Question

Larkspur Inc. offers boat tours around the City Reservoir. The company has signed a lease for a tour boat with an expected lifespan of six years, no estimated salvage value, and cost the leasing company $207,000. The terms of the lease are as follows:

●		The lease term begins on January 1, 2019, and runs for 3 years.
●		The lease requires payments of $51,900 each January 1, starting on January 1, 2019, and each payment includes $5,100 for maintenance and insurance costs.
●		At the end of the initial lease term, the lease can be renewed for another two years at Larkspur’s option for only $29,000 per year, including $2,000 for maintenance and insurance costs. The normal rental cost of a similar used boat is $33,500 per year. Larkspur expects to renew the lease for the second term.
●		At the end of the lease term, the boat is to be returned to the lessor.
●		The lessor’s implied interest rate is 6%, and Larkspur uses straight-line depreciation for similar equipment. Larkspur’s year-end is May 31.

Assuming that Larkspur follows ASPE, identify how Larkspur should classify this lease.

Lease should be considered as____________

Assuming that Larkspur follows IFRS and the new leases standard IFRS 16, identify the circumstances under which the lease would result in a right-of use asset capitalized on Larkspur’s statement of financial position.

Answer 1

IFRS 16 is a new International Financial Reporting Standard for lease accounting which came into force on 1st January 2019. It replaced the existing IAS 17 accounting standard and was introduced by the IASB. The objective is to ensure that companies report information for all of their leased assets in a standarized way and bring transparency on companies's lease assets and liabilities. Earlier operating leases were not included on balance sheets but were simply accounted for via profit and loss accounts. But now under IFRS 16, most leased items have to be included as an asset in the company books, following the new " right to use " model which says :

" A contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a period of time in exhange for consideration. "

Therefore Larkspur will classify this lease as

ON ASSET SIDE : Right to use asset representing its right to use the underlying leased asset and

ON LIABILITY SIDE : as a lease liability representing its obligation to make lease payments.

IFRS 16 STATES THE CIRCUMSTANCES UNDER WHICH THE LEASE WOULD RESULT IN A RIGHT OF USE ASSET :

- Where the lessee has the right to direct how and for what purpose the asset is used throughout its period of use ;or

- The relevant decisions about use are predetermined and the customer has the right to operate the asset throughout the period of use without the supplier having the right to change these operating instructions.

The " Right to use asset " would include the following amounts, where relevant :

a) Any payments made to the lessor at or before the commencement date of the lease less any lease incentives received.

b) Any intial direct costs incurred by the lessee.

c) An estimate of any costs to be incurred by the lessee in dismantling and removing the underlying asset or removing the underlying asset or restoring the site on which it is located.

NOTE : Many leasing contracts contain elements other than the actual rental of the underlying asset ( eg : services such as maintenance). Under IFRS 16 these don't constitute part of the lease and will need to be spilt out as a separate charge by the supplier.