PFRS 16 - Leases

Basic Concepts

Identifying a Lease:

●​ At the inception of a contract, an entity determines whether the

contract is, or contains, a lease. This is true if the contract conveys
the right to control the use of an identified asset for a period in
exchange for consideration.

Commencement Date vs. Inception Date of the Lease:

●​ Commencement Date - The date the lessor makes the underlying

asset available for use by the lessee.
●​ Inception Date - The earlier of the date of the lease agreement or the
date when the parties commit to the principal terms and conditions of
the lease.

Lease Term

●​ The lease term is the non-cancellable period during which the lessee
has the right to use the asset, 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 that option.
○​ The entity considers all relevant facts and circumstances that
could affect the exercise of these options.

Lessee Accounting

Recognition of a Lease by the Lessee:

●​ All leases are accounted for as finance leases by the lessee under
PFRS 16.
●​ At the commencement date, the lessee recognizes a right-of-use
asset and a lease liability.
 ●​ However, if the lease is short-term or involves a low-value asset, the
lessee may recognize lease payments as an expense on a
straight-line or systematic basis instead of recognizing a right-of-use
asset and lease liability.

Initial Measurement of the Right-of-Use Asset:

●​ The right-of-use asset is measured at cost, which includes:

○​ Initial measurement of the lease liability.
○​ Lease payments made before the commencement date (less
any incentives received).
○​ Initial direct costs incurred by the lessee.
○​ Estimated costs to dismantle, remove, or restore the asset or
site, unless related to producing inventories.

Initial Measurement of the Lease Liability:

●​ The lease liability is measured at the present value of future lease

payments that are not yet paid.
●​ It is discounted using the interest rate implicit in the lease, or if
unavailable, the lessee’s incremental borrowing rate. The lease
liability includes:
○​ Fixed payments (including in-substance fixed payments),
less any incentives receivable.
○​ Variable lease payments depending on an index or rate.
○​ Amounts expected to be paid under residual value
guarantees.
○​ The exercise price of a purchase option if the lessee is
reasonably certain to exercise it.
○​ Penalties for terminating the lease, if applicable.

Definitions:

●​ Fixed Payments - Payments made by the lessee that do not vary,

except for changes in circumstances unrelated to time.
●​ Variable Lease Payments - Payments that vary because of factors
occurring after the lease commencement date, excluding the passage
of time.
●​ Residual Value Guarantee - A third-party guarantee that the
underlying asset will be worth at least a specified amount at the end
of the lease term.
Subsequent Measurement of the Right-of-Use Asset:

●​ The right-of-use asset is measured using a cost model, which

involves:
○​ Accumulated depreciation and impairment losses.
○​ Adjustments for remeasuring the lease liability (due to
reassessment or lease modifications).
●​ The lessee applies depreciation according to PAS 16 (Property, Plant
and Equipment) unless the lease transfers ownership or the lessee is
certain to exercise a purchase option, in which case the asset is
depreciated to the end of its useful life.

Subsequent Measurement of the Lease Liability: (measured by)

●​ Increasing the carrying amount to reflect interest on the liability.

●​ Reducing the liability for lease payments made.
●​ Remeasuring the liability for reassessments or lease modifications.

Impact on Profit or Loss Post-Commencement: (recognizes)

●​ Interest on the lease liability in profit or loss.

●​ Variable lease payments not included in the lease liability are
expensed in the period they are incurred.

Lessor Accounting

Types of Leases under Lessor Accounting:

●​ Finance Lease - The lease transfers substantially all risks and

rewards incidental to ownership of the underlying asset.
●​ Operating Lease - The lease does not transfer substantially all risks
and rewards incidental to ownership.

Situations Leading to a Finance Lease:

●​ A lease is classified as a finance lease if:

○​ Ownership of the asset is transferred to the lessee by the end
of the lease term.
○​ The lessee has the option to purchase the asset at a price
significantly lower than fair value, making it reasonably certain
that the option will be exercised.
○​ The lease term covers the majority of the economic life of the
underlying asset, even if ownership is not transferred.
 ○​ At the commencement date by recording an asset held under
a finance lease in its statement of financial position and
presenting it as a receivable. The amount recorded is the net
investment in the lease, which is the gross investment
discounted at the interest rate implicit in the lease.

Interest Rate Implicit in the Lease:

●​ The interest rate implicit in the lease is the rate that causes the
present value of:
○​ Lease payments
○​ The unguaranteed residual value to equal the sum of:

• The fair value of the underlying asset

• Any initial direct costs incurred by the lessor

Types of Finance Leases

●​ Direct Financing Lease - A lease in which the lessor acquires assets

and leases them to customers, with the primary objective of
generating revenue from interest payments.
●​ Sales-Type Lease - A lease where the lessor is essentially selling the
underlying asset to the lessee, resulting in a recognized profit or loss
from the sale of the asset.

Computation under Direct Financing Lease (Lessor’s Perspective):

●​ Gross Investment - The total of the gross rentals for the lease term
plus the residual value (guaranteed or unguaranteed).
●​ Net Investment - The cost of the asset plus initial direct costs
incurred by the lessor.
●​ Unearned Interest Income - The difference between the gross
investment and net investment.
●​ Initial Direct Costs - Costs incurred by the lessor to secure the
lease, added to the net investment.
Computation under Sales-Type Lease (Lessor’s Perspective):

●​ Gross Investment - Same as in direct financing leases.

●​ Net Investment - Present value of gross rentals plus the present
value of the residual value.
●​ Unearned Interest Income - The difference between the gross
investment and net investment.
●​ Sales Revenue - The lower of the net investment or the fair value of
the asset.
●​ Cost of Goods Sold (COGS) - The cost of the underlying asset plus
initial direct costs.
●​ Gross Income - Sales revenue minus COGS.
●​ Initial Direct Costs - These are expensed immediately as part of
COGS in a sales-type lease.

Subsequent Measurement for Finance Lease (Lessor):

●​ The lessor recognizes finance income over the lease term, using a
pattern that reflects a constant periodic rate of return on the net
investment. Lease payments reduce both the principal and unearned
finance income.

Recognition and Measurement of Operating Lease (Lessor):

●​ For operating leases, the lessor recognizes lease payments as

income, either on a straight-line basis or another systematic basis if it
better reflects the pattern of benefit derived from the asset. The lessor
also recognizes any costs, including depreciation, as an expense.

Initial Direct Costs in Operating Leases:

●​ initial direct costs incurred to obtain an operating lease should be

added to the carrying amount of the underlying asset. These costs
are then expensed over the lease term in a manner that corresponds
with the lease income.

Lease Modifications under Operating Lease (Lessor):

●​ A modification to an operating lease is treated as a new lease starting

from the effective modification date. Any prepaid or accrued lease
payments from the original lease are considered part of the lease
payments for the new lease.
Presentation of Operating Leases (Lessor):

●​ The lessor presents assets subject to operating leases in its

statement of financial position based on the nature of the underlying
asset. For example, real estate leased under an operating lease
would be presented as PPE.