IFRS 16: LEASES

Practice Questions
CFAP 1 – ADVANCED ACCOUNTING & FINANCIAL
REPORTING
COMPILED BY: MURTAZA QUAID, ACA
IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

IFRS 16: Leases

Practice Questions
Question 1. [Identified Asset] [CAF 5 – ICAP Study Support Material]
ABC Ltd enters into a 5 year contract with a freight carrier (XYZ Limited) to transport a specified quantity
of goods.
XYZ Limited uses rail cars of a particular specification and has a large pool of similar rail cars that can be
used to fulfil the requirements of the contract. The rail cars and engines are stored at XYZ Limited’s
premises when they are not being used to transport goods.
Costs associated with substituting the rail cars are minimal for XYZ Limited.
Required: Whether the contract contains a lease?
ANSWER: In this case, because the rail cars are stored at XYZ Limited’s premises, and it has a large pool of
similar rail cars and substitution costs are minimal, the benefits to XYZ Limited of substituting the rail cars
would exceed the costs of substituting the cars.
Therefore, XYZ Limited’s substitution rights are substantive, and the arrangement does not contain a
lease.

Question 2. [Identified Asset] [CAF 5 – ICAP Study Support Material]

Capri Ice, a notable ice cream parlour, enters into a contract with Yardley Limited (YL) to use a space in a
shopping mall owned by YL for a period of five years. The contract specifies the dimensions of space and
location. However, YL has discretion to relocate the space to any other floor to accommodate other
customers who would be conducting promotional events and activities in the mall.
Required: Discuss whether the contract between Capri Ice and Yardley Limited constitute lease or not.
ANSWER: In this contract, the dimension of space and location in shopping mall are specified but still Capri
Ice does not have the right to use the identified space because YL has the substantive right to substitute
the space on following grounds:
 YL has the discretion to relocate Capri to any other floor.
 YL would benefit economically from substituting the space i.e. accommodate other customers for
conducting promotional events and activities in the mall.
Moreover, one of the elements of lease is “exchange of consideration”. In given scenario consideration
for YL has not been mentioned.
In light of the above, this contract does not constitute a lease.

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 3. [Lease Term] [CAF 5 – ICAP Study Support Material]

S Limited acquired a plant on lease for a non-cancellable period of 6 years. S Limited has right to extend
the period of lease further 4 years at the end of first 6 years.
Required: Determine the lease term assuming that:
a) It is reasonably certain that S Limited will not exercise extension option.
b) It is reasonably certain that S Limited will exercise extension option.

Question 4. [Lease Term] [CAF 5 – ICAP Study Support Material]

Sher Khan Limited (lessee) enters in to lease over a plant. Consider the following independent scenarios:
Scenario 1: The lease is non-cancellable for a period of 3 years from commencement date after which
Sher Khan Limited then has the option to extend the lease for a further 2 years. Sher Khan Limited is
reasonably certain that it will exercise the renewal option.
Scenario 2: The lease is non-cancellable for a period of 3 years from commencement date after which
Sher Khan Limited then has the option to extend the lease for a further 2 years. Sher Khan Limited is
reasonably certain that it will not exercise the renewal option.
Scenario 3: The lease is for a 10-year period during which the first 7 years is non-cancellable. At the end
of the 7-year period, Sher Khan Limited has the option to terminate the lease. Sher Khan Limited is
reasonably certain that it will exercise the termination option.
Scenario 4: The lease is for a 10-year period during which the first 7 years is non-cancellable. At the end
of the 7-year period, Sher Khan Limited has the option to terminate the lease. Sher Khan Limited is
reasonably certain that it will not exercise the termination option.
Scenario 5: The lease is for a 10-year period during which the first 7 years is non-cancellable. At the end
of the 7-year period, both Sher Khan Limited and the lessor have the option to terminate the lease. Sher
Khan Limited is reasonably certain that it will not exercise the termination option.
Required: Determine lease term for each of the scenarios along with explanation.
ANSWER:
Scenario 1: Lease term is 5 years. The optional extension period is included because lessee is reasonably
certain that it will exercise the option to extend the lease.
Scenario 2: Lease term is 3 years. The optional extension period is excluded because lessee is not
reasonably certain that it will exercise the option to extend the lease.
Scenario 3: Lease term is 7 years. The optional cancellable period is excluded since it is only included if
there is reasonable certainty that the option to cancel (terminate) the lease would not be exercised.
However, in this case, lessee is reasonably certain that it will exercise its option to cancel.
Scenario 4: Lease term is 10 years. The optional cancellable period is included because we include it if we
are reasonably certain that we would not exercise our option to cancel (terminate) the lease. In this case,
lessee is reasonably certain that it will not wish to cancel the lease.
Scenario 5: Lease term is 7 years. The optional cancellable period is excluded. Although we normally
include the cancellable periods if we are reasonably certain that the option to cancel (terminate) will not
be exercised, and in this case, lessee is reasonably certain that it will not wish to cancel the lease, however,
cancellable period is excluded because the lessor also has the option to cancel the lease during this period.

