IFRS16 Worked Example - Finance Lease (complex)

Scenario details
Two entities, entity A (Lessee) and entity B (Lessor) enter into a lease agreement on the 1st of April 2020. The asset which
a third party as well as upfront payment of £60k paid to the lessor which represents first years' rental charge. The lessor in
assessment is that the this arrangement represents a finance lease. Interest rate implicit in the contract is 5%.

Objectives

The purpose of this example is to show accounting entries and budgeting impact of the finance lease arrangement betwee
There are three tabs in this workbook:

1. Scenario and Data

2. Accounting
3. Budgeting

Firstly, We need to complete few calculations based on the scenario details provided above. These calculations are:
Lessee:

Step 1 Identify discount rate that can be used to calculate present value of the future lease payments
Step 2 Calculate PV of future lease payments using the discount rate
Step 3 Calculate lease liability
Step 4 Calculate value of the RoU asset considering any potential upfront payments, lease incentives etc.
Step 5 Decide what depreciation period of the RoU asset is appropriate considering length of the lease and th

Lessor:

Step 6 Calculate the rate implicit in the lease

Step 7 Calculate Lease Receivable
Step 8 Calculate net book value of the underlying asset

To note: This is a finance lease. The lessor has to recognise lease receivable on the balance sheet and therefore is required

Notes and Relevant Guidance

1 No exemptions apply in this scenario. The asset is not considered to be low value. The contract does no
2 The initial direct costs are incremental costs of obtaining a lease that would not have been incurred if t
The definition of initial direct costs is essentially the same as for incremental costs of obtaining a contr
3 The lessee will present interest expense in the P&L separately from depreciation expense of the ROU a
4 The lessor recognises lease receivable at an amount equal to the gross investment in the lease discoun
5 The lessor accounts for the disposal of the underlying asset in line with IAS 16 "The disposal of an item
The underlying asset is derecognised by the lessor and any difference is immediately recognised in P/L
6 The lessor splits minimum payments received into finance income and reduction of the lease receivabl
of return on the lessor’s net investment in the lease. (IFRS16.75-76)
7 Under the finance lease substantially all the risks and rewards incidental to legal ownership are transfe
treated by the lessor as repayment of principal and finance income to reimburse and reward the lessor
 8 Lessor - The recognition of finance income shall be based on a pattern reflecting a constant periodic ra
9 The lessee's discount rate has been provided in this scenario (5%). The rate implicit in the contract is th
the fair value of the underlying asset and (ii) any initial direct costs of the lessor. If this rate is not readi
10 The lessor's discount rate implicit in the lease has been calculated in line with a guidance in IFRS16.68.
if that rate can be readily determined, or the lessee’s incremental borrowing rate (IBR). For lessors, the

Step 1

The contract starts on the 1st April 2022.

Commencement date 4/1/2022

Discount rate - for lessee 5%

Step 2

Future payments for the lease are listed in the table below. For each payment, the discount factor is calculated in order to
of the lease liability. Initial measurement of a lease liability amounts to £426,469 and is calculated as follows:

Calculation of the PV of future payments

Payment Date of payment
0 60,000 4/1/2022
1 60,000 4/1/2023
2 60,000 4/1/2024
3 60,000 4/1/2025
4 60,000 4/1/2026
5 60,000 4/1/2027
6 60,000 4/1/2028
7 60,000 4/1/2029
8 60,000 4/1/2030
9 60,000 4/1/2031

Step 3

Using the present value of the lease payments We can establish lease liability.
The lessee is required to present finance cost of the lease in the P&L separately from depreciation expense of the ROU ass
Below calculation also provides closing balance of the lease liability recognised by the lessee every year over the term of th

LESSEE - Liability (IFRS 16.26)

426,469.30 Lease liability at initial recognition

Year Opening (1 Apr) payment (1 Apr)

2022-23 426,469 -
2023-24 447,793 (60,000)
2024-25 407,182 (60,000)
2025-26 364,542 (60,000)
2026-27 319,769 (60,000)
2027-28 272,757 (60,000)
2028-29 223,395 (60,000)
 2029-30 171,565 (60,000)
2030-31 117,143 (60,000)
2031-32 60,000 (60,000)

Step 4 and 5

The initial direct costs paid by lessee, upfront payments and lease incentives are included in the initial recognition of the R

RoU Asset components

20,000 Initial direct costs paid by lessee
(5,000) Lease incentives received by lessee
60,000 Upfront lease payment paid by lessee

The right-of-use asset is depreciated under IAS 16 requirements (IFRS 16.31).

