Lease rentals prepayment

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Porus
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Lease rentals prepayment

Post by Porus »

A company has accounted for a 4 year lease contract in accordance with IFRS 16 in 2019 (the year of initial application). So it has a right-of-use asset and lease liability on its balance sheet as at 31-12-19. In the 2nd year, sometime in the middle of the year, owing to good cashflows, it decides to prepay the entire remaining lease rentals. So, with effect from that date, it does not have any liability towards the lessor. However, as can be noted, the PV of the remaining lease payments on the date of the prepayment will be less than the amount of the lease rentals paid to the lessor. Where will this difference be accounted ? Will there be any impact on the amount of the right-of-use asset in the following 2 scenarios:

Scenario A: Lessee does not obtain ownership of the asset, the lease is to continue until the expiry of the lease term.
Scenario B: Ownership of the asset passes to the lessee, lease is terminated early.
JRSB
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Re: Lease rentals prepayment

Post by JRSB »

A landlord's dream!
ngadidala@gmail.com
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Re: Lease rentals prepayment

Post by ngadidala@gmail.com »

This is interesting question no doubt :)

As per me, ROU is unaffected. it was calculated upfront based on Liability and it is only liability which is going down to zero. No further 'Interest' expense in this case.

If the asset is purchased, your ROU needs to be closed and offset with the Asset cost...something like:

Asset Cost.....Dr
Asset Clearing......Cr

Accumulated Amort..Dr
Asset Clearing.........Dr
ROU a/c....................Cr.

There maybe gain/loss as well.
Porus
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Re: Lease rentals prepayment

Post by Porus »

The liability goes down to zero undoubtedly. So the entry might look like this:
Dr. Lease Liability 90
Dr. ???????? 10
Cr. Bank 100
All lease rentals paid, amounting to 100. The PV of those lease rentals as at the date of the prepayment (as per the amortisation table) is 90. Question is where do we adjust the diff of 10 ? I agree there is no further interest expense, since the liability has been settled. So would the diff of 10 be added to the ROU Asset in that case ?
ngadidala@gmail.com
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Re: Lease rentals prepayment

Post by ngadidala@gmail.com »

After paying the remaining amount, Liability is remeasured to '0' with the future interest amount.
Since this is not termination, it is to be treated as remeasurement of Liability and hence the difference between carrying value of Liability and Lease Payments to be adjusted into ROU as well.
Porus
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Re: Lease rentals prepayment

Post by Porus »

I thought so too, thanks
ngadidala@gmail.com
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Re: Lease rentals prepayment

Post by ngadidala@gmail.com »

But if there is no leverage on paying in advance, why would lessee close the Liability in advance?
Just wondering if the lessee is given an incentive to pay PV of payments only coz thats so logical, there may not be any that amount left in the Lease Liability...isn't it? Just curious :)
Porus
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Re: Lease rentals prepayment

Post by Porus »

Even I was surprised, and am trying to find out why he paid everything early ? I was assuming the ownership passed to him, but that is not confirmed yet.
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Marek Muc
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Re: Lease rentals prepayment

Post by Marek Muc »

Entities that manage their cash flow KPIs can sometimes be like:
takemymoney.jpg

IFRS 9 says that (par 2.1b):
lease liabilities recognised by a lessee are subject to the derecognition requirements in paragraph 3.3.1 of this Standard
which applies to your case I would say, which in turn leads us to paragraph IFRS 9.3.3.3:
The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, shall be recognised in profit or loss.
Porus
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Re: Lease rentals prepayment

Post by Porus »

Hahaaaa....the cartoon was apt!

So, what 9.3.3.3. says is that the diff between the carrying amt (90 in my example), and the lease rentals paid off (100 in my example), ie. 10, should be recognised as a loss in P&L.

My initial reasoning for debiting that 10 to ROU Asset, was that by paying upfront, the cost of the ROU asset has increased, as the benefit of time value has disappeared on the date of prepayment. However, given that IFRS says what is says under 9.3.3.3, that is the way forward I think.
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Marek Muc
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Re: Lease rentals prepayment

Post by Marek Muc »

paying upfront was just a way to extinguish/settle the lease liability, it had nothing to do with the RoU asset, so it makes perfect sense to me to recognise the difference (10 in your example) in P/L
Porus
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Re: Lease rentals prepayment

Post by Porus »

Yes I agree, although I'm still trying to find out why they paid upfront, what was the quid pro quo.
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Marek Muc
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Re: Lease rentals prepayment

Post by Marek Muc »

for example:

1. Their cash flows were much better than expected / budgeted this year, so they prepaid all of the liability to improve cash flows in the coming years (KPI management)
2. Negative interest rates are more and more common and corporates often have to pay to hold cash
Porus
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Re: Lease rentals prepayment

Post by Porus »

Yes Reason 1 is likely, let's see what we come up with
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