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 5. [Lease Payment] [CAF 5 – ICAP Study Support Material]

Adeel Limited (AL) acquired a machine on lease from Kashif Limited (KL) on following terms:
 Down Payment Rs. 5 million
 Annual Payments (in arrears) Rs. 8 million
 Lease Term 5 years
In addition to above information consider the following three independent scenarios:
Scenario 1: AL has guaranteed residual value of Rs. 10 million, although it expects to pay Rs. Nil as machine
has expected residual value of Rs. 15 million.
Scenario 2: AL has guaranteed residual value of Rs. 10 million, although it expects to pay only Rs. 3 million
as machine has expected to have market value of Rs. 7 million at end of lease term.
Scenario 3: AL has not guaranteed any residual value, however, M Limited (manufacturer of machine) has
guaranteed KL to purchase the machine at the end of lease term at Rs. 13 million if KL so desire.
Required: Calculate total lease payments for AL and KL for each of the above scenarios.

Question 6. [Lessee Accounting] [ICAP Study Support Material]

On 1 January 2020, Multan Limited (ML) acquired a machine on lease from Vehari Leasing Limited (VLL)
for 3 years. The first annual instalment amounting to Rs. 35 million was paid on 1 January 2020 and two
more subsequent annual instalments of Rs. 35 million are payable on 1 January each year.
ML incurred initial direct cost of Rs. 5 million. ML uses similar owned machines for 7 years and depreciates
them on straight line basis.
Interest rate implicit in the lease is not known to ML. However, ML’s incremental borrowing rate is 12%.
The machine shall be returned to VLL at the end of lease term. The estimated residual value of the machine
at the end of 3 years is estimated at Rs. 30 million, out of which ML has guaranteed Rs. 20 million.
ML is also obliged to incur decommissioning cost of Rs. 4 million at the end of the lease term. The pre‑tax
rate that reflects current market assessments of the time value of money and the risks specific to such
obligation is 10%.
Required: Prepare the journal entry at commencement date of lease and at each year end (assuming that
no payment was required to be paid at the end of lease term for residual value guarantee as expected
earlier).

Question 7. [Lessee Accounting] [ICAP Study Support Material]

Progress Ltd. acquired a machine from Fine Rentals Ltd. on January 3, 2016 under a lease agreement
extending over three years.
The agreement required them to make an initial deposit of Rs. 1,280,000 to be followed by three annual
payments of Rs. 800,000 on 31 December each year starting from 2016.
The cash price of the machinery was Rs. 3,200,000 and Fine Rentals Ltd. added 12.044% interest which
was duly communicated to Progress Ltd.
Required: Journalize the above transaction

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 8. [Lessee Accounting] [ICAP Study Support Material]

 Jhang Construction (Lessee) enters into a 6 year lease of a machine on 1 January Year 1.
 The fair value of the machine at the commencement of the lease was Rs.80,000 and Jhang
Construction incurred initial direct costs of Rs.2,000 when arranging the lease.
 The annual lease payments are Rs.18,000, payable at the end of each year.
 The estimated residual value of the asset at the end of the lease is Rs.8,000 and Jhang Construction
has guaranteed this amount.
 The interest rate implicit in the lease is 11.18%.
Required: Journalize the above transaction

Question 9. [Lessee Accounting] [IFRS Kit – IFRS Box]

On 1 January 20X1 Stamper Co, producer of metal casts, enters into a lease contract to lease the stamping
machine as follow:
 Cash price of machine was Rs. 500,000.
 Stamper incurred additional costs of Rs. 2,000 for arranging the lease contract.
 The lessor’s initial direct costs were Rs. 3,000.
 Economic life of stamping machine is 6 years.
 Lease term is 5 years.
 Annual lease payments are Rs. 110,000 payable 31 December each year.
 At the end of the lease term, Stamper has an obligation to purchase the machine for Rs. 1,000.
 Interest rate implicit in the lease is 3.11% per annum.
Required: How would this transaction appear in the financial statements of Stamper Co. at 31 December
20X1?

Question 10. [Lease with incremental borrowing rate] [IFRS Kit – IFRS Box]
On 1 January 20X1 Worker rents a car under the lease contract. The lease term is for 1 year, with the
option to extend the lease for another year. Monthly lease payments are Rs. 10,000 for first year and Rs.
5,000 per month (1/2 of market rentals) for second year. Due to this favorable condition, Worker
expects to extend the lease term.
Worker also incurred the legal cost of Rs. 1,200 associated with negotiating the lease contract. Assume
incremental borrowing rate = 3% per annum.
Required: How would this transaction appear in the financial statements of Worker at 31 December
20X1?

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 11. [Lessee Accounting] [BDO - IFRS in Practice - IFRS 16: Leases]
Entity Z (the lessee) enters into a 5-year lease of a floor of a building, with an option to extend the lease
for a further 5 years. Lease payments are Rs. 50,000 per annum during the initial term and Rs. 55,000 per
annum during the optional period, all payable at the beginning of each year. To obtain the lease, Entity Z
incurs initial direct costs of Rs. 20,000 (Rs. 15,000 to the former tenant occupying the floor and CU 5,000
for real estate commissions).
At the commencement date, Entity Z concludes that it is reasonably certain to exercise the option to
extend the lease. Therefore, the lease term is 10 years.
Entity Z’s incremental borrowing rate is 5% per annum.
Required: How would this transaction appear in the financial statements of Entity Z.