The difference between closing value of the RoU asset and lease liability is shown in column E

LESSEE - ROU Asset

501,469 Gross book value of the right-of use asset at initial recognition

Year NBV opening (1 Apr) Depreciation

2022-23 501,469 (50,147)
2023-24 451,322 (50,147)
2024-25 401,175 (50,147)
2025-26 351,029 (50,147)
2026-27 300,882 (50,147)
2027-28 250,735 (50,147)
2028-29 200,588 (50,147)
2029-30 150,441 (50,147)
2030-31 100,294 (50,147)
2031-32 50,147 (50,147)

Step 6

Lessor's discount rate implicit in the lease has been calculated in line with the guidance in the standard. For lessees, the le
if that rate can be readily determined, or the lessee’s incremental borrowing rate (IBR). For lessors, the discount rate will a
Rate implicit in the contract is the interest rate that causes the present value of (a) the lease payments and (b) the unguar
the fair value of the underlying asset and (ii) any initial direct costs of the lessor.

LESSOR -Calculation of the rate implicit in the lease - note 10

0 4/1/2022 (500,000)
0 4/1/2022 60,000
0 4/1/2022 (5,000)
1 4/1/2023 60,000
2 4/1/2024 60,000
3 4/1/2025 60,000
4 4/1/2026 60,000
5 4/1/2027 60,000
6 4/1/2028 60,000
7 4/1/2029 60,000
8 4/1/2030 60,000
9 4/1/2031 60,000
 4.05% - Discount Rate implicit in the lease

Step 7

Opening Balance of the lease receivable is calculated above (445,000).

Lessor splits minimum payments received into finance income and reduction of the lease receivable. The finance income i
of return on the lessor’s net investment in the lease.

LESSOR - Receivable (IFRS 16.26)

Year Opening (1 Apr) payment (1 Apr)

2022-23 445,000 -
2023-24 463,032 (60,000)
2024-25 419,364 (60,000)
2025-26 373,926 (60,000)
2026-27 326,646 (60,000)
2027-28 277,451 (60,000)
2028-29 226,263 (60,000)
2029-30 173,000 (60,000)
2030-31 117,579 (60,000)
2031-32 59,912 (60,000)

Step 8

This is a finance lease which means that the underlying asset is transferred to lessee.

Underlying Asset
1,000,000 Cost Value
(500,000) Accumulated Depreciation
500,000 Net Book Value
50,000 Annual Depreciation (20 years - straight line)
 se agreement on the 1st of April 2020. The asset which is a subject to a lease arrangement has a net book value of £0.5m at the date o
which represents first years' rental charge. The lessor incurs cost of lease incentives of £5k paid to lessee. There is no option to extend
. Interest rate implicit in the contract is 5%.

dgeting impact of the finance lease arrangement between two entities.

io details provided above. These calculations are:

late present value of the future lease payments

e discount rate

ny potential upfront payments, lease incentives etc.

set is appropriate considering length of the lease and the useful life of the asset

ceivable on the balance sheet and therefore is required to calculate the rate implicit in the lease.

t is not considered to be low value. The contract does not meet the definition of a short-term lease (IFRS16.5-8) (IFRS16 B3-B8)
obtaining a lease that would not have been incurred if the lease had not been obtained (IFRS 16.Appendix A). Examples of such costs
y the same as for incremental costs of obtaining a contract in IFRS 15 and is consistent with treatment of directly attributable costs un
P&L separately from depreciation expense of the ROU asset (IFRS16.49) (IFRS16 BC209)
mount equal to the gross investment in the lease discounted at the interest rate implicit in the lease. (IFRS 16.67).
erlying asset in line with IAS 16 "The disposal of an item of property, plant and equipment may occur in a variety of ways (e.g. by sale,
sor and any difference is immediately recognised in P/L as a gain/loss on disposal of an asset (IFRS community)
nto finance income and reduction of the lease receivable. The finance income is recognized based on a pattern reflecting constant per
lease. (IFRS16.75-76)
ks and rewards incidental to legal ownership are transferred by the lessor, and thus the lease payment receivable is
and finance income to reimburse and reward the lessor for its investment and services. (IAS17.37)
 l be based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the finance lease. (IAS 17.39)
n this scenario (5%). The rate implicit in the contract is the interest rate that causes the present value of (a) the lease payments and (b)
ny initial direct costs of the lessor. If this rate is not readily available entities will use interest rates published by HMT
has been calculated in line with a guidance in IFRS16.68. For lessees, the lease payments are required to be discounted using either the
ssee’s incremental borrowing rate (IBR). For lessors, the discount rate will always be the interest rate implicit in the lease. (BDO)

ch payment, the discount factor is calculated in order to determine the total present value
ts to £426,469 and is calculated as follows:

Discount Factor Discounted Amount

1.0000 60,000
0.9524 57,143
0.9070 54,422
0.8638 51,830
0.8227 49,362
0.7835 47,012
0.7462 44,773
0.7107 42,641
0.6768 40,610
0.6446 38,677
426,469

ase liability.
&L separately from depreciation expense of the ROU asset.
y recognised by the lessee every year over the term of the contract.

