Question

Daniel Hardware Co. is considering alternative financing arrangements for equipment used in its warehouses. Besides purchasing the equipment outright, Daniel is also considering a lease. Accounting for the outright purchase is fairly straightforward, but because Daniel has not used equipment leases in the past, the accounting staff is less informed about the specific accounting rules for leases. The staff is aware of some general lease rules related to "right-of-use," but they are unsure how the accounting rules apply to their situation. Daniel has asked you to conduct some research on these items related to lease capitalization criteria

Instructions:

Access the IFRS authoritative literature at the IASB website (http://eifrs.iasb.org/). (Click on the IFRS tab and then register for free eIFRS access if necessary.) When you have accessed the documents, you can use the search tool in your Internet browser to respond to the following questions. (Provide paragraph citations.)

(a) What is included in the measurement of (1) the lease liability and (2) the right-of-use asset?

(b) Besides the non-cancelable term of the lease, what are other considerations in determining the "lease term"?

(c) When should a lessee account for a lease modification? What procedures are followed?

Answer 1

According to IFRS 16, 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 exchange for consideration. Lease are of two types : Operating lease and Finance Lease.

• Finance lease : Finance Lease is a type of lease in which risk and rewards incidental to ownership of the underlying assets get transferred.
• Operating Lease : Operating lease is a lease other than financial lease i.e risk and rewards incidental to ownership does not get transferred.

There are two terms which are the basic terms in the context of lease and these are :

• Lessor : A person who gives his property on lease.
• Lessee : A person who takes the property on lease.

Below are the answers of the above questions :

(a)

(1) The Lease liability : According to ASC 842, the lease liability is the lessee’s obligation to make the lease payments arising from a lease, measured on a discounted basis. This means by calculating present value through discounting, lease liability can be calculated.

(2)Right-of-use asset : According to ASC 842, Right-of-use-asset means an asset that represents a lessee’s right to use an underlying asset for the lease term.

(b)Besides the non-cancelable term of the lease, the other considerations in determining 'lease term' are:

• Lease term is decided accroding to the bargain purchase option becomes exercisable as lease term cannot exceed the period when the bargain purchase option becomes excercisable.
• Lease term is decided according to the need of the lessee. So, this is also a deciding factor for determining 'lease term'.
• 'Lease term' is also sometimes decided on minimum lease payments to be paid so that through that we come to know about determining lease term.
• Policy of lessors are also considered in determining lease term.

(c) Lessee should account for  a lease modification when:

• Lessee wants additional right of use of an asset. For example: if lessee is using one part of land and want to use second part too, lease modification is needed.
• Lessee wants to increase or decrease lease period.
• Lessee wants to alter the risk and rewards related to the lease that is when lessee wants to convert his lease to operating or financial lease.

For lease modifications procedure, here is the General Guidelines on Lease Modification/Waiver for School Applications by Lands Department :

Procedures for processing Lease Modification/Wavier Applications

(a) As a general rule, all lease modification/waiver applications must be submitted by the registered owner(s) of the property concerned or his/their authorized persons.

(b) Upon receipt of a lease modification/waiver application and payment of initial administrative fee, Lands Department will consult relevant Government departments. Each case will be considered in its merits after full consideration of the circumstances.

(c) If the application is approved, a basic terms offer letter setting-out the amount of premium/waiver fee, balance of the administrative fee (if any) and the deposit payable etc., will be issued to the applicant. The applicant will be required to indicate acceptance of the basic terms within the period stated in the letter before a formal modification letter/waiver letter is issued.

(d) Once an offer is accepted and payment made, the Lands Department will issue the modification letter/waiver letter to the applicant for execution. A certified copy for the executed modification letter/waiver letter will be registered by memorial at the Land Registry. The applicant shall also pay the concerned registration fee to be charged by the Land Registry.

(e) If the application is not approved, a letter giving the reasons for disapproval will be sent to the applicant.