PFRS-16 LEASES

Kathleen Jamica Bumanglag

Lerson Blanco
 PFRS-16 LEASES
• PFRS 16 prescribes the accounting and
disclosure requirements for leases. The
objective is to provide information that is
faithfully represented, necessary for financial
statement users to assess the effect of leases
on the financial posistion, financial
performance and cashflows of an entity.
 PFRS 16 applies to all leases, including subleases,
except for:
a) leases to explore for or use minerals and similar resources:
b) leases of biological assets;
c) service concession arrangements;
d) lincenses of intellectual property; and
e) lessee’s rights under licensing agreements relating to
motion picture films, cideo recordings, plays, manuscripts,
patents and copyrights. A lessee may apply PFRS 16 to
leases of intangible assets pther than these items.
 PFRS-16 LEASES
• LEASES is defined as a contract or a part of a
contract that conveys the right to use the
underlying asset for a period of time in exchange
for consideration.
• The underlying asset is the subject to a lease for
which the right to use that asset has been provided
by the lessor to the lessee.
The following are the parties to a lease contract;
a) Lessee- the entity that obtains the right to use an
underlying asset for a perid of time in exchange
for consideration.
b) Lessor- the entity that provides the right to use an
underlying asset for a period of time im exchange
for consideration.
 Finance lease model for lessee
• IFRS 16, paragraph 22, providest that at the commencement
date, a lessee shall recognize a right of use asset and a lease
liability.
• This simply means that a lessee is required to initially
recognize a right of use asset for the right to use the underlying
asset over the lease term and a lease liability for the obligation
to make payments.
• All leases shall be accounted for by the lessee as a finace lease
under the new lease standard.
 Operating lease model for lessee
• IFRS 16, paragraph 5, provides that a lessee is permitted to
make an accounting policy election to apply the operating lease
accounting and not recognize an asset and lease liability in two
optional exemptions.
a) Short-term lease
b) Low value lease
• Stated differently, a lessee may or may not apply the operatinf
lease accounting if the lease is short-term or if the underlying
asset is of low value.
 Short-term lease
• A short-term lease as a lease is defined
that has a term of 12 motnths or less at
the commencement date of the lease.
• A lease that contains a purchase option is
not a short-term lease.
 Low value lease
• The new lease standard does not provide a
quantitative threshold for low value asset.
• The lease shall assess the value of an underlying
asset based on the value of the asset when it is new
regardless of the age of the asset being leased.
• A lease of an underlying asset does not qualify as a
low value lease if the nature of the asset is such
that asset is typically not a low value when new.
 Low value lease
EXAMPLE:
A lease for car would not qualify as low value lease
because a new car would typically not be of low value.

