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IFRS 16 summary
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Detailed summary of the implications of IFRS 16.
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LeasesGAAP Handbook
Objective
In substance, when an entity leases an asset, it acquires the right to use the asset through
an agreement (contract).
Fundamental concepts
Inception of lease versus commencement of lease (Appendix A)
Inception date of the lease is the earlier of the lease agreement data and the date that the
parties commit to the principal terms and conditions of the lease, the commencement date
of the lease is when the recognition and measurement of the lease takes place, and this is
when the lessor makes the underlying asset available to the lessee.
Lease term (Appendix A)
The lease term is the non-cancellable period of the lease which considers both the extension
option if it is reasonably certain that the lessee will take this option and any termination
options if it is reasonably certain that the entity will not take this option.
Remember that the lease term includes any rent-free periods provided to the lessee by the
lessor.
The contract between the lessee and the lessor is no longer enforceable when both the
lessee or lessor can terminate the lease without significant penalty, if only the lessor can
terminate the lease then we include the termination period, however if only the lessee can
terminate the lease, then we need to see if he has an economic incentive to do so, if he
does then we will exclude that period of termination from the lease term.
When we determine the lease term, we take the following into account: the non-cancellable
period of the lease, extension or termination options for the lease, guaranteed return,
reassessment of your extension and termination options, then ultimately the extension of
the lease term.
Just a quick recap of the guaranteed residual value, this is an amount guaranteed by the
lessee to the lessor at the end of the lease term, therefore this amount is the same
regardless of whether an option is taken or not, therefore when there is a guaranteed
residual value, we will always assume that the lessee WILL take the option to extend the
lease and NOT take the option to terminate the lease. Why is this? Because the lessee must
pay this amount, so it makes sense to offset this cost to the economic benefits received
using the asset for the full term of the lease.
Guaranteed versus unguaranteed residual value
The residual value guarantee is a guarantee made to the lessor by a party unrelated to the
lessor that the value of the underlying asset at the end of the lease term will be a certain
amount.
,The unguaranteed residual value is that portion of the guaranteed residual value of the
underlying asset that is NOT ASSURED by a party related to the lessor.
Lease payments (Appendix A)
Fixed payments
less lease •All fiixed payments are included.
•Including in-substance fixed payments
incentives
•Has to be based on an index or a rate, it can be predicted by the entity by using
the finaical market data.
Variable payments •If it is not based on an index or a rate it cannnot be predicted, such as rental that
is determined based on sales from a retial store, this is not included in the lease
payments as it cannot be predicted therefore those rental payments are
expensed in P/L when the sales occur (unpredictable event occurs).
Exercise price of an
option to extend or •Has to be reasonably certain that the option will be taken (economic incentive
penalties for for the lessee).
termination
Lessee: Lease vs
non-lease •Do not allocate payments for non-lease components unless the practical
expedinet is applied
components
Lessor: Residual •These guarantees can be provided by a party related to the lessee but has to be
unrelated to the lessor (does not have to be lessee)
value guarantees •For the lessor you do not allocate any payment to a non-lease component.
Economic life versus useful life
They are virtually the same in the way that they refer to the period over which an asset is
expected to be available or the number of production units that is expected to be obtained,
the difference lies in that the economic life refers to the period that the asset can be used
,by the entity and others (everyone) and the useful life only refers to the period by that one
entity.
Interest rates (Interest rate implicit in the lease is in Appendix A)
We will go into two rates, namely the interest rate implicit in the lease and the lessee’s
incremental borrowing rate.
Interest rate implicit in the lease:
PV of the
Interest rate
Fair value of
in the lease
implicit
lease
=
payments + the
unguaranteed underlying
residual value asset + initial
direct costs of
the lessor
The interest rate implicit in the lease is used by both the lessee and the lessor to account for
the lease. Since you need the unguaranteed residual value and the initial direct costs of the
lessor, the lessee may sometimes not be able to calculate the interest rate implicit in the
lease and that is when they will use their incremental borrowing rate (lessee’s incremental
borrowing rate).
Lessee’s incremental borrowing rate:
The incremental borrowing rate of the lessee is the rate that the lessee will get the same
type of lease, amount, and term and otherwise in the economic environment. We will
always be given the incremental borrowing rate of the lessee.
If you can use the interest rate implicit in the lease, use it rather than the lessee’s
incremental borrowing rate.
Identifying a lease
For a contract to be a lease or to contain a lease, it needs to convey the right to use to
control an identified asset for a period in exchange for consideration. This will be met when:
1. The customer has the right to obtain substantially all the economic benefits from the
use of the identified asset.
2. The right to direct the use of the identified asset.
, If the customer has the right to control the use of the asset for a portion of time, the
contract contains a lease for only that period of time.
Identified asset
Substantive
Explicityl Implicitly
It will be clear cut from the If a supplier can only substitution
identified scenario that an asset exists, identified supplier one specific asset
If the supplier has
righs substantive substitution
such as machinery. in terms of the contract, but rights then the customer
has many of the same assets does not have the right to
of similar nature, this is use an identified asset.
implicitly identified asset. Make sure that you meet
the two requirements.
Example 10.1: Implicit identification of an asset
This contract does not explicitly identify the asset to be provided to A Ltd, as B Ltd can
provide any of the 20 cargo ships that it owns. But, once the cargo ship is leased to A Ltd,
then it would have been implicitly identified, because once A Ltd leaves the harbor and uses
the cargo ship, nobody else can direct the use of the asset before the end of the period.
What are substantive substitution rights
Substantive substituion rights
Make sure that you meet BOTH of the requirements. Only include facts and circumstances at the inception of the contract, do not
include future events that are unlikely to occur at inception date.
Supplier's ability to substitute
The supplier has the practical ability to substitute the asset and the customer cannot stop this from happening and the supplier
has alternative assets that are readily available to substitute the identified asset with in a reasonable period of time. Must be
througout the WHOLE period of use.
Economic benefits > Cost of substitution
The supplier would benefit economically from the exercising of the substitution, the economic benefits form the substitutino
exceed the costs of the substitution.
General notes:
- If the asset is at the premises of the customer, then the substation costs for the supplier
would generally be higher as he would now have to transport the asset back to his premises.
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