IFRS 16 – Lease Accounting Trickiest Questions

Question 1: Initial Measurement of ROU Asset & Liability
Scenario: On 1 January 20X6, Alpha Co enters into a 7-year lease for a manufacturing facility.

• Annual lease payments are $100,000, payable in arrears.
• Alpha Co incurs $15,000 in direct legal fees to arrange the lease.
• The lessor grants a $5,000 cash incentive to Alpha Co on the commencement date.
• Alpha Co is contractually required to restore the facility to its original condition at the end of Year

7. The estimated cost of restoration is $40,000 (undiscounted).

• The interest rate implicit in the lease is 5% per annum.
• Discount factors at 5%: 7-year ordinary annuity = 5.7864; 7-year present value factor = 0.7107.
  Required:
  Calculate the initial carrying amount of the Right-of-Use (ROU) asset and the Lease Liability on 1 January
  20X6. Show all workings clearly

Answer :

Question 2: Sale and Leaseback (Performance Obligation Met)
Scenario: On 30 June 20X6, Beta Co sells an office building with a carrying amount of $2,000,000 to a
financial institution for its fair value of $3,000,000. Beta Co immediately leases the building back for a 10-
year term.

• The present value of the annual leaseback payments is calculated to be $1,200,000.
• The transaction qualifies as a sale under IFRS 15 (Revenue from Contracts with Customers).
  Required:
  Explain and calculate the following for Beta Co on 30 June 20X6:

1. The right-of-use asset retained.
2. The gain on disposal to be recognized in profit or loss.
3. The journal entry to record the entire sale and leaseback transaction.

Answer :

Question 3: Sale and Leaseback with Above-Market Terms
Scenario: Gamma Co sells a specialized piece of machinery to a lessor for $850,000 and leases it back for 5
years.

• On the date of the sale, the fair value of the machinery is $750,000, and its carrying amount in
  Gamma Co’s books is $500,000.
• The present value of the contractual lease payments is $350,000.
• The transfer satisfies the criteria to be accounted for as a sale under IFRS 15.
  Required:
  Explain how the $100,000 excess of the sale price over the fair value must be treated under IFRS 16.
  Calculate the adjusted value of the lease liability and the ROU asset to be recognized.

Answer

Question 4: Lease Modification (Reduction in Scope)
Scenario: Delta Co initially leases 3,000 square meters of commercial office space for 10 years. At the start
of Year 6, the carrying amount of the ROU asset is $600,000 and the lease liability is $680,000.

• On the first day of Year 6, Delta Co amends the contract to reduce the space to 1,500 square
  meters (a 50% reduction in scope) for the remaining 5 years.
• The remaining lease payments are structured such that the revised lease liability at the
  modification date is calculated to be $390,000 (using a current revised discount rate of 6%).
  Required:
  Detail the multi-step accounting treatment required for this modification. Calculate the gain or loss on
  partial termination and the final adjustment to the ROU asset.

Answer:

Question 5: Lease Modification (Extension of Lease Term)
Scenario: Epsilon Co is 3 years into an 8-year lease of equipment.

• At the beginning of Year 4, the carrying amount of the lease liability is $240,000 and the ROU
  asset is $210,000.
• Epsilon Co and the lessor agree to modify the lease to extend the term by an additional 3 years
  (making the remaining term 8 years instead of 5).
• The payments are adjusted, and the present value of the revised lease payments over the new 8-
  year remaining term—discounted at a revised interest rate of 7%—is $335,000.
  Required:
  Explain how this modification should be accounted for under IFRS 16. Provide the financial statement
  adjustments required at the date of modification.

Answer

Question 6: Variable Lease Payments
Scenario: Eta Co leases a retail outlet for 5 years. The lease agreement specifies two types of variable
payments:

1. Annual payments will increase each year in line with the national Consumer Price Index (CPI). At
   commencement, the CPI indicates an expected annual increase, but IFRS 16 rules apply.
2. An additional annual payment equal to 2% of the store’s gross turnover generated from that
   specific outlet.
   Required:
   In accordance with IFRS 16, critically evaluate which of these variable payments must be factored into the
   initial measurement of the lease liability and which must be expensed as incurred. Explain the underlying
   conceptual rationale.

Answer

Question 7: Short-Term Lease Exemption & Subleasing

Scenario: Theta Co operates in the logistics sector and signs a 9-month lease contract for an overflow
storage warehouse to handle peak seasonal inventory.