Interest Expense closing (31 Mar)

21,323 447,793
19,390 407,182
17,359 364,542
15,227 319,769
12,988 272,757
10,638 223,395
8,170 171,565
 5,578 117,143
2,857 60,000
- -

incentives are included in the initial recognition of the RoU asset.

ability is shown in column E

nitial recognition

NBV closing (31 Mar) Diff to liability

451,322 3,530
401,175 (6,007)
351,029 (13,513)
300,882 (18,887)
250,735 (22,022)
200,588 (22,807)
150,441 (21,124)
100,294 (16,849)
50,147 (9,853)
- -

ne with the guidance in the standard. For lessees, the lease payments are required to be discounted using either the interest rate impl
borrowing rate (IBR). For lessors, the discount rate will always be the interest rate implicit in the lease.
sent value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i)
of the lessor.

Upfront payment 1.0000 60,000

Lease incentive paid to lessee 1.0000 (5,000)
0.9611 57,663
0.9235 55,412
0.8876 53,254
0.8530 51,180
0.8198 49,187
0.7878 47,266
0.7571 45,425
0.7276 43,656
0.6993 41,956
 Total 500,000
Received at commencement 55,000
Lease receivable 445,000

reduction of the lease receivable. The finance income is recognised based on a pattern reflecting constant periodic rate

Interest Income - note 3 closing (31 Mar)

18,032 463,032
16,331 419,364
14,562 373,926
12,721 326,646
10,805 277,451
8,811 226,263
6,737 173,000
4,579 117,579
2,333 59,912
(4) (92)

nsferred to lessee.
value of £0.5m at the date of transfer. Lease term is 10 years. The lessee incurs £20k of the initial direct costs paid to
There is no option to extend the contract nor there is an option to purchase the asset by the lessee. The lessor's

6.5-8) (IFRS16 B3-B8)

A). Examples of such costs are professional fees.
irectly attributable costs under IAS 16

variety of ways (e.g. by sale, by entering into a finance lease or by donation) (IAS16.69)"

ttern reflecting constant periodic rate

nance lease. (IAS 17.39)
the lease payments and (b) the unguaranteed residual value to equal the sum of (i)

discounted using either the interest rate implicit in the lease (IRIL),
icit in the lease. (BDO)
either the interest rate implicit in the lease (IRIL),
periodic rate
ACCOUNTING ENTRIES - Group Finance Lease
LESSEE
YEAR 1 (31/03/2023) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 21,323
Lease finance income
Depreciation - RoU Asset 50,147
Profit & Loss on Disposal of the underlying asset
TOTAL 21,323 50,147

BALANCE SHEET Movements Lessee (Lease) Lessee (RoU Asset)

Right of use of asset 426,469
Right of use of Assets - Lease Payment / Receipt 60,000
Right of use of Assets upfront cost 20,000
Right of Use Assets Lease Incentive (5,000)
Finance lease liability discounted at 5% (426,469)
Lease Interest (21,323)
Investment in the lease - lease receivable
PPE Cost derecognition
PPE accumulated depreciation - derecognition
Accumulated Depreciation - RoU asset (50,147)
Cash Lease (payment) / receipt (60,000)
Cash Initial direct costs - (payment) / receipt (20,000)
Cash Lease Incentive (payment) / receipt 5,000

TOTAL MOVEMENTS (522,793) 451,322

Lease Liability C/F (447,793)

Right of Use of Asset NBV C/F 451,322
Receivable C/F
Closing (447,793) 451,322

LESSEE
YEAR 2 (31/03/2024) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 19,390
Depreciation cost - RoU asset 50,147
Lease finance income
TOTAL 19,390 50,147

BALANCE SHEET Movements

Lease Unwinding of Discount (19,390)
Depreciation (50,147)
Finance Lease liability payment 60,000
Finance Lease Receivable
Cash Finance Lease (payment) / receipt (60,000)

TOTAL MOVEMENTS (19,390) (50,147)

