Considertion: a payment

Topic
Leases – Part A

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 Topic objectives

See CANVAS Modules Topic Leases “This week’s objectives…”

Type text here

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 Lease: definition

Right to use = you don't own the asset but you get to decide how to use it

A contract, or part of a contract, that conveys the right to use an asset (the
underlying asset) for a period of time in exchange for consideration
Consideration= obligation to make payment
For accounting purposes there are some issues to consider:

1.Does it matter who is the asset’s owner?

2.Who has the control over the asset?

Do you remember from ‘assets’ definition?

A firm may recognise assets it does not own as

long as it is able to control the use
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 Lease: definition

A lease exists when the customer controls the use of the underlying asset
throughout the period of use, meaning that the customer (i.e., the lessee):
• obtains substantially all of the economic benefits from the use of the
identified asset throughout the period of use; and
• directs the use of the asset throughout the period of use, which means the
lessee has the ability to change how, and for what purpose, the asset is
used during the contractual term.

Lessor (owner)---------------->Lessee (customer)----------------> right to use

Lessor has no say in the use of the asset.

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 Key terms

With the lease contract a supplier (lessor) conveys the right to use an asset to
a customer (lessee) in exchange for consideration (lease payments) throughout
a period of time (lease term)

Lessee: the individual/firm obtaining the right to use the asset and having an
obligation to pay the lessor at established dates
Lessor: the individual/firm providing the asset and receiving payments at
established dates Type text here

Lease payments: fixed payments (excluding service cost component, if any) +

(if included in the lease contract) residual value guarantee and/or price of a
purchase option
Lease term: the period for which a lessee has the right to use the underlying
asset, from the commencement date of the contract. Based on expectations
about whether lessee likely to exercise an option to extend the lease term
Lessee payment : Lessee pays lessor a fixed amount (exclude serivce cost).
Example:
5 RM 1100= Rm 1000 (lease payment) + Rm 100 (repair)
The repair amount in the 1100 is not included in lease payment, it is considered as expenses.
so the lease payment is only 1000
 Key terms

When to recognise a lease: Commencement date is the 1st day of leasing according to the lease contract.
At the commencement date, a lessee shall recognise a
right-of-use asset and a lease liability : Asset increases, Liability increases

Commencement date is defined as:

The date on which a lessor makes an underlying asset available for
use by a lessee

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 The accounting issue
Can the right-of-use the asset acquired under the lease contract be
considered an asset? If all the below criterias are satisfied, lessee can recognize the asset.
Future So should
Description of right Control Past event economic asset be
benefit recognised?

Right to use the Delivery

Legally enforceable
identified asset e.g., following
right established by Yes Yes!
machinery during the signing of the
the lease contract
lease term Once contract is signed lessee lease contract
has complete control over the
use of the asset without
any complictions.

Exceptions:
1. Short-term leases (leases with a duration of 12 months or less)
2. Leases of low value assets (tablets, phones, laptops, etc…)
Low value asset: cost of the asset is very insignificant to the company.
Low value asset will be directly be recognized as an expenses (whole payment), whereas higher value
value asset will be capitalized (recognize as capital expenditure and charged depreciation).

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 The accounting issue

Can the obligation to make lease payments in the future be

considered a liability? to lessee

Outflow of So should
Description of economic liability be
obligation Present obligation Past event benefits recognised?
Obligation to pay Legally enforceable Delivery following Yes (cash Yes!
rentals obligation signing of the payments)
established by the lease contract
lease contract

In order to recognize asset or liabilty,

something need to happen in the past.

in this case, a lease contract has to take

place in order to triger the liability. A lease
contract is called a 'trigering event'.

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 Accounting for leases by the lessee
Commencement End of the
date lease term

Fixed payments Last fixed payment

+
Guaranteed residual
If any Com+
Price of bargain
purchase option

The lessee acquires the right to use the asset and

commits to lease payments.
How is this accounted for? Let’s consider the following
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example/illustration
 Illustration 1 Accounting for leases by the lessee
On 1 July 2022, Bells Beach Ltd enters into a four-year lease of a machine. Bells
Beach Ltd will pay fixed annual payments of $100 000 for four years with the first
payment on 30 June 2023
To enter the lease Bells Beach Ltd incurs direct costs of $10 000 at the
commencement of the lease term
There is a bargain purchase price option (that Bells Beach Ltd is willing to
exercise) for $25 000 at the end of the lease term
The machine is expected to have a useful life of 10 years and no residual value
Additional information
• Lessee’s incremental borrowing rate: 6%
• Present value of an annuity in arrears of $1 for 4 periods at 6% = 3.4651
• Present value of $1 in 4 periods at 6% = 0.7921
Determine the initial measure of the lease liability and right-of-use asset and prepare the
related accounting journal entries for the year ended 30 June 2022.

