Ind AS 116, Leases, Important Questions with Solutions for CA Final Financial Reporting May & Nov 2021 Exams
Question 1 –
Entity W entered into a contract for lease of retail store with Entity J on January 01/01/2017. The initial term of the lease is 5 years with a renewal option of further 3 years. The annual payments for initial term and renewal term is Rs. 100,000 and Rs. 110,000 respectively. The annual lease payment will increase based on the annual increase in the CPI at the end of the preceding year. For example, the payment due on 01/01/18 will be based on the CPI available at 31/12/17.
Entity W’s incremental borrowing rate at the lease inception date and as at 01/01/2020 is 5% and 6% respectively and the CPI at lease commencement date and as at 01/01/2020 is 120 and 125 respectively.
At the lease commencement date, Entity W did not have a significant economic incentive to exercise the renewal option. In the first quarter of 2020, Entity W installed unique lease improvements into the retail store with an estimated five-year economic life. Entity W determined that it would only recover the cost of the improvements if it exercises the renewal option, creating a significant economic incentive to extend.
Is Entity W required to remeasure the lease in the first quarter of 2020?
Solution –
Since Entity W is now reasonably certain that it will exercise its renewal option, it is required to remeasure the lease in the first quarter of 2020.
The following table summarizes information pertinent to the lease remeasurement.
Remeasured lease term | 5 years; 2 years remaining in the initial term plus 3 years in the renewal period |
Entity W’s incremental borrowing rate on the remeasurement date | 6% |
CPI available on the remeasurement date | 125 |
Right-of-use asset immediately before the remeasurement | Rs. 1,81,840 (Refer note 1) |
Lease liability immediately before the remeasurement | Rs. 1,85,947 (Refer note 1) |
To remeasure the lease liability, Entity W would first calculate the present value of the future lease payments for the new lease term (using the updated discount rate of 6%). The following table shows the present value of the future lease payments based on an updated CPI of 125. Since the initial lease payments were based on a CPI of 120, the CPI has increased by 4% approx. As a result, Entity W would increase the future lease payments by 4%. As shown in the table, the revised lease liability is Rs. 490,589.
Year | 4 | 5 | 6 | 7 | 8 | Total |
Lease payment | 104,000 | 104,000 | 114,400 | 114,400 | 114,400 | 551,200 |
Discount | 1 | 0.943 | 0.890 | 0.840 | 0.792 | |
Present value | 104,000 | 98,072 | 101,816 | 96,096 | 90,605 | 490,589 |
To calculate the adjustment to the lease liability, Entity W would compare the recalculated and original lease liability balances on the remeasurement date.
Revised lease liability | 490,589 |
Original lease liability | (1,85,947) |
3,04,642 |
Entity W would record the following journal entry to adjust the lease liability.
ROU Asset Dr. | 3,04,642 | |
To Lease liability | 3,04,642 | |
Being lease liability and ROU asset adjusted on account of remeasurement. |
Working Notes:
1. Calculation of ROU asset before the date of remeasurement
Year beginning | Lease Payment (A) |
Present value factor @ 5% (B) |
Present value of lease payments (AxB=C) |
1 | 1,00,000 | 1.000 | 1,00,000 |
2 | 1,00,000 | 0.952 | 95,200 |
3 | 1,00,000 | 0.907 | 90,700 |
4 | 1,00,000 | 0.864 | 86,400 |
5 | 1,00,000 | 0.823 | 82,300 |
Lease liability as at commencement date | 4,54,600 |
2. Calculation of Lease Liability and ROU asset at each year end
Year | Lease Liability | ROU asset | |||||
Initial value | Lease payments | Interest expense | Closing balance | Initial Value | Depreciation | Closing balance | |
1 | 4,54,600 | 1,00,000 | – | 3,54,600 | 4,54,600 | 90,920 | 3,63,680 |
2 | 3,54,600 | 1,00,000 | 17,730 | 2,72,330 | 3,63,680 | 90,920 | 2,72,760 |
3 | 2,72,330 | 1,00,000 | 13,617 | 1,85,947 | 2,72,760 | 90,920 | 1,81,840 |
4 | 1,85,947 | 1,81,840 |
Question 2 –
Lessee enters into a 10-year lease for 2,000 square metres of office space. The annual lease payments are Rs. 1,00,000 payable at the end of each year. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the commencement date is 6% p.a.
