to the lease, a lessor may treat the land and buildings as a single unit for the purpose of
lease classification and classify it as a finance lease or an operating lease. In such a case,
a lessor regards the economic life of the buildings as the economic life of the entire
underlying asset. [IFRS 16.B57].
6.1.3
Residual value guarantees included in the lease classification test
In evaluating IFRS 16’s lease classification criteria, lessors are required to include in the
‘substantially all’ test any (i.e. the maximum obligation) residual value guarantees
provided by both lessees and any other third party unrelated to the lessor.
6.1.4
Reassessment of lease classification
Lease classification is made at the inception date and is reassessed only if there is a lease
modification. Changes in estimates (for example, changes in estimates of the economic
life or of the residual value of the underlying asset), or changes in circumstances (for
example, default by the lessee), do not give rise to a new classification of a lease for
accounting purposes. [IFRS 16.66].
Lessors reassess lease classification as at the effective date of the modification using the
modified conditions at that date. If a lease modification results in a separate new lease,
that new lease would be classified in the same manner as any new lease. See 6.1.1 above.
6.2 Finance
leases
At commencement date, a lessor recognises assets held under a finance lease in its
statement of financial position and presents them as a receivable at an amount equal to
the net investment in the lease. [IFRS 16.67].
The net investment in the lease is defined as ‘the gross investment in the lease
discounted at the interest rate implicit in the lease’. [IFRS 16 Appendix A]. The gross
investment in the lease is ‘the sum of (a) the lease payments receivable by a lessor under
a finance lease and (b) any unguaranteed residual value accruing to the lessor.’
[IFRS 16 Appendix A].
6.2.1 Initial
measurement
At lease commencement, a lessor accounts for a finance lease, as follows:
(a) derecognises the carrying amount of the underlying asset;
(b) recognises the net investment in the lease; and
(c) recognises, in profit or loss, any selling profit or selling loss.
Leases (IFRS 16) 1747
The lessor uses the interest rate implicit in the lease to measure the net investment in
the lease. In the case of a sublease, if the interest rate implicit in the sublease cannot be
readily determined, an intermediate lessor may use the discount rate used for the head
lease (adjusted for any initial direct costs associated with the sublease) to measure the
net investment in the sublease. [IFRS 16.68].
Initial direct costs, other than those incurred by manufacturer or dealer lessors, are
included in the initial measurement of the net investment in the lease and reduce the
amount of income recognised over the lease term. The interest rate implicit in the lease
is defined in such a way that the initial direct costs are included automatically in the net
investment in the lease; there is no need to add them separately. [IFRS 16.69].
At the commencement date, the lease payments included in the measurement of the net
investment in the lease comprise the following payments for the right to use the
underlying asset during the lease term that are not received at the commencement date:
(a) fixed payments (including in-substance fixed payments), less any lease incentives
payable;
(b) variable lease payments that depend on an index or a rate, initially measured using
the index or rate as at the commencement date;
(c) any residual value guarantees provided to the lessor by the lessee, a party related
to the lessee or a third party unrelated to the lessor that is financially capable of
discharging the obligations under the guarantee;
(d) the exercise price of a purchase option if the lessee is reasonably certain to
exercise that option; and
(e) payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease. [IFRS 16.70].
6.2.2
Manufacturer or dealer lessors
At the commencement date, a manufacturer or dealer lessor recognises the following
for each of its finance leases:
(a) revenue being the fair value of the underlying asset, or, if lower, the present value of
the lease payments accruing to the lessor, discounted using a market rate of interest;
(b) the cost of sale being the cost, or carrying amount if different, of the underlying
asset less the present value of the unguaranteed residual value; and
(c) selling profit or loss (being the difference between revenue and the cost of sale) in
accordance with its policy for outright sales to which IFRS 15 applies. A
manufacturer or dealer lessor recognises selling profit or loss on a finance lease at
the commencement date, regardless of whether the lessor transfers the underlying
asset as described in IFRS 15. [IFRS 16.71].
Manufacturers or dealers often offer to customers the choice of either buying or leasing
an asset. A finance lease of an asset by a manufacturer or dealer lessor gives rise to profit
or loss equivalent to that resulting from an outright sale of the underlying asset, at
normal selling prices, reflecting any applicable volume or trade discounts. [IFRS 16.72].
Manufacturer or dealer lessors sometimes quote artificially low rates of interest in order
to attract customers. The use of such a rate would result in a lessor recognising an
1748 Chapter 24
excessive portion of the total income from the transaction at the commencement date.
