Leasing

Lessee

Basic lease, implicit rate

1/1/X1, XYZ leased a production machine for five years. Annual payments (in arrears) were 2,927 and XYZ retained the asset. Prices of comparable machines were readily available. On this basis, XYZ determined the machine's fair value was 12,000 and rate implicit in the lease was 7%. XYZ intended to use the machine 6 years, then sell it for 1,200. It actually sold it for 1,250 on 3/31/X7.

Put simply, the rate implicit in the lease is the rate that will cause the present value of the lease payments to equal the asset's fair value.

IFRS 16.Appendix A: [The] interest rate implicit in the lease [is] the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.

ASC 842-20-20: The rate of interest that, at a given date, causes the aggregate present value of (a) the lease payments and (b) the amount that a lessor expects to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the lessor and (2) any deferred initial direct costs of the lessor.

A rate implicit in the lease can thus be (readily) determined if, and only if, the asset's fair value can be (readily) determined.

The simplest way to calculate an implicit rate is using Excel's =rate function:

7.0039771424884% =RATE(5,-2927,12000,0,0,10%).

The syntax for the function is =RATE(number of periods, -payment, present value, future value, type of payment (0 beginning of period, 1 arrears), initial guess.

A collection of other useful Excel formulas and functions can also be downloaded on our formula page.

Dr/Cr

1/1/X1 | 1.1.X1

 

 

Production machine (right-of-use asset)

12,000

 

 

Lease liability

 

12,000


Current common practice is to recognize leased tangible assets as PP&E. This practice is expected to continue under IFRS 16 | ASC 842 even though right-of-use assets are, technically speaking, intangible assets.

IFRS 15 Appendix A | ASC 842-20-20 define a right-of-use asset as "An asset that represents a lessee's right to use an underlying asset for the lease term".

12/31/X1 | 31.12.X1

 

 

Interest expense (leasing)

840

 

Lease liability

2,087

 

 

Cash

 

2,927

Depreciation expense (right-of-use asset)

1,800

 

 

Accumulated depreciation (right-of-use asset)

 

1,800



P

Liability

Discount rate

Interest expense

Payment

Liability amortization

A

B (B+1) = B - F

C

D = B x C

E

F = E - D

1

12,000

7.00%

840

2,927

2,087

2

9,913

7.00%

694

2,927

2,233

3

7,681

7.00%

538

2,927

2,389

4

5,292

7.00%

370

2,927

2,556

5

2,735

7.00%

191

2,927

2,735

 

 

 

 

 

12,000

 

 

 

 

 

 


31/3/X7 | 3.31.X7

 

 

Accumulated depreciation (right-of-use asset)

10,800

 

Cash

1,250

 

 

Production machine (right-of-use asset)

 

12,000

 

Asset disposal gain

 

50


Upfront payments

Same facts except payments of 2,735 were paid up front.

1/1/X1 | 1.1.X1

 

 

Production machine

12,000

 

 

Cash

2,735

 

 

Lease liability

 

9,265


12/31/X1 | 31.12.X1

 

 

Interest expense

649

 

Lease liability

2,087

 

Depreciation expense

1,800

 

 

Accrued lease payment

 

2,735

 

Accumulated depreciation

 

1,800


P

Liability

Discount rate

Interest expense

Payment

Liability amortization

A

B (B+1) = B - F

C

D = B x C

E

F = E - D

0

12,000

7.00%

0

2,735

2,735

1

9,265

7.00%

649

2,735

2,087

2

7,178

7.00%

502

2,735

2,233

3

4,945

7.00%

346

2,735

2,389

4

2,556

7.00%

179

2,735

2,556

 

 

 

 

 

12,000

 

 

 

 

 

 


7.00%=RATE(5,-2735,12000,0,1,10%)

A collection of other useful Excel formulas and functions can be downloaded on our formula page.

Principal and interest can also be recognized separately:

 

Accrued lease payment: Principal

 

2,087

 

Accrued lease payment: Interest

 

649


1/1/X2 | 1.1.X2

 

 

Accrued lease payment

2,735

 

 

Cash

 

2,735


Interim entries

Same facts except XYZ made quarterly accruing entries.

3/31/X1 | 31.3.X1

 

 

Interest expense

162

 

Lease liability

522

 

Depreciation expense

450

 

 

Accrued lease payment

 

684

 

Accumulated depreciation

 

450


Implicit rate not determinable, monthly payments, purchase option

1/1/X1, XYZ leased a made-to-order machine for 3 years. Monthly payments were 342 and XYZ had an option to buy the machine for 1,000. Prices of comparable machines were not available so XYZ could not determine the machine's fair value. Its incremental borrowing rate was 7.5%. XYZ kept the machine 6 years and scrapped it 31/12/X6.

Put simply, the rate implicit in the lease is the rate that will cause the present value of the lease payments to equal the asset's fair value.

IFRS 16.Appendix A: [The] interest rate implicit in the lease [is] the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.