Question 12. [Lessee Accounting] [ICAP Study Support Material]

X Limited acquired a machine on lease. The terms of the lease are as follows:
(i) The lease period is for four years from 1 January 2016 with an annual rental of Rs.4,000,000
payable on 31 December each year.
(ii) The lessee is required to pay all repairs, maintenance and other incidental costs.
(iii) The interest rate implicit in the lease is 15% p.a.
Note: Estimated useful economic life span of the machine is four years.
Required: Prepare an extract of the Statement of Financial Position of X Limited for the year ended 31
December 2016.

Question 13. [Short-Term Lease] [KPMG First Impression – IFRS 16 Leases]

Lessee L enters into a 10-year lease of a machine to be used in manufacturing parts for a plane that it
expects to remain popular with consumers until it completes development and testing of an improved
model. The cost to install the machine in L’s manufacturing facility is not significant. L and Lessor M each
have the right to terminate the lease without a penalty on each anniversary of the lease
commencement date.
Solution: The lease term consists of a one-year non-cancellable period because both L and M have a
substantive termination right – both can terminate the lease without penalty – and the cost to install the
machine in L’s manufacturing facility is not significant. As a result, the lease qualifies for the short-term
lease exemption.

Question 14. [Short-Term Lease] [ICAP Study Support Material]

An entity leased a car under a ten months lease at Rs. 40,000 per month for first five months and Rs.
30,000 for next five months. The asset had fair value of Rs. 3,000,000. The ownership will not transfer to
the lessee.
Required: Journalize the above transaction assuming that the entity wants to apply recognition
exemption under IFRS 16.

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 15 [Short term lease] [IFRS Kit – IFRS Box]

On 1 January 20X1 Worker rents a car under the lease contract. The lease term is for 1 year, with the
option to extend the lease with the same lease payments for another year. At the lease commencement
date, Worker concludes that the option will not be exercised, because for the same rentals, the new car
can be leased and also it's been Worker's practice to change the cars after 1 year.
Monthly lease payments are Rs. 10,000 and Worker incurred the legal cost of Rs. 1,200 associated with
negotiating the lease contract.
How would this transaction appear in the financial statements of Worker at 31 December 20X1?

Question 16. [Low Value Lease] [KPMG First Impression – IFRS 16 Leases]
Lessee A is in the pharmaceutical manufacturing and distribution industry and has the following leases:
 Leases of real estate: both office building and warehouse;
 Leases of office furniture;
 Leases of company cars, both for sales personnel and for senior management and of varying quality,
specification and value;
 Leases of trucks and vans used for delivery; and
 Leases of IT equipment such as laptops.
Solution: A determines that the leases of office furniture and laptops qualify for the recognition
exemption on the basis that the underlying assets, when they are new, are individually of low value. B
elects to apply the exemption to these leases.
As a result, it applies the recognition and measurement requirements in IFRS 16 to its leases of real
estate, company cars, trucks and vans.

Question 17. [Low Value Lease] [ICAP Study Support Material]

Saima Limited (SL) leased a laptop computer under a 24 months lease at Rs. 2,500 per month. A sum of
Rs. 4,800 was also deposited as non-refundable down payment. The fair value of the laptop computer is
Rs. 95,000. SL determines that it is low value asset.
Required: Journalize the above transaction assuming that SL want to apply recognition exemption under
IFRS 16.

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 18. [Lessee Accounting] [ICAP Study Support Material]

On 1 April 2015 Acacia Ltd entered into the following lease agreement.
(i) Plant with a fair value of Rs. 275,000 was leased under an agreement which requires Acacia Ltd to
make annual payments of Rs. 78,250 on 1 April each year, commencing on 1 April 2015, for four
years. After the four years Acacia Ltd has the option to continue to lease the plant at a nominal
rent for a further three years and is likely to do so as the asset has an estimated useful life of six
years. The present value of the lease payments is Rs. 272,850. Acacia Ltd is responsible for
insuring and maintaining the plant during the period of the lease.
(ii) Office equipment with a fair value of Rs. 24,000 was leased under a non-cancellable agreement
which requires Acacia Ltd to make annual payments of Rs. 6,000 on 1 April each year,
commencing on 1 April 2015, for three years. The lessor remains responsible for insuring and
maintaining the equipment during the period of the lease. The equipment has an estimated useful
life of ten years. The present value of the lease payments is Rs. 16,415. This lease is considered
low value item lease by Acacia Ltd.
The interest rate implicit in the lease is 10%.
Required: Prepare all relevant extracts from Acacia Ltd.’s financial statements for the year ended 31
March 2016.

Question 19. [Variable lease payments and lease re-measurement – Updating lease payment]
On 1 January 20X1 Worker enters into a 4-year lease of the office space. The information about the
contract is as follows:
 Semiannual payment of Rs. 12,000 to be paid on 30th June and 31st December each year.
 Every 2 years on 1 January, the rental payments are adjusted for the annual inflation rate prevalent
at the time of adjustment.
 If Worker installs new window blinds, then the lease payments decrease by Rs. 1,200 for 1 year.
Worker incurred the following expenditures related to the contract:
 Legal fees associated with the contract: Rs. 5,000
 Salary of an employee who negotiated the contract: Rs. 10000 (allocated based on the hourly wage)
The property owner (lessor) provided a 6-month rent-free period to Worker as an initial bonus. Worker
took the office space on 1 January 20X1, but due to unexpected events, Worker moved in the office
space on 1 May 20X1.
Inflation rates: 20X3 - 2.1%. Incremental borrowing rate is 4% p.a.
How would this transaction appear in the financial statements of Worker at 31 December 20X1?
On 1 January 20X3, Worker completed the installation of new window blinds and as a result, the lease
payments will decrease by Rs. 1,200 for 1 year (starting from January 20X3).
Also, the lease payments are adjusted by the inflation rate as agreed in the contract.
How would these transactions appear in the financial statements of Worker at 31 December 20X3?