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 Illustration 1 - Solution
Lease liability is measured as the present value of the lease payments* that
are to be made over the lease term by the lessee.

I----------------I-----------------I----------------I-----------------I
100K 100K 100K
= $100 000 100K
25K
Consider Time Value of Money
= $25 000

To determine their present value, the lease payments shall be

discounted using the interest rate implicit in the lease or the lessee’s
incremental borrowing rate (6 per cent).

* = fixed payments + (if included in the lease contract) expected payment under
a residual value guaranteed and/or price of bargain purchase option
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 Illustration 1 - Solution
Lease liability
• Fixed payments are to be multiplied for present value of an annuity
in arrears of $1 for 4 periods at 6 per cent

• Purchase options is to be multiplied by the present value of $1 in 4

periods at 6 per cent

$100 000 x 3.4651 = $346 510 +

$25 000 x 0.7921 = $19 802 =
Lease liability $366 312 Initial lease liability

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 Illustration 1 - Solution

Right-of-use asset
The lessee shall measure the right-of-use asset at COST
The cost comprises:
(a) the initial lease liability 366312

(b) any lease payments made at orabefore the commencement date 0

(c) any initial direct costs incurred by the lessee, and 10k

(d) an estimate of costs to be incurred by the lessee in dismantling and

removing the underlying asset 0

right-of-use asset =
Lease liability $366 312 +
Direct costs $10 000 = $376 312

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 Illustration 1 - Solution

On initial recognition, the accounting journal entry would be:

1 July 2022
Dr Right-of-use asset – machine 376 312
Cr Lease liability 366 312
Cr Cash/payables etc Direct cost 10k 10 000
(to recognise the lease)

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 Illustration 1 - Solution
Subsequent measurement —Lease liability
The liability will be reduced each period with each lease payment constituting
part interest expense, and part repayment of the lease liability using the
effective interest method

Lease payment (cash outflow) = $100 000

Interest expense = Principal repayment =

6% of $366 312 = $21 979 $100 000 – $21 979 = $78 021

Interest expense and repayment are

recalculated every period on the
outstanding lease liability

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 Illustration 1 - Solution

Each period we would also need to amortise the leased asset (or else it will
stay in the accounts indefinitely)
The general principle is that the leased asset shall be
depreciated/amortised over the life of the lease if the lessee is not going
to retain the asset at the end of the lease term
If the lessee is expected to retain the leased asset at the end of the lease
term (perhaps by way of making an additional payment) then the leased
asset shall be depreciated over its expected useful life
• In this example, the leased asset will be acquired at the end of the lease
term so the useful life of the asset will be used for depreciation purposes

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 Illustration 1 - Solution
Subsequent measurement —Lease liability
(1) (2) (3) (4) (5)
Date Lease Interest Principal Present value of lease liability
payment expense reduction
Interest is always
1 July charged at
2022 0 outstanding 0 0 366 312
liability.

30 June 366312*6% 100000-21979

2023 100 000 21 979 78 021 288 291

30 June 288291*6% 100000-17297

2024 100 000 17 297 82 703 205 588

205588*6% 100000-12335
30 June
2025 100 000 12 335 87 665 117 923

30 June 117923*6%
final ans must be 0
2026 125 000 7 076 117 923 0
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 Illustration 1 - Solution

The subsequent accounting journal entries would be:

30 June 2023
Dr Interest expense 21 979
Dr Lease liability 78 021
Cr Cash 100 000
(to recognise lease payment)

Dr Lease depreciation expense 37 631 Right of use value / useful life

Cr Accum. deprec – right-of-use asset—machine 37 631
(to amortise leased asset $376 312/10 years)
asset value is trasfered from lessor to lessee thru right of use, so the lessee owns the asset value. Depereciation is charged to
the party that owns the asset value, the lessee , even though lessee does not have direct ownership.

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 Illustration 1 - Solution

Bell Beach Ltd

Extract Statement of Financial Position as at 30 June 2023
Non-current Assets

Right of Use Asset - Machinery 376 312

Less Accumulated depreciation 37 631

338 681

Current Liabilities

Lease liability 78 021

Non-current Liabilities

Lease liability 210 270

288 291

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 Some implications of AASB 16/IFRS 16

AASB 16/IFRS 16 effective date: 1 January 2019

For some entities (e.g. particularly large retailers who lease many retail
outlets e.g., Coles) AASB 16/IFRS 16 requires recognition of many more
leased assets and lease liabilities than required by the accounting standard
it replaced
This increases their reported debt and assets and increases their reported
leverage receives additional resources
The increased leverage could have implications for various accounting-
based debt covenants
Expenses tend to be ‘front loaded’—that is, they are higher in the earlier
years. This has implications for reported profits and also for contractual
arrangements that use reported profits
front loaded- at the beginning of the contract, you are likely to pay higher expenses. Because a higher
portion of the lease payment goes to paying interest in the beginning.
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