ASC 842-20-20: The rate of interest that, at a given date, causes the aggregate present value of (a) the lease payments and (b) the amount that a lessor expects to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the lessor and (2) any deferred initial direct costs of the lessor.

A rate implicit in the lease can thus be (readily) determined if, and only if, the asset's fair value can be (readily) determined.

As the machine's fair value could not be determined, XYZ used its incremental borrowing rate instead.

IFRS 16.26: At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.

ASC 842-20-30 1: At the commencement date, a lessee shall measure both of the following: a. The lease liability at the present value of the lease payments not yet paid, discounted using the discount rate for the lease at lease commencement ...

ASC 842-20-20: For a lessee, the discount rate for the lease is the rate implicit in the lease unless that rate cannot be readily determined. In that case, the lessee is required to use its incremental borrowing rate.

Dr/Cr


1/1/X1 | 1.1.X1

 

 

Production machine (right-of-use asset)

11,916

 

 

Cash

 

342

 

Lease liability

 

11,574


Current common practice is to recognize leased tangible assets as PP&E. This practice is expected to continue under IFRS 16 | ASC 842 even though right-of-use assets are, technically speaking, intangible assets.

IFRS 15 Appendix A | ASC 842-20-20 define a right-of-use asset as "An asset that represents a lessee's right to use an underlying asset for the lease term".

XYZ calculated the asset's value using this table:

P

Payment

Discount rate

Present value

A

B

C = (1 + 7.5%)1/12 - 1

D = B ÷ (1 + C)A

0

342

0.604%

342

1

342

0.604%

340

-

-

-

-

34

342

0.604%

279

35

1,342

0.604%

1,087

 

 

 

11,916

 

 

 

 


Alternatively, it could have also calculated this value manually (a collection of useful formulas and functions can be downloaded in Excel format on our formula page):

11,916.04(rounded) = (1 + ((1 + 7.5%)(1/12) - 1)) x 342.15 x ((1 - (1 + ((1 + 7.5%)(1/12) - 1))-36) ÷ ((1 + 7.5%)(1/12) - 1)) + 1,000 ÷ (1 + ((1 + 7.5%)(1/12) - 1))35

In Excel syntax:

11916.0356707745=(1+((1+7.5%)^(1/12) - 1))*342.15*((1-(1+((1+7.5%)^(1/12) - 1))^-36)/((1+7.5%)^(1/12) - 1))+1000/(1+((1+7.5%)^(1/12) - 1))^35

1/31/X1 | 31.1.X1

 

 

Interest expense

70

 

Lease liability

272

 

Depreciation expense

166

 

 

Accrued lease payment

 

342

 

Accumulated depreciation

 

166



P

Liability

Discount rate

Interest expense

Payment

Liability amortization

A

B (B+1) = B - F

C

D = B x C

E

F = E - D

0

11,916

0.604%

0.00

342

342

1

11,574

0.604%

70

342

272

-

-

-

-

-

-

34

1,666

0.604%

10

342

332

35

1,334

0.604%

8

1,342

1,334

35

1,000

 

 

 

10,916

 

 

 

 

 

 


2/1/X1 | 1.2.X1

 

 

Accrued lease payment

342

 

 

Cash

 

342


12/1/X3 | 1.12.X3

 

 

Accrued lease payment

342

 

Lease liability

1,000

 

 

Cash

 

1,342


12/31/X6 | 31.12.X6

 

 

Accumulated depreciation

11,916

 

 

Production machine

 

11,916


Asset returned

1/1/X1, XYZ leased a vehicle for three years for 271 per month. Comparable vehicles sold for 12,000, had 6-year economic lives and lost 30% or their value annually. While the lessor used this information and its own required return of 8% to calculate the lease payments, much of this information was not available to XYZ, so XYZ applied its own incremental borrowing rate of 7.5% instead.

217 (rounded) = (12,000 - 4,116 ÷ (1 + (1 + 8%)(1÷12) - 1)(3 x 12)) ÷ ((1 - (1 + ( (1 + 8%)(1÷12) - 1))(-3 x 12)) ÷ ( (1 + 8%)(1÷12) - 1)) x (1 ÷ (1 + ( (1 + 8%)(1÷12) - 1)))

4,116 = 12,000 + 12,000 x -30% + (12,000 + 12,000 x -30%) x -30% + (12,000 + 12,000 x -30% + (12,000 + 12,000 x -30%) x -30%) x -30%

In Excel syntax:

270.782081171774=(12000-4116/(1+(1+8%)^(1/12) - 1)^(3*12))/((1-(1+( (1+8%)^(1/12) - 1))^(-3*12))/( (1+8%)^(1/12) - 1))*(1/(1+( (1+8%)^(1/12) - 1)))

4,116=12000+12000*-30%+(12000+12000*-30%)*-30%+(12000+12000*-30%+(12000+12000*-30%)*-30%)*-30%

A collection of easy to use Excel formulas and functions can be downloaded on our formulas page.

IFRS (finance lease) / US GAAP (operating lease)

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