disclosures

Gross investment in the lease:

due not later than 1 year 8,500
due later than 1 year but not later than 5 years 17,000
due later than 5 years 0
Total 25,500
less unearned finance income -2,440
Present value of minimum lease payments: 23,060

Present value of minimum lease payments:

due not later than 1 year 7,300
due later than 1 year but not later than 5 years 15,760
due later than 5 years 0
Total 23,060

Unearned finance income in respect of finance leases: 2,440

On 1 January 20X1, Lessor Co. made a following offer for operating lease to one of its biggest clients:
1. Lease relates to machinery in total fair value of 1 000 000 EUR.
2. Lease is uncancellable for 6 years, whereas machines have an economic life of 10 years.
3. Annual rentals of 170 000 EUR are payable in arrears on 31 December each year.
4. First rental is decreased to 50 000 EUR as a bonus to great customer.
How would this transaction appear in the financial statements of Lessor Co. at 31 December 20X1?

1. Accounting treatment

1.1 Asset related accounting:

Recognition of assets at inception:

Debit PPE - machinery 1,000,000

-1,000,000
Credit Cash
0

Depreciation charge of PPE for 20X1:

Debit Depreciation expenses (1 000 000 / 10) 100,000

Credit PPE - cummulated depreciation -100,000
0

1.2 Rentals related accounting:

Cash received on 31 December 20X1:

Debit Cash 50,000

-50,000
Credit Rental income
0

Discount on 1st rental payment:

Debit Incentive 120,000

Credit Rental income -120,000
0

Reduction of rental income on straight-line basis:

Debit Rental income (120 000/6) 20,000

Credit Incentive -20,000
0
Rental income in the 1st year (50 000 + 120 000 - 20 000) 150,000

Accounting in the next years:

Debit Cash 170,000

Credit Rental income -170,000
0

Debit Rental income 20,000

-20,000
Credit Incentive
0

2. Disclosures

Future minimum lease payments under non-cancellable operating lease:

due not later than 1 year 170,000
due later than 1 year but not later than 5 years 680,000
due later than 5 years 0
Total 850,000
 Example -10

An entity (Seller-lessee) sells a building to another entity (Buyer-lessor) for cash of CU2,000,000. Immediately before the transaction, the
building is carried at a cost of CU1,000,000. At the same time, Seller-lessee enters into a contract with Buyer-lessor for the right to use the
building for 18 years, with annual payments of CU120,000 payable at the end of each year. The terms and conditions of the transaction are
such that the transfer of the building by Seller-lessee satisfies the requirements for determining when a performance obligation is satisfied in
IFRS 15 Revenue from Contracts with Customers. Accordingly, Seller-lessee and Buyer-lessor account for the transaction as a sale and
leaseback. This example ignores any initial direct costs.
The fair value of the building at the date of sale is CU1,800,000. Because the consideration for the sale of the building is not at fair value, Seller-
lessee and Buyer-lessor make adjustments to measure the sale proceeds at fair value. The amount of the excess sale price of CU200,000
(CU2,000,000 - CU1,800,000) is recognized as additional financing provided by Buyer-lessor to Seller-lessee.

The interest rate implicit in the lease is 4.5 per cent per annum, which is readily determinable by Seller-lessee. The present value of the annual
payments (18 payments of CU120,000, discounted at 4.5 per cent per annum) amounts to CU1,459,200, of which CU200,000 relates to the
additional financing and CU1,259,200 relates to the lease—corresponding to 18 annual payments of CU16,447 and CU103,553, respectively.

Buyer-lessor classifies the lease of the building as an operating lease.

Required: - Discuss the accounting treatment from seller lessee and buyer lessor point view and pass necessary journal entries for the first year?
Answer
Seller-lessee
At the commencement date, Seller-lessee measures the right-of-use asset arising from the leaseback of the building at the proportion of the
previous carrying amount of the building that relates to the right of use retained by Seller-lessee, which is CU699,555. This is calculated as:
CU1,000,000 (the carrying amount of the building) ÷ CU1,800,000 (the fair value of the building) × CU1,259,200 (the discounted lease payments
for the 18-year right-of-use asset).

Seller-lessee recognizes only the amount of the gain that relates to the rights transferred to Buyer-lessor of CU240,355 calculated as follows.
The gain on sale of building amounts to CU800,000 (CU1,800,000 - CU1,000,000), of which:

(a) CU559,645 (CU800,000 ÷ CU1,800,000 × CU1,259,200) relates to the right to use the building retained by Seller-lessee; and

(b) CU240,355 (CU800,000 ÷ CU1,800,000 × (CU1,800,000 - CU1,259,200)) relates to the rights transferred to Buyer-lessor.
At the commencement date, Seller-lessee accounts for the transaction as follows.
Rs. Rs.
Cash 2,000,000
Right to use asset 699,555
Building 1,000,000
Financial liability 1,459,200
Gain on right to use asset 240,355

Buyer-lessor
At the commencement date, Buyer-lessor accounts for the transaction as follows.
Rs. Rs.
Building 1,800,000
Right to use asset 200,000
Cash 2,000,000
After the commencement date, Buyer-lessor accounts for the lease by treating CU103,553 of the annual payments of CU120,000 as lease
payments. The remaining CU16,447 of annual payments received from Seller-lessee are accounted for as (a) payments received to settle the
financial asset of CU200,000 and (b) interest revenue.