At the beginning of Year 6, Lessee and Lessor agree to amend the original lease to:
(a) include an additional 1,500 square metres of space in the same building starting from the beginning of Year 6 and
(b) reduce the lease term from 10 years to eight years. The annual fixed payment for the 3,500 square metres is Rs. 1,50,000 payable at the end of each year (from Year 6 to Year 8). Lessee’s incremental borrowing rate at the beginning of Year 6 is 7% p.a.
The consideration for the increase in scope of 1,500 square metres of space is not commensurate with the stand-alone price for that increase adjusted to reflect the circumstances of the contract. Consequently, Lessee does not account for the increase in scope that adds the right to use an additional 1,500 square metres of space as a separate lease.
How should the said modification be accounted for?
Solution –
The pre-modification ROU Asset and the pre-modification lease liability in relation to the lease are as follows:
Year |
Lease liability | ROU Asset | |||||
Opening balance | Interest
expense @ 6% |
Lease payment | Closing balance | Opening balance | Depreciation charge | Closing balance | |
1 | 7,35,900* | 44,154 | (1,00,000) | 6,80,054 | 7,35,900 | (73,590) | 6,62,310 |
2 | 6,80,054 | 40,803 | (1,00,000) | 6,20,857 | 6,62,310 | (73,590) | 5,88,720 |
3 | 6,20,857 | 37,251 | (1,00,000) | 5,58,108 | 5,88,720 | (73,590) | 5,15,130 |
4 | 5,58,108 | 33,486 | (1,00,000) | 4,91,594 | 5,15,130 | (73,590) | 4,41,540 |
5 | 4,91,594 | 29,496 | (1,00,000) | 4,21,090 | 4,41,540 | (73,590) | 3,67,950 |
6 | 4,21,090 | 3,67,950 |
*Refer Note 4.
At the effective date of the modification (at the beginning of Year 6), Lessee remeasures the lease liability on the basis of:
(a) A three-year remaining lease term (ie. till 8th year),
(b) Annual payments of Rs. 150,000 and
(c) Lessee’s incremental borrowing rate of 7% p.a.
Year | Lease Payments (A) |
Present value @ 7% (B) |
Present value of lease payments (A x B = C) |
1 | 1,50,000 | 0.935 | 1,40,250 |
2 | 1,50,000 | 0.873 | 1,30,950 |
3 | 1,50,000 | 0.816 | 1,22,400 |
Modified lease liability |
3,93,600 |
The modified liability equals Rs. 3,93,600, of which (a) Rs. 1,31,200 relates to the increase of Rs. 50,000 in the annual lease payments from Year 6 to Year 8 and (refer note 1) (b) Rs. 2,62,400 relates to the remaining three annual lease payments of Rs. 1,00,000 from Year 6 to Year 8 with reduction of lease term (Refer Note 3)
Decrease in the lease term:
At the effective date of the modification (at the beginning of Year 6), the pre-modification ROU Asset is Rs. 3,67,950. Lessee determines the proportionate decrease in the carrying amount of the ROU Asset based on the remaining ROU Asset for the original 2,000 square metres of office space (i.e., a remaining three-year lease term rather than the original five-year lease term). The remaining ROU Asset for the original 2,000 square metres of office space is Rs. 2,20,770 [i.e., Rs. (3,67,950 / 5) x 3 years].
At the effective date of the modification (at the beginning of Year 6), the pre-modification lease liability is Rs. 4,21,090. The remaining lease liability for the original 2,000 square metres of office space is Rs. 2,67,300 (i.e., present value of three annual lease payments of Rs. 1,00,000, discounted at the original discount rate of 6% p.a.) (refer note 2).
Consequently, Lessee reduces the carrying amount of the ROU Asset by Rs. 1,47,180 (Rs. 3,67,950 – Rs. 2,20,770), and the carrying amount of the lease liability by Rs. 1,53,790 (Rs. 4,21,090 – Rs. 2,67,300). Lessee recognises the difference between the decrease in the lease liability and the decrease in the ROU Asset (Rs. 1,53,790 – Rs. 1,47,180 = Rs. 6,610) as a gain in profit or loss at the effective date of the modification (at the beginning of Year 6).
