Chapter 18 Lecture Notes

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Leases ● Lessee Accounting ● Sale and leasebacks ● Lessor Accounting ● ASPE Lessee ● Identification of a Lease ● Exemptions ● Non-lease components ● Impact on financial statements IFRS LESSEE ● Identification of a Lease ○ At inception of the contract, need to determine if contract contains lease ○ In order to be considered a lease: ■ Right to control - control the space, hours, etc ■ Specifically identified asset - specific location, defined asset ■ Specified period of time Example: Kiosk that is being moved around the mall → not a lease b/c needs a defined space that is agreed on ● Exemptions → can qualify if it is a short-term lease or low value asset, option to use an exemption or record as ROU asset ○ Short-term leases ■ Less than year ■ If renewal option consider if likely to renew - cannot use short-term lease exemption if likely to be renewed ■ No purchase option - cannot use short-term lease exemption if there is a purchase option (even if not likely to use) ○ Low value assets ■ Based on value new asset (less than $5,000 US) ■ Not dependent on or related other assets ● Ex. Equipment is dependant on other assets - a building or other machinery comes with it ○ If meet exemption option to elect to recognize as lease expense each period instead of recognizing right-of-use asset and lease liability DR Rent expense xxx CR Cash xxx As you make payments then use that entry, incur expense as asset is used Examples ● Lease used vehicle value $3,000 → Not eligible for exemption b/c it is not new ● Lease office space 8 months → Eligible for exemption as short-term lease b/c it is less than a year, no purchase option stated ● Lease employee laptop $2,500 new → Eligible for exemption as a low value asset

● Lease large piece machinery with purchase option → Not eligible for exemption, there is a purchase option ● Lease office space for 1 year with option to renew → Need to consider if it is likely that we will exercise the renewal option, it depends. If likely to renew then does not qualify, if not likely then qualifies as short-term Which of the following examples would qualify for an exemption? Lessee ● Non-Lease Components ○ If the lease contract includes non-lease components (ie. Maintenance) two options: 1. Separate out servicing portion based on stand alone fair value; (allocation based on fair values) or 2. Option to treat entire contract as a lease ● Must exclude if it is third-party costs such as insurance and property taxes - no option to include for these CASE TIPS Issue: Leases / \ ASPE IFRS / \ No exemption Yes exemption - rent expense | ROU Asset | Initial measurement | Subsequent measurement ● Accounting by Lessees - Initial Recognition ○ Recognize “right of use” asset and liability on commencement date - when asset available for use ○ Lease liability recorded at PV of lease payments PMT ○ Payments include: ■ Fixed payments over lease term (annuities) ■ Variable payments if linked to index or rate - CPI (not if linked to sales or usage) ■ FV → Residual guarantee (guarantee as lessee that value of the asset at the end of the lease will be a specified amount) if expected to pay ● Lessee is on the hook to pay if asset doesn’t amount to the guarantee → the lessee has to pay the difference

● This payment is part of the FV when you input it into your calculator ● Amount that is expected to pay ■ FV → Purchase option if expect to exercise ● This payment is part of the FV when you input it into your calculator ■ FV → Termination penalty if lease term suggests will exercise ● This payment is part of the FV when you input it into your calculator ■ Those are the three scenarios that would trigger something in the FV Example Which of the following payments would be included in PV of lease liability? ● Lease payment $5,000 per month 3 year lease → INCLUDE - fixed amount ● Car lease payment $0.20 per km → DO NOT INCLUDE - variable payment that linked to usage not index ● Residual value guarantee $20,000 → INCLUDE if expect to pay ● Lease payment 2% of sales → DO NOT INCLUDE - variable payment that is linked to sales ● Purchase option @ end of 5 year lease → INCLUDE if expect to pay ● Lease payment linked to CPI index → INCLUDE - variable payment that is linked to index N ● Accounting by Lessees - Initial Recognition Lease Liability ○ Lease terms include: ■ Non-cancellable term - all questions include this ■ Plus: Options to extend if reasonably certain (need to assess) ● Example: extending a car lease ● Consider economic incentives to extend ● Temporary space → likely not to extend, Key important space for business → likely to extent ■ Plus: Rent-free periods I/Y ○ Interest rate for discounting is: ■ Lessor’s rate implicit in the lease if known by lessee ; if not known ■ Lessee’s incremental borrowing rate (lessee would need to pay if financed by another source) ○ Right-of-use asset recorded at total of: ■ Starting point amount lease liability (the PV we calculated when doing lease liability) ■ Plus Upfront payment at or before commencement date ■ Plus Initial direct costs to arrange the lease (legal, actg) - this is not maintenance ■ Estimated decommissioning liabilities ■ Less any lease incentives received