• Typically low value underlying assets include

personal computers, office furniture and equipment.
 Accounting for operating lease- Lessee
• If the lessee electsto apply the operating lease
accounting, the lessee shall recognize the lease payments
as rent expense in either a straight line basis over the
lease term or another systematic basis.
• The lease shall apply another systematic basis if this is
more representative of the pattern of the lessee’s benefit.
• Under the operating lease model the periodic rental is
simply recognized as rent expense on the part of the
lessee.
 Finance lease- Lessee
• A finance lease is defined as a lease that
transfer substantially all of the risks and
rewards incidental to ownership of an
underlying asset.
• At the commencement date, the lessee shall
recognize a right of use assets and lease
liability.
 Initial measurement of right of use of asset
• A right of use of asset is defined as an asset that represents the
right of a lessee to use an underlying asset over the lease term
in a finance lease.
• The cost of right of use asset companies:
a) The present value of lease payments
b) Lease payments made to lessor such as lease bonus, less any
lease incentive received.
c) Initial direct costs incurred by the lesse
d) Estimate of cost of dismantling and restoring the underlying
asset for which the lessee has a present obligation
 Initial measurement of right of use of asset
• Lease incentive is payment by the lessor to the lessee associated with a
lease or the reimbursement or assumption y the lessor of the cost of the
lessee.
• The lease incentive should be deducted from the cost of the right of use
of asset.
• Initial direct cost is not is incremental cost of obtaining a lease that
would have incurred of the lease had not been obtained.
• Leasehold improvement is not initial direct cost and not included in the
cost of the right of use of asset.
• Any security deposit refundable upon the lease expiration is accounted
for as an asset y the lessee.
Subsequent measurement of right of use asset
• The lease shall measure the right of use asset
applying the cost model.
• To apply the cost model, the lessee shall
measure the right of use asset at cost less any
accumulated depreciation and impairement
loss.
 Presentation of right of use asset
• The lessee shall present the right use of a asset a separate line
item as noncurrent asset in the statement of financial position.
• As an alternative, the lessee may include the right of use asset
in the appropriat line item within which the corresponding
underlying asset would be presented if owned.
EXAMPLE:
The right of the use asset related to equipment may be
included within property, plant and equipment.
 Depreciation of right of use asset
• The lesse shall apply normal depreciation policy
for right of use asset.
• IFRS 16, paragraph 32, provides that the lessee
shall depreciate the right of use asset over the
useful life of the underlying asset under the
following conditions:
a) The lease transfers ownership of the underlying
asset to the lessee at the end of lease term.
 Depreciation of right of use asset
b) The lease is reasonably certain to exercise a
purchase option.
• If ther is no transfer of ownership to the lessee or if
the purchase option is not reasonably certain to be
exercised, the lessee shall depreciate the right of
use asset over the shorter between the useful life of
the asset and the lease term.
 Measure of lease liability
• The lessee shall measure the lease liability at the
present value of lease payments.
• The lease payments shall be discounted using the
interest rate implicit in the lease desired by the
lessor.
• If the implicit interest rate cannot be readily
determined, the incremential borrowing rate of the
lessee is used.
 Components of lease payments
a) Fixed lease payments or periodic rental
b) Variable lease payments
c) Exercise price of a purchase option if the lessee is
reasonably certain to exercise the option
d) Amount expected to be payable by the lessee under a
residual value guarantee
e) Termination on penalties if th lease term reflects the
exercise of a termination option
 Components of lease payments
• Residual value guarantee made to the lessor by a party
unrelated to the lessor that the value of underlying asset at the
end of the lease term will be at least a specified amount.
• Unguaranteed residual value is that portion of the residual
value of the underlying asset, the realization of which by the
lessor is not assured or is guaranteed solely by a party related to
the lessor.
• Executory costs are ownership exoenses such as maintenance,
taxes and insurance for the underlying asset.
• Suce executory costs are expensed immendiately when
• incurred.
 Illustration
• Lessee Company leased a machine on january 1,2020 with the following pertinent
information:
Fixed ental payment at the end of each year 1,000,000
Lease term 10 years
Useful life of machine 12 years
Implicit interest rate 12%
Present value of an ordinary annuity of 1 for 10 periods at 12% 5.650
Present value of 1 for 10 periods at 12% 0.322
• Lessee company has the option to purchase the machine upon the lease expiration on
Jan. 1, 2030 by paying P500,000.
• The lessee is reasonably certain to exercise the purchase option at the
commencement date of the lease.
• The estimated residual value of the machine at the end of the 12-years life is
P600,00.
 Cost of right of use asset
Present value pf lease payments (1,000,000 x 5.65) 5,650,000
Present value of purchase option (500,000 x .322) 161,000
Total cost of right use asset and lease liability 5,811,000