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 20. [Variable lease payments and lease re-measurement – Updating lease payment]
[IFRS 16, illustrative example 14]
Lessee enters into a 10-year lease of property with annual lease payments of Rs. 50,000, payable at the
beginning of each year. The contract specifies that lease payments will increase every two years on the
basis of the increase in the Consumer Price Index for the preceding 24 months. The Consumer Price
Index at the commencement date is 125. The rate implicit in the lease is not readily determinable.
Lessee’s incremental borrowing rate is 5 % per annum, which reflects the fixed rate at which Lessee
could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a 10-
year term, and with similar collateral.
Lessee is also required to make variable lease payments for each year of the lease, which are
determined as 1 % of Lessee’s sales generated from the leased property.
Lessee generates sales of Rs. 800,000, Rs. 950,000 and Rs. 1,210,000 during the 1st, 2nd and 3rd year of
the lease from the leased property respectively.
At the beginning of the third year of the lease the Consumer Price Index is 135.
How would these transactions appear in the financial statements of Lessee at year 1, year 2 and year 3?

Question 21. [Lease re-measurement - Change in the lease term] [IFRS Kit – IFRS Box]
On 1 January 20X1, Delia enters into a 4-year lease of the office space. The information about the
contract is as follows:
 Annual payment is Rs. 25,000 payable in the beginning of each year;
 After 4 years, Delia has an option to extend the lease for another 2 years for the annual rental
payment of Rs. 25,000 adjusted by the inflation rate prevalent after 4 years. At the lease
commencement, Delia assumes that this option will NOT be exercised, because of significant
increase of new hires and the need to rent a bigger office space.
 Delia paid Rs. 3,000 to the real estate agent for finding the right property and arranging the lease
contract.
Inflation rate in 20X5: 2.2% per annum, incremental borrowing rate: 4% per annum.
How would this transaction appear in the financial statements of Delia at 31 December 20X1?
On 1 January 20X3, after the third payment was made, Delia's managers believe that no new employees
will be hired due to the economic crisis. As a result, Delia's management changes its plan not to exercise
the option to extend the lease and now they assume that the lease will be extended by another 2 years.
The incremental borrowing rate prevalent in 20X3 is 3.5% p.a.
How should Delia recognize these transactions in its financial statements?

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 22. [Lease re-measurement - Change in the lease term] [IFRS 16, illustrative example 13]
Lessee enters into a 10-year lease of a building, with an option to extend for five years. Lease payments
are Rs. 50,000 per year during the initial term and Rs. 55,000 per year during the optional period, all
payable at the beginning of each year. Lessee also incurs initial direct costs of Rs. 20,000, of which Rs.
15,000 relates to a payment to a former tenant occupying the building and Rs. 5,000 relates to a
commission paid to the real estate agent that arranged the lease. As an incentive to Lessee for entering
into the lease, Lessor agrees to reimburse to Lessee the real estate commission of Rs. 5,000.

At the commencement date, Lessee concludes that it is not reasonably certain to exercise the option to
extend the lease and, therefore, determines that the lease term is 10 years.

The interest rate implicit in the lease is not readily determinable. Lessee’s incremental borrowing rate is
5 % per annum, which reflects the fixed rate at which Lessee could borrow an amount similar to the
value of the right-of-use asset, in the same currency, for a 10-year term, and with similar collateral.

At the end of Year 6, Lessee concludes that it is now reasonably certain to exercise the option to extend
its original lease. Lessee’s incremental borrowing rate at the end of Year 6 is 6 % per annum, which
reflects the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use
asset, in the same currency, for a nine-year term, and with similar collateral. Lessee expects to consume
the right-of-use asset’s future economic benefits evenly over the lease term and, thus, depreciates the
right-of-use asset on a straight-line basis.

How would these transactions appear in the financial statements of Lessee at year 1 to year 7?

Question 23. [Lease modifications - Separate lease] [IFRS Kit – IFRS Box]
On 1 January 20X1, Celia enters into a 6-year lease contract for 3,000 square meters of office space.
Annual lease payment is Rs. 120,000 payable on 31 December each year.
On 1 January 20X4, Celia and the property owner agree to amend the original lease for the remaining 3
years to include additional 4,000 square meters of office space. As a result, the lease payment increases
to Rs. 260,000 per year. Celia's incremental borrowing rate is 5% in 20X1 and 6% in 20X4.
How should Celia account for the lease modification?

Question 24. [Lease modifications - Change in the existing lease] [IFRS Kit – IFRS Box]
On 1 January 20X1, Melinda enters into an 6-year lease contract for 5,000 square meters of office space.
Annual lease payment is Rs. 200,000 payable on 31 December each year.
On 1 January 20X4, Melinda and the property owner agree to amend the original lease for the remaining
3 years to decrease the leased office space to only 3,000 square meters. As a result, the lease payment
decreases to Rs. 130,000 per year. Melinda's incremental borrowing rate is 5% in 20X1 and 6% in 20X4.
How should Melinda account for the lease modification?

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 25. [Lease modifications that increase the scope of the lease by extending the contractual
lease term] [IFRS 16, illustrative example 16]
Lessee enters into a 4-year lease for 5,000 square meters of office space. The annual lease payments are
Rs. 100,000 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 %per annum.

At the beginning of Year 3, Lessee and Lessor agree to amend the original lease by extending the
contractual lease term by two years. The annual lease payments are unchanged (i.e. Rs. 100,000 payable
at the end of each year from Year 3 to Year 6). Lessee’s incremental borrowing rate at the beginning of
Year 3 is 7 %per annum.

How should Lessee account for the lease modification?

Question 26. [Lease modifications that is a change in consideration only]

[IFRS 16, illustrative example 19]
Lessee enters into a 6-year lease for 5,000 square meters of office space. At the beginning of Year 4,
Lessee and Lessor agree to amend the original lease for the remaining three years to reduce the lease
payments from Rs. 100,000 per year to Rs. 95,000 per year. The interest rate implicit in the lease cannot
be readily determined. Lessee’s incremental borrowing rate at the commencement date is 6 % per
annum. Lessee’s incremental borrowing rate at the beginning of Year 4 is 7 % per annum. The annual
lease payments are payable at the end of each year.
How should Lessee account for the lease modification?

Question 27. [Lease modification that both increases and decreases the scope of the lease]
[IFRS 16, illustrative example 18]
Lessee enters into a 8-year lease for 2,000 square meters of office space. The annual lease payments are
Rs. 100,000 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 % per annum.
At the beginning of Year 4, Lessee and Lessor agree to amend the original lease to
(a) include an additional 1,500 square meters of space in the same building starting from the
beginning of Year 4 and
(b) reduce the lease term from 8 years to 6 years. The annual fixed payment for the 3,500 square
meters is Rs. 150,000 payable at the end of each year (from Year 4 to Year 6).
Lessee’s incremental borrowing rate at the beginning of Year 4 is 7 % per annum. The consideration for
the increase in scope of 1,500 square meters of space is not commensurate with the stand-alone price
for that increase adjusted to reflect the circumstances of the contract.
How should Lessee account for the lease modification?

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 28. [Lessors: Classification of lease] [ICAP Study Support Material]

Consider the following independent scenarios:
(i) E Limited acquired a special customized engine on lease. The engine can only be used by E
Limited unless substantial modifications are made to the engine.
(ii) P Limited acquired an asset on lease with fair value of Rs. 10 million and present value of lease
payments is Rs. 9.7 million.
(iii) M Limited acquired an asset on lease economic life of 20 years while M Limited wants to use the
asset only for 17 years. The company has no intention to purchase the asset at the end of its
lease term.
(iv) T Limited acquired an asset on lease with an option to buy the asset at the end of lease term for
Rs. 12 million. The fair value of the asset at the end of lease term is expected to be at least Rs.
55 million.
Required: Identify the above leases as either finance or operating leases from the perspective of lessor.

Question 29. [Lessors: Classification of leases] [ICAP Study Support Material]

Jhang Construction has leased a cement lorry. The cash price of the lorry would be Rs.3,000,000. The
lease is for 6 years at an annual rental (in arrears) of Rs.600,000. The asset is believed to have an
economic life of 7 years. The interest rate implicit in the lease is 7%.
Jhang Construction is responsible for maintaining and insuring the asset.
Required: Identify the type of lease Jhang Construction has entered into and state the reasons.

Question 30. [Lessors: Classification of leases] [IFRS Kit – IFRS Box]

Lorry Cars, the leasing company, plans to enter into a lease contract with Lessie and there are 2 options
of how the lease contract can be structured:
General information:
1. Lorry would be leased for 4 years under the non-cancellable lease that starts 1 January 20X1.
2. Rentals are paid annually on 31 December starting year 20X1.
3. At the end of lease, lorry would have market value of 12,400 CU.
4. Normal economic life of lorry is 6 years.
5. Lorry Cars sells this type of lorries for Rs. 35,000 when paid cash.
6. Lorry Car's incremental borrowing rate is 3% (and it is close to the rate implicit in the lease).
Option 1: Lessie would pay annual rentals amounting to Rs. 6,800. At the end of the lease term, Lessie
has an option to buy lorry for its market value or lease it for additional 2 years with the same rental fees.
Option 2: Lessie would pay annual rentals amounting to Rs. 9,500. At the end of the lease term, Lessie
has an option to buy lorry either for Rs. 200, or lease it for another 2 years with rental fee of Rs. 100 per
annum.
Required: Advise Lorry Cars on correct classification of above presented leases.

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 31. [Accounting for Operating Lease by the Lessor] [IFRS Kit – IFRS Box]
On 1 January 20X1, Lessor Co. made a following offer for operating lease to one of its biggest clients:
1. Lease relates to machinery in total fair value of Rs. 1,000,000.
2. Lease is non-cancellable for 6 years, whereas machines have an economic life of 10 years.
3. Annual rentals of Rs. 130,000 are payable in arrears on 31 December each year.
Lessor paid Rs. 50,000 of commission to an agent for mediating the lease.
Required: How would this transaction appear in the financial statements of Lessor Co. at 31 Dec 20X1?