• Due to an unexpected drop in consumer demand, Theta Co realizes after 2 months that it does not
  need the extra space.
• Theta Co immediately subleases the warehouse to a partner business for the remaining 7 months
  of the contract.
• Theta Co’s management wishes to apply the short-term lease recognition exemption to avoid
  recognizing an ROU asset and lease liability on their balance sheet.
  Required:
  Assess whether Theta Co can legally apply the short-term lease exemption to this head lease under IFRS.

Answer :

Question 9: Sale and Leaseback
Scenario: On 1 January 20X6, Omega Co transfers a distribution warehouse to an institutional investor for
$4,000,000 cash and immediately leases it back for a 15-year term.

• The carrying amount of the warehouse in Omega Co’s ledger on that date is $2,800,000.
• Under the terms of the leaseback, Omega Co retains an option to repurchase the warehouse at
  any time during the 15 years for a price equal to its initial sale price plus a 4% compounded
  annual interest factor. Because of this substantive repurchase option, the transfer does not satisfy
  the performance obligation criteria to be classified as a sale under IFRS 15.
  Required:
  Explain how Omega Co must account for this transaction under IFRS 16. Provide the appropriate
  accounting entries required on 1 January 20X6.

Answer :

Question 10: Sale and Leaseback with Below-Market Terms (Shortfall)

Scenario: Sigma Co owns a commercial office building with a carrying amount of $1,500,000. On 31
December 20X6, Sigma Co sells the building to a buyer-lessor for $1,800,000, which is lower than its
verified market fair value of $2,100,000.

• Sigma Co immediately leases the building back for 8 years.
• The present value of the contractual leaseback payments (discounted at an appropriate market
  rate) is $600,000.
• The shortfall of $300,000 below fair value was deliberately negotiated to compensate for
  exceptionally low, below-market annual lease payments over the 8-year term. The transfer
  qualifies as a valid sale under IFRS 15.
  Required:
  Explain the required IFRS 16 matching adjustments for a sale price below fair value. Calculate the
  adjusted lease liability and the carrying amount of the ROU asset to be recognized by Sigma Co.

Answer :

Question 11: Sale and Leaseback
Scenario: Zeta-Prime Co sells an automated assembly line to a finance company for its current fair value of
$1,200,000 and leases it back for a 3-year period.

• The assembly line has been completely depreciated in Zeta-Prime Co’s books due to an aggressive
  historical tax-depreciation policy, resulting in a carrying amount of $0.
• The present value of the leaseback payments over the 3-year term is $400,000.
• The transaction meets the criteria of a sale under IFRS 15.
  Required:
  Calculate the carrying amount of the ROU asset retained by Zeta-Prime Co and determine the exact
  amount of the immediate gain on disposal to be recognized in the Statement of Profit or Loss

Answer:

Question 12: Buyer-Lessor Accounting for Sale and Leaseback
Scenario: On 1 April 20X6, Mu Co (acting as the buyer-lessor) purchases an industrial asset from an
unrelated manufacturer for its fair value of $5,000,000 cash and immediately leases it back to the
manufacturer for a 12-year term.

• The transaction qualifies as a sale under IFRS 15.
• Mu Co classifies the leaseback as an operating lease because the lease term does not cover the
  major part of the asset’s remaining 40-year economic life, and ownership does not transfer at the
  end of the term.
  Required:
  Contrast the seller-lessee accounting principles with the buyer-lessor accounting treatments for this
  transaction on the commencement date. State the journal entries Mu Co must record on 1 April 20X6.

Answer:

Question 13: Sale and Leaseback
Scenario: Rho Co owns a landmark corporate headquarters. Rho Co accounts for its property using the
Revaluation Model under IAS 16. On 1 January 20X6, just before the transaction, the property has:
Data sensitivity – Public

• A revalued carrying amount of $6,000,000.
• A balance in the Revaluation Surplus account of $1,500,000 (accumulated from previous years’
  upward valuations).
• Rho Co sells the property for its fair value of $6,000,000 and leases it back for a 10-year term. The
  present value of the lease payments is $2,000,000. The transfer is a sale under IFRS 15.
  Required:
  Analyze how the pre-existing revaluation surplus should be handled upon execution of the sale and
  leaseback transaction. Calculate the final ROU asset value, the lease liability, and the immediate profit or loss impact

Answer: