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Basic Guide To Leasing: FR

Georgina Roberts

Leasing, Under IFRS 16

Let's start with the basics. 
Leasing, under IFRS 16, is all about recognising assets and liabilities for most leases. This is a significant change from the old standard, so read on!

What Constitutes A Lease?

First, you need to identify what qualifies as a lease. 
A lease exists when there's an identified asset, and the lessee has the right to obtain substantially all economic benefits from its use.

Two Key Elements Of A Lease

Once you've identified a lease, focus on two key elements: the lease liability and the right-of-use asset.

  1. The lease liability is the present value of future lease payments.

  2. The right-of-use asset represents your right to use the leased item.

Exemptions

Don't forget about exemptions! 
Short-term leases (12 months or less) and low-value asset leases have simplified accounting treatments. 
These are often tested in exams, so make sure you understand them.

How To Tackle Lease Questions In The Exam

  1. Carefully read the scenario to identify lease components

  2. Calculate the lease liability using the correct discount rate

  3. Recognise and measure the right-of-use asset

  4. Consider any exemptions that might apply

Example Lease Scenario

Company A leases a piece of equipment from Company B under the following terms:

  1. Lease term: 5 years

  2. Annual lease payments: $10,000 (paid at the end of each year)

  3. Implicit interest rate: 6%

  4. Fair value of the equipment: $45,000

How To Work It Out

Step 1: Calculate the present value of lease payments:
Using a discount rate of 6%, the present value of the lease payments is $42,124.

Step 2: Initial Recognition
On the commencement date, Company A (the lessee) will record the following:

Dr Right-of-use Asset      $42,124
Cr Lease Liability         $42,124

Step 3: Subsequent Measurement
Record interest expense:

Dr Interest Expense        $2,527 ($42,124 x 6%)
Cr Lease Liability         $2,527

Record lease payment:
Dr Lease Liability         $10,000
Cr Cash                    $10,000

Record depreciation (assuming straight-line method over 5 years):
Dr Depreciation Expense    $8,425 ($42,124 / 5 years)
Cr Accumulated Depreciation $8,425

At the end of Year :

Right-of-use Asset: $33,699 ($42,124 - $8,425)

Lease Liability: $34,651 ($42,124 + $2,527 - $10,000)

This process would be repeated for each subsequent year, with the interest expense decreasing and the portion of the payment reducing the liability increasing.

Summary

Remember, this is a simplified example. 
In the  FR exam, you might encounter more complex scenarios involving lease modifications, reassessments, or exemptions for short-term and low-value leases.

Always be prepared to calculate and interpret the impact of leases on financial statements, including the effects on ratios and performance measure.

Finally, don't be discouraged if you find this tricky topic challenging at first. With consistent practice and a focus on understanding rather than just memorising, you'll become more confident in handling lease-related questions :)