Question 32. [Accounting for Operating Lease by the Lessor] [ICAP Study Support Material]
On 1 January 2017, Genuine Properties Limited (GPL) leased a building to Faheem Limited (FL) at Rs.
5,714,000 per annum. Lease term is for nine years and economic life of the building is thirty five years.
First payment was received on 30 December 2017.
Required: Prepare maturity analysis for GPL as at 31 December 2017.

Question 33. [Accounting for Operating Lease by the Lessor] [ICAP Study Support Material]
Jay Limited entered into an operating lease agreement with Mojo Limited on 1 January 2021 incurring
the initial direct cost of Rs. 30,000.

The lease was over a plant (which Jay Limited had bought on 1 January 2020 for Rs. 1,600,000).
The terms of the lease are as follows:
 Commencement date: 1 January 2021
 Lease term 3 years
 Fixed lease instalments, payable as follows:
- 31 December 2021 Rs. 200,000
- 31 December 2022 Rs. 220,000
- 31 December 2023 Rs. 300,000

Plant has total useful life of 8 years and is being depreciated using straight line method.
Required: Prepare the journal entries in the books of Jay Limited from the start to end of lease term. Jay
Limited year-end is 31 December.

Question 34. [Accounting for Finance Lease by the Lessor] [ICAP Study Support Material]
Maria Leasing Limited (MLL) leased an asset (fair value Rs. 285,000) to XYZ Limited for use at annual
rental (in arrears) of Rs. 80,000 for five years. MLL incurred initial direct costs of Rs. 5,227 on inception
of lease. MLL estimated the residual value of Rs. 30,000 at the end of lease term, however, only Rs.
20,000 is guaranteed by XYZ Limited. Interest rate implicit in lease is 14%.
Required: Calculate amounts relevant to finance lease from the above information for MLL.

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 35. [Accounting for Finance Lease by the Lessor] [ICAP Study Support Material]
Sani Limited (SL) leased an asset having fair value of Rs. 3,500,000 from Khan Limited (KL) for a lease
term of 5 years. SL incurred initial direct costs of Rs. 60,000 and KL incurred initial direct costs of Rs.
40,000 separately
KL estimates the residual value of the asset at the end of lease term to be Rs. 500,000 out of which
200,000 is guaranteed by SL.
KL incorporates interest rate implicit in the lease of 15% while incremental borrowing rate of SL is 14%.
Required: Calculate annual rentals (equal) to be paid in arrears in the above lease arrangement.

Question 36. [Accounting for Finance Lease by the Lessor] [ICAP Study Support Material]
On 1 Jan 2017, Oscar Bank Limited (OBL) gave a machine on finance lease to Pervez Limited (PL).
Instalment of Rs. 5,714,000 at the end of each year is receivable for nine years. First payment was
received on 30 December 2017. The interest rate implicit in the lease is 6%.

Required: Prepare disclosure for OBL as at 31 December 2017.

Question 37. [Accounting for finance lease by the lessor] [IFRS Kit – IFRS Box]
On 1 January 20X1 Belinda entered into a finance lease of used stamping machine as a lessor. The fair
value of the machine was Rs. 500,000 and its carrying amount in Belinda's financial statements was Rs.
470,000.
Belinda incurred additional costs of Rs. 3,000 for arranging the lease contract. Remaining economic life
of the stamping machine is 6 years. Lease term is 5 years, annual lease payments are Rs. 110,000
payable 31 December each year. Belinda expects that at the end on the lease term, the machine can be
sold for Rs. 50,000 out of which Rs. 20,000 are guaranteed by the lessee.
Belinda classifies the lease as finance.
Required: How would this transaction appear in Belinda's financial statements at 31 December 20X1?

Question 38. [Manufacturer / dealer Lease] [ICAP Study Support Material]

Multan Motors is a car dealer. It sells cars and offers a certain model for sale by lease. The following
information is relevant:
 Price of the car in a cash sale Rs. 2,000,000
 Cost of the car Rs. 1,500,000
Finance option:
 Annual rental Rs. 804,230
 Lease term 3 years
 Interest rate 10%
 Estimated residual value nil
 Lessor’s cost of setting up the lease Rs. 20,000
The market rate of interest is also 10%.
Required: Journalize the above transaction

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 39. [Manufacturer / dealer Lease] [IFRS Kit – IFRS Box]

In January 20X1, CarProd, manufacturer of cars, offered the following finance lease related to the
newest model of car produced:
1. The newest model of car has fair value equal to its selling price, that is Rs. 30,000. Cost of
manufacture is Rs. 27,000.
2. The lease is non-cancellable for 4 years, with annual installments of Rs. 8,500 paid in arrears.
3. At the end of the lease term, the ownership of the car automatically passes to the client at no
additional cost.
CarProd incurred further cost of Rs. 1,000 related to negotiating contract.
Required: How would this transaction appear in the financial statements of CarProd at 31 Dec 20X1?