Lease Liability | Dr. | 1,53,790 | |
To ROU Asset |
1,47,180 | ||
To Gain |
6,610 |
At the effective date of the modification (at the beginning of Year 6), Lessee recognises the effect of the remeasurement of the remaining lease liability reflecting the revised discount rate of 7% p.a., which is Rs. 4,900 (Rs. 2,67,300 – Rs. 2,62,400*), as an adjustment to the ROU Asset.
*(Refer note 3)
Lease Liability | Dr. | 4,900 | |
To ROU Asset |
4,900 |
Increase in the leased space:
At the commencement date of the lease for the additional 1,500 square metres of space (at the beginning of Year 6), Lessee recognises the increase in the lease liability related to the increase in leased space of Rs. 1,31,200 (i.e., present value of three annual lease payments of Rs. 50,000, discounted at the revised interest rate of 7% p.a.) as an adjustment to the ROU Asset.
ROU Asset | Dr. | 1,31,200 | |
To Lease Liability |
1,31,200 |
The modified ROU Asset and the modified lease liability in relation to the modified lease are as follows:
Year |
Lease liability | ROU Asset | |||||
Opening
balance |
Interest
expense @ 7% |
Lease payment | Closing
balance |
Opening
balance |
Depreciation charge | Closing
balance |
|
6 | 3,93,600 | 27,552 | (1,50,000) | 2,71,152 | 3,47,100** | (1,15,700) | 2,31,400 |
7 | 2,71,152 | 18,981 | (1,50,000) | 1,40,133 | 2,31,400 | (1,15,700) | 1,15,700 |
8 | 1,40,133 | 9,867* | (1,50,000) | – | 1,15,700 | (1,15,700) | – |
*Difference is due to approximation.
**Refer Note 5
Working Notes:
1. Calculation of lease liability on increased consideration:
Year | Lease Payments (A) |
Present value @7% (B) |
Present value of lease payments (A x B = C) |
1 | 50,000 | 0.935 | 46,750 |
2 | 50,000 | 0.873 | 43,650 |
3 | 50,000 | 0.816 | 40,800 |
Modified lease liability |
1,31,200 |
2. Calculation of remaining lease liability for the original contract of 2000 square meters at Original discount rate:
Year | Lease Payments (A) |
Present value factor @ 6% (B) |
Present value of lease payments (A x B = C) |
1 | 1,00,000 | 0.943 | 94,300 |
2 | 1,00,000 | 0.890 | 89,000 |
3 | 1,00,000 | 0.840 | 84,000 |
Remaining lease liability |
2,67,300 |
3. Calculation of remaining lease liability for the original contract of 2000 square meters at revised discount rate:
Year | Lease Payments (A) |
Present value factor @ 7% (B) |
Present value of lease payments (A x B = C) |
1 | 1,00,000 | 0.935 | 93,500 |
2 | 1,00,000 | 0.873 | 87,300 |
3 | 1,00,000 | 0.816 | 81,600 |
Remaining lease liability |
2,62,400 |
4. Calculation of Initial value of ROU asset and lease liability:
Year | Lease Payment (A) |
Present value factor @ 6% (B) |
Present value of lease payments (A x B = C) |
1 | 100,000 | 0.943 | 94,300 |
2 | 100,000 | 0.890 | 89,000 |
3 | 100,000 | 0.840 | 84,000 |
4 | 100,000 | 0.792 | 79,200 |
5 | 100,000 | 0.747 | 74,700 |
6 | 100,000 | 0.705 | 70,500 |
7 | 100,000 | 0.665 | 66,500 |
8 | 100,000 | 0.627 | 62,700 |
9 | 100,000 | 0.592 | 59,200 |
10 | 100,000 | 0.558 | 55,800 |
Lease liability as at modification date |
7,35,900 |
5. Calculation of opening balance of Modified ROU Asset at the beginning of 6th year:
The remaining ROU Asset for the original 2,000 square metres of office space after decrease in term | 2,20,770 |
Less: Adjustment for increase in interest rate from 6% to 7% | (4,870) |
Add: Adjustment for increase in leased space | 1,31,200 |
3,47,100 |
Question 3 –
A lessee enters into a lease of an equipment. The contract stipulates the lessor will perform maintenance of the leased equipment and receive consideration for that maintenance service. The contract includes the following fixed prices for the lease and non-lease component:
Lease | Rs. 80,000 |
Maintenance | Rs. 10,000 |
Total | Rs. 90,000 |
Assume the stand-alone prices cannot be readily observed, so the lessee makes estimates, maximising the use of observable information, of the lease and non-lease components, as follows:
Lease | Rs. 85,000 |
Maintenance | Rs. 15,000 |
Total | Rs. 100,000 |
In the given scenario, assuming lessee has not opted the practical expedient, how will the lessee allocate the consideration to lease and non-lease component?