Lease Liability C/F (407,182)
Right of Use of Asset NBV C/F 401,175
Lease Receivable C/F
Closing (407,182) 401,175

LESSEE
YEAR 3 (31/03/2025) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 17,359
Depreciation - RoU asset 50,147
Lease finance income
TOTAL 17,359 50,147

BALANCE SHEET Movements

Lease Unwinding of Discount (17,359)
Depreciation (50,147)
Finance Lease liability payment 60,000
Finance Lease Receivable
Cash Finance Lease (payment) / receipt (60,000)

TOTAL MOVEMENTS (17,359) (50,147)

Lease Liability C/F (364,542)

Right of Use of Asset NBV C/F 351,029
Receivable C/F
Closing (364,542) 351,029

LESSEE
YEAR 4 (31/03/2026) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 15,227
Depreciation - RoU asset 50,147
Lease finance income
TOTAL 15,227 50,147

BALANCE SHEET Movements

Lease Unwinding of Discount (15,227)
Depreciation (50,147)
Finance Lease liability payment 60,000
Finance Lease Receivable
Cash Finance Lease (payment) / receipt (60,000)

TOTAL MOVEMENTS (15,227) (50,147)

Lease Liability C/F (319,769)

Right of Use of Asset NBV C/F 300,882
Receivable C/F
Closing (319,769) 300,882

LESSEE
 YEAR 5 (31/03/2027) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 12,988
Depreciation - RoU asset 50,147
Lease finance income
TOTAL 12,988 50,147

BALANCE SHEET Movements

Lease Unwinding of Discount (12,988)
Depreciation (50,147)
Finance Lease liability payment 60,000
Finance Lease Receivable
Cash Finance Lease (payment) / receipt (60,000)

TOTAL MOVEMENTS (12,988) (50,147)

Lease Liability C/F (272,757)

Right of Use of Asset NBV C/F 250,735
Receivable C/F
Closing (272,757) 250,735

LESSEE
YEAR 6 (31/03/2028) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 10,638
Depreciation - RoU asset 50,147
Lease finance income
TOTAL 10,638 50,147

BALANCE SHEET Movements

Lease Unwinding of Discount (10,638)
Depreciation (50,147)
Finance Lease liability payment 60,000
Finance Lease Receivable
Cash Finance Lease (payment) / receipt (60,000)

TOTAL MOVEMENTS (10,638) (50,147)

Lease Liability C/F (223,395)

Right of Use of Asset NBV C/F 200,588
Receivable C/F
Closing (223,395) 200,588

LESSEE
YEAR 7 (31/03/2029) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 8,170
Depreciation - RoU asset 50,147
Lease finance income
TOTAL 8,170 50,147
BALANCE SHEET Movements
Lease Unwinding of Discount (8,170)
Depreciation (50,147)
Finance Lease liability payment 60,000
Finance Lease Receivable
Cash Finance Lease (payment) / receipt (60,000)

TOTAL MOVEMENTS (8,170) (50,147)

Lease Liability C/F (171,565)

Right of Use of Asset NBV C/F 150,441
Receivable C/F
Closing (171,565) 150,441

LESSEE
YEAR 8 (31/03/2030) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 5,578
Depreciation - RoU asset 50,147
Lease finance income
TOTAL 5,578 50,147

BALANCE SHEET Movements

Lease Unwinding of Discount (5,578)
Depreciation (50,147)
Finance Lease liability payment 60,000
Finance Lease Receivable
Cash Finance Lease (payment) / receipt (60,000)

TOTAL MOVEMENTS (5,578) (50,147)

Lease Liability C/F (117,143)

Right of Use of Asset NBV C/F 100,294
Receivable C/F
Closing (117,143) 100,294

LESSEE
YEAR 9 (31/03/2031) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 2,857
Depreciation - RoU asset 50,147
Lease finance income
TOTAL 2,857 50,147

BALANCE SHEET Movements

Lease Unwinding of Discount (2,857)
Depreciation (50,147)
Finance Lease liability payment 60,000
Finance Lease Receivable
Cash Finance Lease (payment) / receipt (60,000)

TOTAL MOVEMENTS (2,857) (50,147)

Lease Liability C/F (60,000)

Right of Use of Asset NBV C/F 50,147
Receivable C/F
Closing (60,000) 50,147

LESSEE
YEAR 10 (31/03/2032) Lessee (Lease) Lessee (RoU Asset)
I&E
Lease Interest cost 0
Depreciation - RoU asset 50,147
Lease finance income
TOTAL 0 50,147