Question 40. [Manufacturer / dealer lease with unguaranteed residual value]

[ICAP Study Support Material]
Hyderabad Motors is a car dealer. It sells cars and offers a certain model for sale by lease. The following
information is relevant:
 Price of the car in a cash sale Rs. 2,000,000
 Cost of the car Rs. 1,500,000
 Annual rental Rs. 764,018
 Lease term 3 years
 Interest rate 10%
 Estimated residual value (Unguaranteed) Rs. 133,100
 Lessor’s cost of setting up the lease Rs. 20,000
The market rate of interest is also 10%.
Required: Journalize the above transaction

Question 41. [Manufacturer / dealer lease with artificially low / no rate of interest]
[ICAP Study Support Material]
Karachi Motors (KM) is a car dealer. It sells cars on cash and also offers a certain model for sale by lease.
KM sold a car on lease on 1 January 2022. The following information is relevant:
 Price of the car in a cash sale Rs. 2,000,000
 Cost of the car Rs. 1,500,000
 Annual rental Rs. 764,018
 Lease term 3 years
 Interest rate 10%
 Estimated residual value Rs. 133,100
 Lessor’s cost of setting up the lease Rs. 20,000
The market rate of interest is 15%. KM has quoted artificially low rate to attract customers.
Required: Journalize the above transaction

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 42. [Manufacturer / dealer lessors with artificially low / no rate of interest]
[ICAP CFAP 1 Study Support Material]
A motor dealer acquires vehicles of a particular model from the manufacturer for Rs. 21,000, a 20%
discount on the recommended retail price of Rs. 26,250. It offers them for sale at the recommended
retail price with 0% finance over three years, provided three annual payments of Rs.8,750 are made in
advance. The market rate of interest is 8%.
Required: How should the transaction be recognised by the dealer.

Question 43. [Lessors: land and building elements in the lease] [IFRS Kit – IFRS Box]
On 1 January 20X1, Belinda enters into a lease contract as a lessor to lease a specialized production hall
with land. The lease contract has the following characteristics:
1. The lease term is 40 years (= remaining economic life of the hall). At the end, the hall has no
residual value.
2. No ownership to the hall or land is transferred to the lessee after the end of the lease term.
3. Annual rentals are paid on 31 December each year amounting to Rs. 43,750 CU.
4. Belinda's incremental borrowing rate is 3.1%.
5. At the end of 20X0, the fair value of the hall and land was Rs. 800,000 and Rs. 200,000 CU
respectively.
Advise Belinda how to classify the lease.

Question 44. [Sale and leaseback – Sale at fair value] [ICAP CFAP 1 Study Support Material]
On 1 April 2015, a company sold a machine for Rs. 1.5 million which is also fair value and leased it back
under a five-year lease. The asset has a carrying value of Rs. 1 million. The lease payments made by the
lessee is Rs. 200,000 per annum paid at the end of the year. The interest rate implicit in the lease is 5%
p.a. Assume that the transfer of machine by the seller-lessee satisfies the requirements of IFRS 15 to be
accounted for as a sale
Required: Explain how the above transaction should be accounted for, with all relevant calculations, in
the financial statements for the year ended 31 March 2016.

Question 45. [Sale and leaseback – Sale above fair value] [IFRS Kit – IFRS Box]
On 1 January 20X1, Relia sells an administrative building to FinanceMaster for Rs. 600,000 and at the
same time, Relia leases the same building back for 15 years for an annual payment of Rs. 50,000 due 31
December each year. Additional info:
 Fair value of the building at the time of the sale is Rs. 500,000.
 Carrying amount of the building in Relia's books right before the sale is Rs. 480,000
 Transaction meets the definition of a sale under IFRS 15.
 Interest rate implicit in the lease is 4% p.a.
 FinanceMaster classifies the lease as operating
How should Relia and FinanceMaster account for the transaction?

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Question 46. [Sale and leaseback – Sale below fair value] [ICAP CFAP 1 Study Support Material]
Atlas Ltd. sells its manufacturing equipment at a price of Rs. 5,500,000 to Hybrid Leasing Co. (buyer-
lessor). The fair value of the equipment at time of sale is Rs. 6,000,000 and the carrying value is Rs.
3,000,000. The seller-lessee leases back the equipment for 10 years in exchange for annual rent
payments of Rs. 400,000 payable at the end of each year. The seller-lessee’s incremental borrowing rate
is 6%. Assume that the transfer of equipment by the seller lessee satisfies the requirements of IFRS 15 to
be accounted for as a sale.
Required: Explain how the above transaction should be accounted for, with all relevant calculations, in
the financial statements.

Question 47. [Sale and leaseback – Sale above fair value] [IFRS 16, illustrative example 24]
An entity (Seller-lessee) sells a building to another entity (Buyer-lessor) for cash of Rs. 2,000,000.
Immediately before the transaction, the building is carried at a cost of Rs. 1,000,000. At the same time,
Seller-lessee enters into a contract with Buyer-lessor for the right to use the building for 18 years, with
annual payments of Rs. 120,000 payable at the end of each year. The terms and conditions of the
transaction are such that the transfer of the building by Seller-lessee satisfies the requirements for
determining when a performance obligation is satisfied in IFRS 15 Revenue from Contracts with
Customers.
The fair value of the building at the date of sale is Rs. 1,800,000. The interest rate implicit in the lease is
4.5 per cent per annum, which is readily determinable by Seller-lessee.
Buyer-lessor classifies the lease of the building as an operating lease.
Required: Explain how the above transaction should be accounted for, with all relevant calculations, in
the financial statements of Seller-lessee and Buyer-lessor.

