CHAPTER 10  Penalties for terminating the lease

LESSEE ACCOUNTING early

Basic Principles
Subsequent Measurement
IFRS 16 – new lease standard
 Right of use of asset
Lease – contract or part of contract that conveys Depreciation expense xx
the right to use the underlying asset for a period of
time in exchange for consideration ROU-Acc Dep xx
 Cost Model
-must convey the right to control the use of
 Fair Value Model
an identifiable asset
 Revaluation Model
being explicitly specified in a contract OR  Impairment Tests
implicitly specified when made available to the
customer Presentation of right of use asset

RIGHT TO CONTROL THE USE OF AN ASSET Paragraph 47 provides that the lessee shal
present the right of use asset as a separate line
Rights of a customer:
item in the statement of financial position.
a. Obtain substantially all of the economic
benefits from the use of the identified assets Depreciation of right of use asset
b. Direct Use of the identified asset The lessee shall depreciate the right of use
asset over the useful life of the underlying asset
under the following conditions.
FINANCE LEASE MODEL FOR LESSEE
 The lease transfer ownership of the
IFRS 16 paragraph 22- The lessee shall recognize
underlying asset to the lessee at the end of
a right of use asset and a lease liability.
the lease term
 Underlying asset- is the subject of a lease  The lessee is reasonably certain to exercise
 Lessee- is the entity that obtains the right to a purchase option
use an underlying asset.
 Lessor- is the entity that provides the right If there is no transfer of ownership to the lessee or
to use an underlying asset. if the purchase option is not reasonably certain to
be exercised, the lessee shall depreciate the right
No classification of leases= all financial lease of use asset over the shorter between the useful
Initial measurement life of the asset and the lease term

 Right of use Asset Measurement of the lease liability

 Amount for lease liability Measure the lease liability at the present value of
 Lease payment before/on lease payments.
commencement date – lease
incentives  The lease payments shall be discounted
 Initial direct costs using Interest rate Implicit in the lease.
 Estimate of dismantling costs  Incremental borrowing rate (If the implicit
(restoration) rate cannot be determined)
 Lease Liability
Incremental borrowing rate- The rate of interest
- payments not paid at the
that the lessee would have to pay to borrow funds.
commencement date
-discounted (interest rate implicit in Components of lease payments
the base)
 Fixed Lease payments
 Fixed payments
 Variable lease payments
 Variable payments (index)
 Exercise price of a purchase option
 Residual Value Guarantee
 Residual value guaranteed
 Exercise price of purchase option
 Termination Option
Fixed payments Present Value Computation:
- Fixed Payments made by the lessee to Lease Term: 4 years
the lessor for the right of use to an Payments: 100,000 at the end of each year
underlying asset. Implicit Rate: 12%
Examples: Date: Jan 01, 2020
 Payments that must be made only if
an asset is proven to be capable of
Present Value: 100,000 X 3.0373 (PV of OA 1 at
operating under the lease.
12% for 4 periods) =303,730
 Payments that must be made only if
an event occurs with no genuine Right of use asset 303,730
possibility of not occurring. Lease Liability 303,730
 When there is more than one set of
payments, only the realistic set of Depreciation of right of use asset
payments should be recognized. Depreciation 75,932
 Payments that are initially Variable Accumulated depreciation 75,932
but will become fixed when resolved. (303,730/4 years)
Variable Payments Ammortization table
 Variable payments made by the lessee
for the right to use the underlying asset
during the lease term that vary because
of changes in facts or circumstances.
Residual Value Guarantee
Journal Entries
 Value of an underlying asset at the end
Dec 31, 2020
of the lease term will be at least a
specified amount made by a party Interese Expense 36,448
unrelated to the lessor. Lease Liability 63,552
Cash 100,000
Unguaranteed residual value
 Portion of the residual value that the
Presentation as of Dec 31, 2020
realization of which by the lessor is not
Right if use Asset 303,730
assured.
A/D (75,932)
Executory Costs CA 227,798

