Measurement of Lease Payments: Comprehensive Guide for Canadian Accounting Exams

13.6 Measurement of Lease Payments

In the realm of intermediate accounting, understanding the measurement of lease payments is crucial for both lessees and lessors. This section delves into the components that constitute lease payments, the methodologies for calculating them, and the implications of these calculations under Canadian accounting standards, specifically IFRS 16 and ASPE. This comprehensive guide aims to equip you with the knowledge needed to tackle lease accounting questions on Canadian accounting exams confidently.

Understanding Lease Payments

Lease payments are the payments made by a lessee to a lessor for the right to use an asset over a specified period. The measurement of these payments is a critical aspect of lease accounting, affecting both the lessee’s and lessor’s financial statements.

Components of Lease Payments

Lease payments typically include the following components:

1. Fixed Payments: These are payments that are fixed over the lease term, including any in-substance fixed payments. They are straightforward and form the base of lease payments.

2. Variable Lease Payments: These payments depend on an index or rate, such as a consumer price index or a market interest rate. Variable lease payments are initially measured using the index or rate at the commencement date.

3. Residual Value Guarantees: A lessee may guarantee the residual value of the leased asset at the end of the lease term. The guaranteed amount is included in the lease payments.

4. Purchase Options: If the lessee is reasonably certain to exercise a purchase option, the exercise price is included in the lease payments.

5. Termination Penalties: If the lease term reflects the lessee exercising an option to terminate the lease, any penalties for termination are included in the lease payments.

6. Non-Lease Components: These are payments for services or other activities that are not related to the use of the leased asset. Under IFRS 16, lessees can choose to separate non-lease components from lease components.

Calculating Lease Payments

The calculation of lease payments involves several steps and considerations, particularly under IFRS 16 and ASPE. Let’s explore these in detail.

Step-by-Step Calculation Process

1. Identify Lease Components: Determine which payments are related to the lease and which are for non-lease components. This step is crucial as it affects the measurement of lease liabilities and right-of-use assets.

2. Determine Fixed Payments: Calculate the total fixed payments over the lease term. This includes any in-substance fixed payments that are unavoidable.

3. Assess Variable Lease Payments: Identify variable lease payments that depend on an index or rate. Use the index or rate at the commencement date to measure these payments.

4. Include Residual Value Guarantees: If applicable, add the guaranteed residual value to the lease payments.

5. Consider Purchase Options: If the lessee is reasonably certain to exercise a purchase option, include the exercise price in the lease payments.

6. Account for Termination Penalties: Include any penalties for terminating the lease if the lease term reflects the lessee exercising a termination option.

7. Discount Lease Payments: Lease payments are typically discounted to present value using the interest rate implicit in the lease or, if that rate cannot be readily determined, the lessee’s incremental borrowing rate.

Example Calculation

Consider a lease agreement with the following terms:

• Fixed annual payments of $10,000 for 5 years.
• Variable payments based on a consumer price index, initially measured at $500 per year.
• A residual value guarantee of $2,000.
• A purchase option at the end of the lease term for $5,000, which the lessee is reasonably certain to exercise.
• An implicit interest rate of 5%.

Calculation:

1. Fixed Payments: $10,000 x 5 = $50,000
2. Variable Payments: $500 x 5 = $2,500 (initial measurement)
3. Residual Value Guarantee: $2,000
4. Purchase Option: $5,000

Total Lease Payments: $50,000 + $2,500 + $2,000 + $5,000 = $59,500

Present Value of Lease Payments: Discount $59,500 at 5% over 5 years.

Regulatory Framework and Standards

IFRS 16 Leases

Under IFRS 16, lessees recognize a right-of-use asset and a lease liability at the commencement date of the lease. The lease liability is initially measured at the present value of the lease payments that are not paid at that date. IFRS 16 requires lessees to include all components of lease payments in the measurement of lease liabilities, except for variable lease payments that are not based on an index or rate.

ASPE Section 3065 Leases

ASPE provides guidance on lease accounting for private enterprises in Canada. Under ASPE, leases are classified as either capital or operating leases. The measurement of lease payments under ASPE focuses on the classification of the lease and the recognition of lease-related expenses.

Practical Examples and Scenarios

Case Study: Retail Lease Agreement

A Canadian retail company enters into a lease agreement for a storefront. The lease includes fixed payments, a variable component based on sales, and a purchase option. The company must assess the lease payments under IFRS 16:

1. Fixed Payments: $15,000 annually for 10 years.
2. Variable Payments: 1% of annual sales, estimated at $1,000 initially.
3. Purchase Option: $10,000 at the end of the lease term.

Analysis: The company will include the fixed payments and the purchase option in the lease liability. The variable payments will be recognized in profit or loss as incurred.

Scenario: Equipment Lease with Residual Value Guarantee

A manufacturing firm leases equipment with a residual value guarantee. The lease term is 7 years, with annual payments of $8,000 and a residual value guarantee of $3,000.

Calculation:

1. Fixed Payments: $8,000 x 7 = $56,000
2. Residual Value Guarantee: $3,000

Total Lease Payments: $59,000

Challenges and Best Practices

Common Pitfalls

• Misclassification of Lease Components: Incorrectly identifying non-lease components can lead to errors in measuring lease liabilities.
• Ignoring Variable Payments: Failing to account for variable payments based on an index or rate can result in inaccurate financial reporting.

Strategies for Accurate Measurement

• Thorough Contract Review: Carefully review lease agreements to identify all components of lease payments.
• Regular Updates: Update the measurement of lease payments for changes in indices or rates affecting variable payments.

Exam Tips and Strategies

• Understand Key Differences: Be aware of the differences between IFRS 16 and ASPE in lease accounting.
• Practice Calculations: Work through practice problems to become proficient in calculating lease payments and present value.
• Focus on Components: Pay attention to the components of lease payments and their impact on financial statements.

Conclusion

The measurement of lease payments is a critical aspect of lease accounting, influencing both lessees’ and lessors’ financial statements. By understanding the components and calculation methods, you can effectively navigate lease accounting questions on Canadian accounting exams. Remember to consider the regulatory framework and apply best practices to ensure accurate financial reporting.

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