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 48. [Sale and leaseback] [ICAP CFAP 1 Question Bank]

Moazzam Textile Mills Limited (MTML) is facing severe financial difficulties. To improve the cash flows,
the management has decided to sell and lease back three power generators of the company under three
different sale and lease back arrangements which were signed on August 15, 2016. At the same time,
MTML enters into a contract with the buyer-lessor for the right to use the generators for 5 years, with
annual payments of Rs.1,000,000 for Generator A and Generator B and Rs.1,500,000 for Generator C,
payable at the end of each year. The interest rate implicit in the lease is 4.5%. The related information as
on August 15, 2016 is given below:
Carrying Amount of
Cost Fair value Value in use
Particular amount financing
-------------------------------------- Rs. in 000’s --------------------------------------
Generator A 10,000 7,500 6,000 6,500 6,000
Generator B 12,000 6,000 5,000 5,000 6,000
Generator C 10,000 7,000 10,000 12,000 10,000
Required
Prepare the accounting entries that should be recorded by the company on August 15, 2016 in respect
of the above transactions. Note: Cost of making sale is negligible. Ignore tax and deferred tax
implications, if any.

Question 49. [Sale and leaseback – Short term lease] [ICAP CFAP 1 Study Support Material]
A company sold the furniture for Rs.200,000 and leased it back under a ten months lease at Rs.4,000 per
month The asset had a carrying value of Rs.160,000 and
(i) Fair value of Rs. 200,000.
(ii) Fair value of Rs. 180,000.
(iii) Fair value of Rs. 230,000.
Required: Journalize the above in the books of Lessee.

Question 50. [Sale and leaseback – Transfer of asset is not a sale]

[ICAP CFAP 1 Study Support Material]
A company sold a machine for Rs.1.5 million which is also fair value and leased it back under a five-year
lease. The asset has a carrying value of Rs.1 million. The lease payments made by the lessee is Rs.
346,462 per annum paid at the end of the year. The buyer-lessor interest rate implicit in the lease is 5%
p.a. The machine has a remaining economic life of 6 years. A lessor determines that the machine is of
such a specialize nature that only the lessee can use it without major modification. Initial direct costs are
ignored.
Required: Journalize the above in the books of Lessor and Lessee.

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 51. [Separating the lease element from the non-lease element] [IFRS Kit – IFRS Box]
On 1 January 20X1, Worker Corp. enters into a lease contract with Rentor, for the rent of 3 printers, a
cutting system and a copy machine for 2 years. It is assumed that the machines will be returned back to
Rentor. The economic life of all machines is 5 years.
Worker will pay monthly payments of Rs. 5,000 for the rent of all the machines and their maintenance
as well.
Worker could have bought one printer for Rs. 60,000, a cutting system for Rs. 40,000 and a copy
machine for Rs. 45,000 when paying cash. The third party company provides similar maintenance
services for Rs. 30 per machine per month.
Required: Advise Worker and Rentor how to account for the contract under IFRS 16.

Question 52. [Separating the lease element from the non-lease element]
[CFAP 1 Past Paper, Summer 2014, Q3(a), 10 marks]
In December 2012, Arabian Automotives Limited (AAL) had launched a campaign to offer Hybrid
Technology cars under a finance lease arrangement.
 On 1 January 2013, AAL provided 10 cars to a customer. Details of the lease of each car are as under:
 Rs. 300,000 were paid on delivery of the car.
 Three equal annual installments of Rs. 580,000 each are payable in arrears.
 Periodic servicing of the car will be free of charge for the entire lease period. The estimated cost of
servicing a car is Rs. 10,000 per year. AAL provides such services at cost plus 20%.
 Actual servicing cost incurred for the year ended 31 December 2013 amounted to Rs. 11,000
 Implicit rate of return is 12% which is equivalent to market rate of interest.
Ex-factory price fixed by the manufacturer is Rs. 1,800,000. AAL gets 15% discount on the ex-factory
price from the manufacturer.
Required: Compute the impact of the above transactions on various items forming part of profit and
loss account and statement of financial position of AAL for the year ended 31 December 2013 in
accordance with International Financial Reporting Standards. (Notes to the financial statements are not
required)

Question 53. [Sublease classified as a finance lease] [IFRS 16, illustrative example 20]
Head lease—Entity A (intermediate lessor) enters into a five-year lease for 5,000 square meters of office
space (the head lease) with Entity B (the head lessor) at an annual rent of Rs. 100,000 payable in arrears.
Sublease—At the beginning of Year 3, Entity A subleases the 5,000 square meters of office space for the
remaining three years of the head lease to Entity C (sub lessee) at an annual rent of Rs. 120,000.
The incremental borrowing rate of Entity A is 8% and 10% at the beginning of year 1 and year 3
respectively.
Required: How this transaction is accounted for in the books of intermediate lessor.

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IFRS 16: Leases – Practice Questions Compiled by: Murtaza Quaid

Question 54. [Sublease classified as an operating lease] [IFRS 16, illustrative example 21]
Head lease—Entity A (intermediate lessor) enters into a five-year lease for 5,000 square meters of office
space (the head lease) with Entity B (the head lessor) at an annual rent of Rs. 100,000 payable in arrears.
Sublease—At commencement of the head lease, Entity A subleases the 5,000 square metres of office
space for two years to Entity C (sub lessee) at an annual rent of Rs. 110,000.
The incremental borrowing rate of Entity A is 8% at the beginning of year 1.
Required: How this transaction is accounted for in the books of intermediate lessor

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