 Are ownership expenses such as Illustration: Certain Purchase Option

maintenance taxes and insurance for the
underlying asset. Fixed Rental Payments: 1,000,000
Lease Term: 10 years
 Expensed Immediately
Useful life of the mach: 12 years
Lease Term Incremental rate: 14%
Implicit: 12%
Noncancelable period for which the lessee has the
Purchase option: 500,000
right to use the underlying asset with both of the *Reasonably certain to purchase asset
following: Residual Value: 600,000
PV of OA 1 for 10 periods
 Period covered by an option to extend the lease
if the lessee is reasonably certain to exercise 14% = 5.216
the extension option. 12% = 5.650
 Period covered by an option to terminate the PV of 1 for 10 periods
lease if the lessee is reasonably certain not to 14% = 0.270
exercise the termination option. 12% = 0.322
PV of lease payments (1,000,000x5.65) 5,650,000 PV of lease payments(1M x3.16987) 3,169,870
PV of purchase option (500,000x .322) 161,000 PV of purchase option (200,000x.683) 161,000
Cost of ROUA 3,306,470
Lease Liability 5,811,000
JE: 2020
Right of use asset 5,811,000
Lease Liability 5,811,000
Depreciation 434,250
Accumulated Depreciation 434,250
JE:
(5,811,000 – 600,000 / 12)
*useful life of the machine is used because the purchase option is reasonably
certain Right of use asset 3,306,470
Lease Liability 3,306,470
Interest Expense 697,000
Lease Liability 302,000 Depreciation 776,617
Cash 1,000,000 Accumulated Depreciation 776,617
(3,306,470 – 200,000 / 4)

Interest Expense 330,647

Lease Liability 669,353
Cash 1,000,000
Return of equipment
Exercise of the purchase option Interest expense 109,090
Lease liability 890,910
Lease Liability 500,000
Cash 1,000,000
Cash 500,000

A/D (776,617 x 4) 3,106,470

Non Exercise of purchase option
Lease Liability 200,000
A/D 4,342,500 Right of use asset 3,306,470
Lease Liability 500,000
Illustration- Initial direct cost
Loss on Finance Lease 968,500
Right of use asset 5,811,000 Fixed Rental Payments advanced at the
beginning of the year: 1,000,000
ROUA 5,811,000
Indirect cost paid: 250,000
A/D (434,250 x 10) 4,342,500
Residual value guarantee: 300,000
CA: 1,468,500
Lease Incentive received: 150,000
Less: Purchase Option 500,000
Lease Term: 5 years
Loss on finance lease 968,500
Useful life of the equip: 6 years
Implicit rate: 8%
Illustration: Residual Value gurantee and no
PV of OA 1 in advance at 8% for 5 periods
purchase option.
4.3121
PV of 1 for 5 periods at 8%: 0.6806
Fixed Rental Payments: 1,000,000
Lease Term: 4 years
PV of rentals (1M x 4.3121) 4,312,100
Useful life of the equip: 5 years
PV of residual Value (300k x .6806) 204,180
Implicit: 10%
Lease Liability 4,516,280
PV of OA 1 for 4 periods at 10%: 3.16987
Initial Indirect cost 250,000
PV of 1 for 4 periods at 10%: 0.683
lease Incentive received (150,000)
Residual value: 200,000
cost of right of use of asset 4,616,280
 Executory Cost 50,000
Cash 50,000
Interest Expense 261,000
lease Liability 338,400
Cash 600,000
JE: 2020
Depreciation (3,240,000 /6) 540,000
Right of use asset 4,616,280 A/D 540,000
Lease Liability 4,516,280
Cash (250,000-150,000) 100,000 Return of equipment to lessor
Lease Liability 1,000,000 A/D (540,000 x 6) 3,240,000
Cash 1,000,000 Equipment 3,240,000

Depreciation 863,256 Actual Purchase of Underlying Asset

Accumulated Depreciation 863,256
-The cost of the asset purchased is equal to
(4,616,280 – 300,000 / 5)
the carrying amount of the leased asset plus
Interest Expense 281,302 cash payment minus the balance of the lease
Accrued Interest Payable 281,302 liability
2021
Accrued Interest Expense 281,302
Lease Liability 781,698 Illustration:
Cash 1,000,000
An entity purchased equipment that it had been
Illustration: Unguaranteed residual value: leasing under a finance lease for 4,000,000
The balances of certain accounts on the date
Fixed Rental Payments: 600,000 of actual purchase are:
Residual value unguaranteed: 200,000
Payment to Lessor: 224,000 Right of use asset: 5,000,000
present value of cost of restoring asset A/D: 1,500,000
required by contract: 400,000 Lease Liability: 3,800,000
Annual Executory cost paid: 50,000
Lease Term: 6 years
Useful life of the equip: 8 years JE:
Implicit rate: 8%
PV of OA 1 at 10% for 6 periods 4.36
Equipment 3,700,000
PV of 1 at 10% for 6 periods: 0.56 A/D 1,500,000
Lease Liability 3,800,000
Lease Liability (600,000 x 4.36) 2,616,000 Right of use asset 5,000,000
Payment to lessor for long term lease 244,000 Cash 4,000,000
PV of restoration cost 400,000
Right of use asset 5,000,000
ROUA 3,240,000
A/D 1,500,000
JE: CA 3,500,000
Right of use asset 3,240,000 Add:Cash Payment 4,000,000
Lease Liability 2,616,000 total Consideration 7,500,000
Cash 224,000 Less:Lease Liability 3,800,000
Estimated Restoration 400,000 cost of equipment 3,700,000