• The lease payments shall be discounted using the 12% implicit interest rate.
 Journal entries for 2020
1. To record the acquisition of the machinery under a finance lease:
Right of use asset 5,811,000
Lease liability 5,811,000
2. To record the first rental payment on Dec. 31, 2020:
Interest expense 697,320
Lease liability 302,680
Cash 1,000,000
Lease liability Jan. 1, 2020 5,811,000
Payment on Dec 31,2020 1,000,000
Interest for 2020 (12% x 5,811,000) (697,320) 302,680
Lease liability- Dec. 31, 2020 5,508,320
 Journal entries for 2020
3. To record the annual depreciation:
Depreciation 434,250
Accumulated depreciation (5,211,000/12) 434,250
The asset is depreciated over the useful life ecausenthere is
purchase option that is reasonably certain to be exercised.
Cost of right of use asset 5,811,000
Residual value (600,000)
Depreciation amount 5,211,000
 Exercise of the purchase Option
• If accountsare properly posted, the lease liability would
show a balance on Dec. 31, 2029 at P500,000.
• Whe the purchase option is exercised on Jan. 1, 2030
which is the lease expiration the journal entry to record
the payment is:
Lease liability 500,000
Cash 500,000
 Lessor accounting
• IFRS 16, paragraph 61, provides that a lessor shall
clasify leases as either an operating lease or a finance
lease.
• An operating lease is a lease tha does not transfer
substantially all the risks and rewards imcidental to
ownership of an underlying asset.
• a finance lease is a lease that transfers substamtially all
the risks and rewards incidental to ownership of an
underlying asset.
 When is a lease classified as a finance lease
• Whether a lease is a finance lease or an operating lease depends
on the substance of the transaction rather than the form of the
contract.
• Under IFRS 16, paragraph 63, among others, any of the following
situations lead to a lease being classified as a finance lease:
a) The lease transfers ownership of the underlying asset to the
lessee at the end of the lease term.
b) The lessee has an option to purchase the asset at a price which is
expected to be sufficiently lower than the fair value at the date
the option becomes execisable.
 When is a lease classified as a finance lease
At the inception of the lease,it is reasonably certain that the option will be
exercised.
c) The lease term is for the major part of the economic life of the
underlying asset even if title is not transferred.
Under USA GAAP, major part means at least 75% of the economic life of
an asset.
d) The present value of the lease payments amouts to substantially all of
the fair value of the underlying asset at the inception of the lease.
Under USA GAAP, substantially all means at least 90% of the fair value of
the underlying asset.
 Operating lease Lessor
• IFRS 16, paragraph 81, provides that a lessor shall recognize lease
ayments from Operationg lease as income either on a straight line
basis or another systematic basis.
• The lessor shall apply another systematic basis if this is more
representative of the pattern in which benefit from the use of the
underlying asset is diminished.
• Otherwise stated, the periodic rental received by the lesso in an
operating lease is simply recognized as rent income.
• A lessor shall present an underlying asset subject to operating lease
in the statement of financial position, according to the nature of the
asset.
 Operating lease Lessor
• The underlying asset remains as an asset of the lessor.
Consequently, the lesso bears all ownership or executory
costs such as depreciation of leased property, real
property taxes, insurance and maintenance. However,
the lessor may pass on to the lessee the payment for
taxes, insurance and maintenance cost.
• The depreciation policy for depreciable leased asset shall
be consistent with the lessor’s normal depreciation for
similar asset.
 Operating lease Lessor
• Initial direct cost incurred by lessor in an operating lease
shall be added to the carrying amount of the underlying
asset and recognized as an expense over the lease term
on the same basis as the lease income.
• Any security deposit refundable upon the lease
expiration shall be accounted for as liability by the
lessor.
• Any lease bonus received by the lessor from the lessee is
recognized as unearned rent income to be amortized
 Illustration
1. At the beginning of current year, Simple Company purchased machinery for
P3,000,000 cash for the purpose of leasing it. The machine is expected to have a
10-year life and no residual value.
Machinery 3,000,000
Cash 3,000,000
2. On the same date, Simple Company leased the machine to another entity for 3 years
at a monthly rental of P80,000, payable at the begenning of every month.
Cash (80,000 x 12) 960,000
Rent income 960,000
3. Simple Company received a security deposit of P600,000 to be refunded upon the
lease expiration.
Cash 600,000
Liability for rent deposit 600,000
 Illustration
4. In addition to the rental, Simple Company received from the lessee a
lease bonus of P120,000.
Cash 120,000
Unearned rent income 120,000
5. Simple Company paid initial direct cost of P300,000.
Deferred initial direct cost 300,000
Cash 300,000
6. During the current year, Simple Company paid repair and maintenance
of P50,000.
Repair and maintenance 50,000
Cash 50,000
 Illustration
7. The lease bonus is amortized over 3 years or annually.
Unearned rent income 40,000
Rent income 40,000
8. The machinery is over 10 years or P300,000 annually.
Depreciation 300,000
Accumulated depreciation 300,000
9. The initial direct cost is recognized as expense over the lease term.
Amortizatio of initial direct cost 100,000
Deferred initial direct cost 100,000
 Illustration
• The balance of the deferred initial direct cost shall be presented as an
addition tot he carrying amount of machinery.
Machinery 3,000,000
Accumulated depreciation (300,000)
Carrying amount 2,700,000
Deferred initiak direct cost 200,000
Adjusted carrying amount 2,900,000
Deferred initial direct cost 300,000
Amortization for the currrent year (100,000)
Balance 200,000
 Computation of net rent income
Annual rent income 960,000
Lease bonus 40,000
Total rent income 1,000,000
Depreciation (300,000)
Repair and maintenance (50,000)
Amortization of initial direct cost (100,000)
Net rent income 550,000
 Finance lease classification-lessor
• A finance lease is either:
a) Direct financing lease
b) Sales type lease
• The main distinction between the two is the presence or
absence of a manufacturer or deaer profit or loss.
• A direct financing lease recognizes only interest income.
• A sales type ;ease recognizes interest income and gross
profit on sale.
 Illustration-Direct financing lease
• At the beginning of current year, Lessor Company leased machinery
to anoher entity with the following details:

Cost of machinery 1,520,000

Annual rental payable at the end of each year 500,000
Lease term 4 years
Useful life of machinery 4 years
Implcit interest rate 12%
Present value of ordinary annuity of 1 to 4 years a 12% 3.04
 Illustration-Direct financing lease
1. To record the direct financing lease:
Lease receivable (500,000 x 4) 2,000,000
Machinery 1,520,000
Unearned interest income 480,000
2. To record the collection of annual rental:
Cash 500,000
Lease receivable 500,000
3. To record the interest income for current year:
Unearned interest income 182,400
Interest income (12% x 1,520,000) 182,400
 Illustration- sales type lease
• Lessor Company is a dealer in machinery.
• At the beginning of current year, a machine was leased to Lessee Company
with the following provisions:

Annual rental payable at the end each year 400,000

Lease term 5 years
Useful life of machinery 5 years
Cost of machinery 1,000,000
Implicit interest rate 12%
Present value of ordinary annuity of 1 to 5 years at 12% 3.60
 Computation
Gross renatls (400,000 x 5) 2,000,000
Present value of rentals (400,000 x 3.60) 1,440,000
Unearned interest income 560,000

Present value of rentals- sales 1,440,000

Cost of machinery-cost of good sold 1,000,000
Gross income of sale 440,000
 Journal entries
1. To record the sale:
Lease receivable 2,000,000
Sales 1,440,000
Unearned interest income 560,000
The gross income of is not separately recorded because it is included already in the sales
revenue.
2. To record the cost of good sold, assuming the perpetual system is used:
Cost of good sold 1,000,000
Inventory 1,000,000
3. To record the collection of the annual rental:
Cash 400,000
Lease receivable 400,000
 Journal entries
4. To record the interest income for current year:
Unearned interest income 172,000
Interest income 172,000

Present value Jan. 1 1,440,000

Principal payment- Dec. 31:
Annual rental 400,000
Interest(12% x 1,440,000) (172,800) (227,200)

Balance-Dec 31 1,212,800
 Summary
• Lease is defined as a contract or a part of a contract that
conveys the right use the underlying asset for a period of
time in exchange for consideration.
• The underlying asset is the subject to a lease for which
the right to use that asset has been provided by the lessor
to the lessee.
• The lessee is the entity that obtains the right to use and
underlying asset for a period of time in exchange for
consideration.
 Summary
• The lessor is the entity that provides the right to use an
underlying asset for a period ofmtime in exchange for
consideration.
• A lessee may or may not apply the operating lease
accounting if the lease is short-term or if the underlying
asset is of low value.
• A finance lease is defined as a lease that transfers
substantially all of the risks and rewards incidental to
ownership of an underlying asset.