Solution –
The stand-alone price for the lease component represents 85% (i.e., Rs. 85,000 / Rs. 1,00,000) of total estimated stand-alone prices. The lessee allocates the consideration in the contract (i.e., Rs. 90,000), as follows:
Lease | * Rs. 76,500 |
Maintenance | ** Rs. 13,500 |
Total | Rs. 90,000 |
* Rs. 90,000 x 85%
** Rs. 90,000 x 15%
Question 4 –
Lessee enters into a 10-year lease for 5,000 square metres of office space. The annual lease payments are Rs. 1,00,000 payable at the end of each year. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the commencement date is 6% p.a. At the beginning of Year 7, Lessee and Lessor agree to amend the original lease by extending the contractual lease term by four years. The annual lease payments are unchanged (i.e., Rs. 1,00,000 payable at the end of each year from Year 7 to Year 14). Lessee’s incremental borrowing rate at the beginning of Year 7 is 7% p.a.
How should the said modification be accounted for?
Solution –
At the effective date of the modification (at the beginning of Year 7), Lessee remeasures the lease liability based on:
(a) An eight-year remaining lease term
(b) Annual payments of Rs. 1,00,000 and
(c) Lessee’s incremental borrowing rate of 7% p.a.
The modified lease liability equals Rs. 5,97,100 (W.N.1). The lease liability immediately before the modification (including the recognition of the interest expense until the end of Year 6) is
Rs. 3,46,355 (W.N.3). Lessee recognises the difference between the carrying amount of the modified lease liability and the carrying amount of the lease liability immediately before the modification (i.e., Rs. 2,50,745) (W.N. 4) as an adjustment to the ROU Asset.
Working Notes:
1. Calculation of modified lease liability:
Year | Lease Payment (A) |
Present value factor @ 7% (B) |
Present value of lease payments (A*B=C) |
7 | 100,000 | 0.935 | 93,500 |
8 | 100,000 | 0.873 | 87,300 |
9 | 100,000 | 0.816 | 81,600 |
10 | 100,000 | 0.763 | 76,300 |
11 | 100,000 | 0.713 | 71,300 |
12 | 100,000 | 0.666 | 66,600 |
13 | 100,000 | 0.623 | 62,300 |
14 | 100,000 | 0.582 | 58,200 |
Modified lease liability |
5,97,100 |
2. Calculation of Lease liability as at commencement date:
Year | Lease Payment (A) |
Present value factor @ 6% (B) |
Present value of lease payments (A x B = C) |
1 | 100,000 | 0.943 | 94,300 |
2 | 100,000 | 0.890 | 89,000 |
3 | 100,000 | 0.840 | 84,000 |
4 | 100,000 | 0.792 | 79,200 |
5 | 100,000 | 0.747 | 74,700 |
6 | 100,000 | 0.705 | 70,500 |
7 | 100,000 | 0.665 | 66,500 |
8 | 100,000 | 0.627 | 62,700 |
9 | 100,000 | 0.592 | 59,200 |
10 | 100,000 | 0.558 | 55,800 |
Lease liability as at modification date |
7,35,900 |
3. Calculation of Lease liability immediately before modification date:
Year | Opening lease liability (A) |
Interest @ 6% (B) = [A x 6%] |
Lease payments (C) |
Closing liability (D) = [A+B-C] |
1 | 7,35,900 | 44,154 | 100,000 | 6,80,054 |
2 | 6,80,054 | 40,803 | 100,000 | 6,20,857 |
3 | 6,20,857 | 37,251 | 100,000 | 5,58,108 |
4 | 5,58,108 | 33,486 | 100,000 | 4,91,594 |
5 | 4,91,594 | 29,496 | 100,000 | 4,21,090 |
6 | 4,21,090 | 25,265 | 100,000 | 3,46,355 |
Lease liability as at modification date |
3,46,355 |
4. Adjustment to ROU asset:
Modified Lease liability | 5,97,100 |
Original Lease liability as at modification date | (3,46,355) |
Adjustment to ROU asset | 2,50,745 |
The ROU asset will be increased by Rs. 2,50,745 on the date of modification.