If artificially low rates of interest are quoted, a manufacturer or dealer lessor restricts
selling profit to that which would apply if a market rate of interest were charged.
[IFRS 16.73].
A manufacturer or dealer lessor recognises as an expense costs incurred in connection with
obtaining a finance lease at the commencement date because they are mainly related to
earning the manufacturer or dealer’s selling profit. Costs incurred by manufacturer or
dealer lessors in connection with obtaining a finance lease are excluded from the definition
of initial direct costs and, thus, are excluded from the net investment in the lease. [IFRS 16.74].
6.2.3 Subsequent
measurement
After commencement a lessor recognises finance income over the lease term, based on
a pattern reflecting a constant periodic rate of return on the lessor’s net investment in
the lease. [IFRS 16.75]. A lessor aims to allocate finance income over the lease term on a
systematic and rational basis. A lessor applies the lease payments relating to the period
against the gross investment in the lease to reduce both the principal and the unearned
finance income. [IFRS 16.76]. Thus, the lessor reduces the net investment in the lease for
lease payments received (net of interest income calculated above).
The lessor also recognises income from variable payments that are not included in the
net investment in the lease (e.g. performance or usage based variable payments)
separately in the period in which the income is earned.
>
A lessor applies the derecognition and impairment requirements in IFRS 9 to the net
investment in the lease. The lessor reviews regularly estimated unguaranteed residual
values used in computing the gross investment in the lease. If there has been a reduction
in the estimated unguaranteed residual value, the lessor revises the income allocation
over the lease term and recognise immediately any reduction in respect of amounts
accrued. [IFRS 16.77].
A lessor that classifies an asset under a finance lease as held for sale (or includes it in a
disposal group that is classified as held for sale) applies IFRS 5 – Non-current Assets
Held for Sale and Discontinued Operations. [IFRS 16.78].
Example 24.19: Lessor accounting for a finance lease
Assume Lessor enters into a 10-year lease of equipment with Lessee. The equipment is not specialised in
nature and is expected to have alternative use to Lessor at the end of the 10-year lease term. Under the lease:
• Lessor receives annual lease payments of CU15,000, payable at the end of the year.
• Lessor expects the residual value of the equipment to be CU50,000 at the end of the 10-year lease term.
• Lessee provides a residual value guarantee that protects Lessor from the first CU30,000 of loss for a sale
at a price below the estimated residual value at the end of the lease term (i.e. CU50,000).
• The equipment has an estimated remaining economic life of 15 years, a carrying amount of CU100,000
and a fair value of CU111,000.
• The lease does not transfer ownership of the underlying asset to Lessee at the end of the lease term or
contain an option to purchase the underlying asset.
• The interest rate implicit in the lease is 10.078%.
Lessor classifies the lease as a finance lease because the sum of the present value of lease payments amounts
to substantially all of the fair value of the underlying asset.
Leases (IFRS 16) 1749
At lease commencement, Lessor accounts for the finance lease, as follows:
To record the net investment in the finance lease and derecognise the underlying asset:
Net investment in the lease
CU111,000
(a)
Cost of goods sold
CU92,344
(b)
Revenue
CU103,344
(c)
Property held for lease
CU100,000
(d)
(a) The net investment in the lease consists of (1) the present value of the 10 annual payments of CU15,000
plus the guaranteed residual value of CU30,000, both discounted at the interest rate implicit in the lease,
which equals CU103,344 (i.e. the lease payment) and (2) the present value of unguaranteed residual
asset of CU20,000, which equals CU7,656. Note that the net investment in the lease is subject to the
same considerations as other assets in classification as current or non-current assets in a classified
balance sheet (see 6.6 below).
(b) Cost of goods sold is the carrying amount of the equipment of CU100,000 less the present value of the
unguaranteed residual asset of CU7,656.
(c) Revenue equals the lease receivable.
(d) The carrying amount of the underlying asset.
At lease commencement, Lessor recognises selling profit of CU11,000 which is calculated as revenue (i.e.
the lease payments of CU103,344) less the cost of goods sold which is the carrying amount of the asset
(CU100,000), net of any unguaranteed residual asset (CU7,656), which equals CU92,344.
Year 1 journal entries for a finance lease:
Cash CU15,000 (a)
Net investment in the lease
CU3,813 (b)
Interest
income
CU11,187
(c)
(a) Receipt of annual lease payments at the end of the year.