○ Amount recorded as lease liability will not necessarily be equal to the amount of right-of-use asset ○ Amount of lease liability is the starting point for measurement right-of-use asset Example - Part 1 ● 5 year lease starting Jan 1, 20X6 ● $100,000 per year plus 1% of sales in period ● Implicit rate not know incremental borrowing rate 5% ● Straight-line depreciation ● Lease payment end of year ● Dec 31 year-end What is the amount for ROU asset and lease liability at inception lease? N - 5 I/Y - 5% PMT - 100,000 FV - 0 CPT PV - 432,948 Journal Entry: DR ROU Asset 432,948 CR Lease Liability 432,948 Example - Part 2 How would the journal entry change if? ● Part 1 - Initial legal costs of $5,000 to obtain lease - add to the ROU asset Journal Entry: DR ROU Asset 437,948 CR Lease Liability 432,948 CR Cash 5,000 ● Part 2 - Decommissioning costs of $50,000 (PV) required by lease contract? - add to the ROU asset and set up decommissioning liability - no PV calculation given cause they already gave us the PV Journal Entry: DR ROU Asset 482,948 CR Lease liability 432,948 CR Decommissioning Liability 50,000 Lessee ● Subsequent Measurement of Right-of-use Asset ● Use cost model, revaluation model, fair value model (investment property) ○ Cost model - most common for leases ■ Initial measurement less:

● Accumulated depreciation earlier end useful life or lease term unless transfer ownership then useful life ● Accumulated impairment ● Plus or less remeasurement lease liability ○ Also option to use revaluation model or fair value model if those criteria are met ● Subsequent Measurement of Lease Liability ○ Adjust for: ■ Interest expense using effective interest method ■ Discount rate does not change unless ● Change in lease term (n) ● Change in amount payable purchase option ● In these cases we have to recompute I/Y ■ Payments made - lessee’s payments reduce lease liability ■ Remeasurements if variable lease payments linked to index or rate change or there are substantial modifications to lease (pg. 1261) ● Any remeasurements ex change in CPI index if payment linked to CPI index lease liability will also adjust amount of right-of-use asset ● Also need to adjust interest and amortization expense based on new information Journal Entries: ● Each year (if no remeasurements): ○ Record interest to bring up liability to face value Dr. Interest expense xx Cr. Lease liability xx ○ Record payments on lease Dr. Lease liability xx Cr. Cash xx ○ Record amortization of asset Dr. Amortization expense xx Cr. Acc amortization xx Example - Part 3 Using information from Part 1 what are journal entries in 20X6 if sales were $2 million? Initial entry was: Dr. ROU asset 432,948 Cr. Lease liability 432,948 5 year lease Payment 1% sales What are the journal entries we would record in 20X6: 1. Interest Expense Lease liability = 432,948 * 0.05 = 21,647 Remember - always take interest on the lease liability DR Interest Expense 21,647 CR Lease liability 21,647

2. Depreciation of ROU asset 432,948 / 5 years = 86,590 DR Depreciation expense 86,590 CR Acc Amortization 86,590 3. Lease payment 2 million in sales x 1% = 20,000 DR Lease liability 20,000 CR Cash 20,000 Example: Payments are at the beginning Calculator → change to begin Or excel → enter 1 as the type for the PV formula Recalculate lease liability after payment was made → record interest on top of that Example: Accruals (pg. 1257) IFRS - Steps ● Step 1 - Initial entry (assuming no other adjustments right-of-use asset) Dr. ROU Asset = PVMLP Cr. Lease liability = PVMLP ● Step 2 - Accrue interest (assuming no remeasurements) Dr. Interest expense Cr. Lease liability ○ = Liability @ beginning of year x interest rate ● Step 3 - Amortize asset (assuming no remeasurements) Dr. Amortization expense Cr. Accumulated amortization ● Step 4 - Recognize payments Dr. Lease liability Cr. Cash ● Step 5 - Calculate closing balance of lease liability ○ Opening bal + interest - payment Lessee ● Presentation by Lessee ○ Presentation on Statement of Financial Position ■ Lease liabilities separate line item split into current and non-current ■ Right-of-use assets together with property, plant, and equipment or as separate line item ○ Presentation on Income Statement ■ Separate line items for amortization of lease assets and interest on lease liability ○ Presentation on cash flow statement ■ Operating activities - lease payments if meet exemption, variable lease payments linked to sales or usage

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