ABC Limited manufactures and sells high-end fashion products

HKFRS 16 Leases (1) Identifying a lease At inception of a contract, an entity shall assess whether the contract contains a lease. Lease . A contract conveys the right to use of an identified asset for a period of time in exchange for consideration . *****Key issues in the assessment of a contract***** Right to control the use of asset An entity has the right to control an asset if it has the right to: (a) obtain substantially all economic benefits from use of the identified asset; AND (b) Direct the use of the identified asset Identified asset – Explicitly or implicitly specified in a contract – Without supplier substantive substitution rights during the period of use Supplier substantive substitution rights  Has the ability to substitute alternative assets, and  Would benefit economically from doing so A period of time – Lease term Right to obtain substantially all economic benefits from use – exclusive use of the asset throughout the period – obtain economic benefits directly or indirectly e.g. using, holding or sub -leasing the asset. – include its primary output and by -products Right to direct the use (customer can decide “what, when, where, whe ther” decisions) – can direct how and for what purpose the asset is used throughout the period of use; or – the relevant decisions about how and for what purpose the asset is used are predetermined and:  the customer has the right to operate the asset througho ut the period of use without the supplier chang ing those operating instructions; or  the customer designed the asset in a way that predetermines how and for what purpose the asset will be us ed (2) Lessee Accounting (Single Lease Accounting Model) Recognition At the commencement date, a lessee shall recognize a right -of -use asset and a lease liability Measurement Initial Measurement Subsequent Measurement Lease Liability – Present value of the lease payments that are not paid at that date Future lease payment  Fixed payments  Variable lease payments  Residual value guarantees  Exercise price of purchase option if reasonably certain to be exercised  payments of penalties for terminating the lease Lease liability is subsequently – reduce by the lease payments made – increase to reflect interest on the lease liability Right -of-use asset – At COST Cost components – Initial measurement of the lease liability – Lease payments made at or before the commencement date – Initial direct costs incurred by the lessee – Estimated dismantling and restoring costs at the end of lease term – LESS lease incentives – Cost Model (cost less acc. depreciation and any acc. impairment losses) Depreciation period of the ROU asset  shorter of lease term and useful life  over useful life of asset UNLESS certain that lessee will obtain the asset Other subsequent measurement model – HKAS 16 Revaluation Model – HKAS 40 Fair Value Model Accounting Treatment (I) Right -of-use asset and lease liability are recorded in statement of financial position Dr Right of Use Cr Lease Liability (II) Initial costs are added to the amount recognized as asset (III) Depreciation Dr Depreciation expense Cr Accumulated depreciation (IV) Record lease payment and interest Payment in advance (paid at the beginning of the year) Year Bal @ 1/1 Lease payment Lease Liability after lease payment Interest @ 10% Bal @ 31/12 2013 3,000,000 – 3,000,000 300,000 3,300,000 1/1 Dr Lease Liability Cr Cash 31/12 Dr interest expense Cr Lease Liability Payment in arrears (paid at the end of the year) Year Bal @ 1/1 Interest @ 10% Lease Liability after incurring interest Lease payment Bal @ 31/12 2013 3,000,000 300,000 3,300,000 1,000,000 2,300,000 31/12 Dr Interest expense Dr Lease liability Cr Cash Simplified accounting – Short term leases (less than 12 months) – Leases for assets of low value (less than US$5,000) (4) Lessor Accounting A lessor shall classify each of its leases as either an operating lease or a finance lease . Definition of Lease (Depends upon transfer of risks and rewards) Finance lease – transfers substantially all the risks and rewards incidental to ownership of an underlying asset Operating lease – does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset Risk of ownership Rewards of ownership Possibility of losses from idle capacity Profitable operation over asset ’s life Possibility of losses from technological obsolescence Unrestricted access to asset Variation in return due to changing economic situation Gain in appreciation in value or realization of residual value Classification Criteria The lease will be classified as finance lease if it has ONE of the following characteristics: A. the lease transfers ownership of the underlying asset to the lessee by the end of the lease term ; B. the lessee has the option to purchase the underlying asset at a price that is expected to be sufficiently lower than the fair val ue at the date the option becomes exercisable for it to be reasonably certain , at the inception date, that the option will be exercised / ( Bargain Purchase Option ); C. the lease term is for the major part of the economic life of the underlying asset; D. at the inception date, the present value of the lease payments amounts to at least substantially all of the fair value of the underlying asset; E. the underlying asset is of such a specialised nature that only the lessee can use it without major modifications Les sor Accounting – Finance Lease – Measurement Initial Measurement – Recognize the amount due from lessee a receivable at an amount of net investment in the lease – Underlying asset should be derecognized – Initial direct costs (e.g. commissions, legal fees and other directly attributable costs) Net investment is present value of the sum of the following (fixed payments + variable lease payments + residual value guarantees + exercise price of purchase option if reasonably certain to be exercise d + penalties for terminating the lease + unguaranteed residual value ) Subsequent Measurement – Recognise finance income over the lease term reflecting a constant periodic rate of return on the lessor’s net investment in the lease – Record lease payments received in reducing both the principal and the unearned finance income Lessor Accounting – Operating Lease – Measurement Accounting Treatment – Recognize lease payments as income – Retain t he underlying asset remains in statement of financial position – Add initial direct costs of obtaining the lease to the carrying amount of asset – Depreciation should be provided

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