5.2 Leases under PFRS 16: Lessee, Lessor, and Sale-and-Leaseback

Leases under PFRS 16: Lessee, Lessor, and Sale-and-Leaseback

Leases carry four FAR items: initial and subsequent measurement of the lessee's right-of-use asset and lease liability, their presentation, lessor accounting for finance, manufacturer or dealer, and operating leases, and sale-and-leaseback transactions. This section works through each with PFRS 16 formulas and amortization tables.

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1. PFRS 16 Leases

PFRS 16 eliminates the historical classification of leases as either operating or finance leases for lessees, introducing a unified, on-balance sheet accounting model.

Identifying a Lease

A contract contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Control requires both:

1. The right to obtain substantially all of the economic benefits from use of the identified asset; and
2. The right to direct the use of the identified asset.

Lessee Accounting Model

At the commencement date, a lessee recognizes a Right-of-Use (ROU) Asset and a corresponding Lease Liability.

                             Initial ROU Asset Measurement
                                           │
       ┌────────────────────────┬──────────┴──────────┬────────────────────────┐
       ▼                        ▼                     ▼                        ▼
 Initial Lease           Lease Payments         Initial Direct          Estimated PAS 37
   Liability             Made at/before             Costs                Dismantling &
(Present Value)           Commencement            Incurred                Restoration
                                                                             Costs

A. Initial Measurement of the Lease Liability

The lease liability is measured at the present value of the lease payments that are not paid at the commencement date, discounted using:

• The interest rate implicit in the lease, if readily determinable; or
• The lessee's incremental borrowing rate.

Included Lease Payments:

• Fixed payments (including in-substance fixed payments), less any lease incentives receivable.
• Variable lease payments that depend on an index or a rate (e.g., CPI, market reference rate), measured using the index or rate at commencement.
• Amounts expected to be payable under residual value guarantees.
• The exercise price of a purchase option if the lessee is reasonably certain to exercise that option.
• Penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate.
• Strict Exclusion: Variable lease payments based on future sales or asset usage (e.g., 2% of gross retail sales) are expensed in profit or loss as incurred and never capitalized into the lease liability.

B. Initial Measurement of the Right-of-Use (ROU) Asset

$\text{ROU Asset} = \text{Initial Lease Liability} + \text{Payments made at/before commencement} + \text{Initial Direct Costs} + \text{Estimated Restoration Provision (PAS 37)} - \text{Lease Incentives Received}$

C. Subsequent Measurement

• Lease Liability: Measured at amortized cost using the effective interest method. Periodic payments are split between interest expense (carrying amount $\times$ discount rate) and principal reduction.
• ROU Asset: Measured under the cost model (cost less accumulated depreciation and accumulated impairment losses under PAS 36).
  • Depreciation Period: If ownership transfers to the lessee by the end of the lease term or if the lessee is reasonably certain to exercise a purchase option, the ROU asset is depreciated over the useful life of the underlying asset.
  • Otherwise, the ROU asset is depreciated over the shorter of the lease term and the useful life of the underlying asset.

D. Recognition Exemptions

A lessee may elect not to apply the ROU asset and lease liability requirements to:

1. Short-Term Leases: Leases with a lease term of 12 months or less at commencement date containing no purchase option.
2. Low-Value Asset Leases: Leases where the underlying asset has a low value when brand new (standard guidance suggests underlying assets valued around $5,000 or less, such as laptops, personal computers, office chairs, and small office equipment).

• Accounting Treatment: Lease payments under exempt leases are recognized as rent expense on a straight-line basis over the lease term.

Comprehensive Worked Example: Lessee Amortization Table

On January 1, 2026, Cebu Distribution Corp enters into a 3-year lease of commercial warehousing equipment. Annual lease payments of PHP 500,000 are due each December 31, beginning December 31, 2026. The rate implicit in the lease is 8%. Cebu incurs initial direct costs of PHP 30,000 and estimates dismantling costs under PAS 37 with a present value of PHP 50,000. There is no purchase option, and the equipment reverts to the lessor at year 3.

Present value of ordinary annuity factor (8%, 3 periods): $2.577097$

$\text{Initial Lease Liability} = \text{PHP }500{,}000 \times 2.577097 = \text{PHP }1{,}288{,}549$ $\text{Initial ROU Asset} = \text{PHP }1{,}288{,}549 + \text{PHP }30{,}000 + \text{PHP }50{,}000 = \text{PHP }1{,}368{,}549$ $\text{Annual Straight-Line Depreciation} = \frac{\text{PHP }1{,}368{,}549}{3 \text{ years}} = \text{PHP }456{,}183$

Adjusted by PHP 1 for rounding.

Lessor Accounting Framework

Lessors classify each lease as either an Operating Lease or a Finance Lease (transferring substantially all risks and rewards incidental to ownership):

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2. Lessor Accounting Details and Sale-and-Leaseback Transactions

Finance Leases in the Lessor's Books

At commencement, a lessor derecognizes the underlying asset and recognizes a net investment in the lease, equal to the present value of the lease payments receivable plus any unguaranteed residual value, discounted at the interest rate implicit in the lease. For a manufacturer or dealer lessor:

• Sales revenue is the lower of the asset's fair value and the present value of the lease payments;
• Cost of sales is the asset's cost (or carrying amount) less the present value of the unguaranteed residual value;
• Costs of obtaining the lease are expensed when the selling profit is recognized, unlike initial direct costs of other lessors, which are included in the net investment.

Operating Leases in the Lessor's Books

The lessor keeps the asset, recognizes lease income on a straight-line basis (or another systematic basis), depreciates the asset, and adds initial direct costs to the carrying amount of the underlying asset, expensing them over the lease term.

Sale and Leaseback (FAR topic 8.2.3)

The first question is whether the transfer is a sale under PFRS 15 (control passes to the buyer-lessor).

Worked example. A seller-lessee sells a building with a carrying amount of PHP 1,000,000 for its fair value of PHP 1,800,000 and leases it back; the present value of the lease payments is PHP 1,200,000 and the transfer qualifies as a sale.

$\text{ROU asset} = 1{,}000{,}000 \times \frac{1{,}200{,}000}{1{,}800{,}000} = \text{PHP }666{,}667$

$\text{Gain recognized} = (1{,}800{,}000 - 1{,}000{,}000) \times \frac{1{,}800{,}000 - 1{,}200{,}000}{1{,}800{,}000} = \text{PHP }266{,}667$

Entry: Dr. Cash 1,800,000; Dr. Right-of-Use Asset 666,667; Cr. Building 1,000,000; Cr. Lease Liability 1,200,000; Cr. Gain on Sale and Leaseback 266,667. If the sale price is below fair value, the shortfall is a prepayment of lease payments (added to the ROU asset); if above fair value, the excess is additional financing from the buyer-lessor.