(b) Reduction of the net investment in the lease for lease payments received of (CU15,000), net of interest
income of CU11,187.
(c) Interest income is the amount that produces a constant periodic discount rate on the remaining balance
of the net investment in the lease. See computation below.
The following table summarises the interest income from this lease and the related amortisations of the net
investment over the lease term:
Net investment at
Year
Annual rental payment
Annual interest income (a)
end of year
Initial net investment CU
–
CU
–
CU
111,000
1 15,000
11,187
107,187
2 15,000
10,803
102,990
3 15,000
10,380
98,370
4 15,000
9,914
93,284
5 15,000
9,401
87,685
6 15,000
8,837
81,522
7 15,000
8,216
74,738
8 15,000
7,532
67,270
9 15,000
6,780
59,050
10 15,000
5,950
50,000
(b)
(a) Interest income equals 10.078% of the net investment in the lease at the beginning of each year. For
example, Year 1 annual interest income is calculated as (CU111,000 initial net investment × 10.078%).
(b) The estimated residual value of the equipment at the end of the lease term.
1750 Chapter 24
6.2.4
Remeasurement of the net investment in the lease
After lease commencement, the net investment in a lease is not remeasured unless:
• the lease is modified (i.e. a change in the scope of the lease, or the consideration for
the lease, that was not part of the original terms and conditions of the lease) and the
modified lease is not accounted for as a separate contract (see 6.4 below); or
• the lease term is revised when there is a change in the non-cancellable period of
the lease (see 4.4 above).
6.3 Operating
leases
Under IFRS 16, lessors account for operating leases in a manner similar to the
requirements under IAS 17. That is, they continue to recognise the underlying asset and
do not recognise a net investment in the lease on the balance sheet or initial profit (if
any) on the income statement. The underlying asset continues to be accounted for in
accordance with applicable accounting standards (e.g. IAS 16).
Lessors recognise lease payments as income on either a straight-line basis or another
systematic basis if that basis is more representative of the pattern in which benefit
derived from the use of the underlying asset is diminished. [IFRS 16.81]. After lease
commencement, lessors recognise variable lease payments that do not depend on an
index or rate (e.g. performance- or usage-based payments) as they are earned.
A lessor recognises costs, including depreciation, incurred in earning the lease income
as an expense. [IFRS 16.82]. A lessor adds initial direct costs incurred in obtaining an
operating lease to the carrying amount of the underlying asset and recognises those
costs as an expense over the lease term on the same basis as the lease income. [IFRS 16.83].
The depreciation policy for depreciable underlying assets subject to operating leases
must be consiste
nt with the lessor’s normal depreciation policy for similar assets. A
lessor calculates depreciation in accordance with IAS 16 and IAS 38. [IFRS 16.84]. A lessor
applies IAS 36 to determine whether an underlying asset subject to an operating lease is
impaired and to account for any impairment loss identified. [IFRS 16.85].
A manufacturer or dealer lessor does not recognise any selling profit on entering into an
operating lease because it is not the equivalent of a sale. [IFRS 16.86].
6.4 Lease
modifications
A lease modification is a change in the scope of a lease, or the consideration for a lease,
that was not part of the original terms and conditions of the lease (for example, adding
or terminating the right to use one or more underlying assets, or extending or shortening
the contractual lease term). [IFRS 16 Appendix A].
If a lease is modified, the modified contract is evaluated to determine whether it is or contains
a lease (see 3.1 above). If a lease continues to exist, the lease modification can result in:
• a separate lease (see 6.4.1 below); or
• a change in the accounting for the existing lease (i.e. not a separate lease) (see 6.4.2
and 6.4.3 below).
Leases (IFRS 16) 1751
6.4.1
Determining whether a modification to a finance lease results in a
separate lease
A lessor accounts for a modification to a finance lease as a separate lease if both:
(a) the modification increases the scope of the lease by adding the right to use one or
more underlying assets; and
(b) the consideration for the lease increases by an amount commensurate with the
stand-alone price for the increase in scope and any appropriate adjustments to
that stand-alone price to reflect the circumstances of the particular contract.
[IFRS 16.79].
If both of the conditions above are met, the lease modification results in two separate
leases, the unmodified original finance lease and a separate lease. Lessors account for
the separate lease in the same manner as other new leases. If either of the conditions is
not met, the lease modification does not result in a separate lease.
6.4.2
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