BALANCE SHEET Movements

Lease Unwinding of Discount 0
Depreciation (50,147)
Finance Lease liability payment 60,000
Finance Lease Receivable
Cash Finance Lease (payment) / receipt (60,000)

TOTAL MOVEMENTS 0 (50,147)

Lease Liability C/F 0

Right of Use of Asset NBV C/F 0
Receivable C/F
Closing 0 0
LESSOR
Lessor (Lease) Lessor (Asset)

(18,032)

0
(18,032) 0

Lessor (Lease) Lessor (Asset)

(60,000)

5,000

18,032
500,000
(1,000,000)
500,000

60,000
0
(5,000)

73,032 (55,000)

463,032 0
463,032 0

LESSOR
Lessor (Lease) Lessor (Asset)

(16,331)
(16,331) 0

(43,669)
60,000

16,331 0
 419,364 0
419,364 0

LESSOR
Lessor (Lease) Lessor (Asset)

(14,562)
(14,562) 0

(45,438)
60,000

14,562 0

373,926 0
373,926 0

LESSOR
Lessor (Lease) Lessor (Asset)

(12,721)
(12,721) 0

(47,279)
60,000

12,721 0

326,646 0
326,646 0

LESSOR
 Lessor (Lease) Lessor (Asset)

(10,805)
(10,805) 0

(49,195)
60,000

10,805 0

277,451 0
277,451 0

LESSOR
Lessor (Lease) Lessor (Asset)

(8,811)
(8,811) 0

(51,189)
60,000

8,811 0

226,263 0
226,263 0

LESSOR
Lessor (Lease) Lessor (Asset)

(6,737)
(6,737) 0
 (53,263)
60,000

6,737 0

173,000 0
173,000 0

LESSOR
Lessor (Lease) Lessor (Asset)

(4,579)
(4,579) 0

(55,421)
60,000

4,579 0

117,579 0
117,579 0

LESSOR
Lessor (Lease) Lessor (Asset)

(2,333)
(2,333) 0

(57,667)
 60,000

2,333 0

59,969 0
59,969 0

LESSOR
Lessor (Lease) Lessor (Asset)

0
0 0

(60,004)
60,000

(4) 0

(35) 0
(35) 0
IFRS16 Worked Example - Finance Lease - Budget

Year 1

LESSEE ACCOUNTS
Worked Example SOCNE SOFP
("I&E") ("Bal sheet")
Income Expense Assets Cash
ROU Asset recognition 501,469
Lease Liability recognition
Lease Interest 21,323
Depreciation 50,147 (50,147)
Cash Paid (75,000)
Total budgeting
Check Accounting DR/CR

LESSOR ACCOUNTS
Worked Example SOCNE SOFP
("I&E") ("Bal sheet")
Income Expense Assets Cash
Asset disposal 0 (500,000)
Lease Receivable - recognition
Finance Income (18,032)
Cash
Total budgeting
Check Accounting DR/CR

* Depreciation scores to NRF RDEL for Providers

Year 2

LESSEE ACCOUNTS
Worked Example SOCNE SOFP
("I&E") ("Bal sheet")
Income Expense Assets Cash
ROU Asset
Lease Liability
Lease Interest 19,390
Depreciation 50,147 (50,147)
Cash Paid (60,000)
Total budgeting
Check Accounting DR/CR

LESSOR ACCOUNTS
Worked Example SOCNE SOFP
("I&E") ("Bal sheet")
Income Expense Assets Cash
Lease Income (16,331)
Finance Income
Cash 60,000
Total budgeting
Check Accounting DR/CR

* Depreciation scores to NRF RDEL for Providers

Future Years mirror approach taken in year 2
 BUDGETS
SOFP RDEL RF RDEL NRF RDEL Total RAME
("Bal sheet") Equity
Liability

(426,469)
(21,323) 21,323
50,147

50,147 21,323 - -
0

BUDGETS
SOFP RDEL RF RDEL NRF RDEL Total RAME
("Bal sheet") Equity
Receivable

500,000
18,032 (18,032)

- (18,032) - -
0

BUDGETS
SOFP RDEL RF RDEL NRF RDEL Total RAME
("Bal sheet") Equity
Liability

(19,390) 19,390
50,147
60,000
50,147 19,390 - -
0

BUDGETS
SOFP RDEL RF RDEL NRF RDEL Total RAME
("Bal sheet") Equity
Receivable
16,331 (16,331)
-
(60,000)
- (16,331) - -
0
 CDEL CAME

501,469
-

501,469 -

CDEL CAME

(500,000)

(500,000) -

CDEL CAME

-
-

- -

CDEL CAME

- -