IFRS 16: Leases – Exam Notes and Case Studies (UNISA FAC3703, CTA & CUT Financial Reporting Guides)

IFRS 16 is one of the most heavily examined standards in South African financial reporting courses, especially in UNISA FAC3703 (Financial Accounting), CTA level modules, and CUT Financial Reporting and Cost and Management Accounting programmes. These notes focus on the core principles, calculations, and typical exam-style case studies relevant for IFRS 16, tailored to the style of questions asked at UNISA, CUT, NWU, UJ, and other South African universities.

1. Overview of IFRS 16 and Exam Context in South Africa

1.1 Purpose and Scope of IFRS 16

IFRS 16: Leases replaced IAS 17 for annual periods beginning on or after 1 January 2019. Its main objective is to provide a single lessee accounting model that brings most leases onto the statement of financial position.

Key ideas:

For lessees, almost all leases are recognised as:
- a right‑of‑use (ROU) asset, and
- a lease liability.
For lessors, accounting is broadly similar to IAS 17:
- Finance leases and operating leases classification retained.
IFRS 16 applies to all leases, except:
- leases to explore for or use minerals, oil, natural gas and similar non‑regenerative resources,
- leases of biological assets (IAS 41),
- service concession arrangements (IFRIC 12),
- licences of intellectual property (IFRS 15),
- rights held by a lessee under certain licensing agreements (e.g. motion picture films, patents).

In South African university exams, the focus is overwhelmingly on the lessee model, with lessor accounting appearing in more advanced modules (especially CTA and UNISA postgraduate accounting).

1.2 Why IFRS 16 Matters for UNISA, CUT and CTA Students

For UNISA FAC3703 exam notes, CTA study notes, and CUT Financial Reporting modules, IFRS 16 is examinable because:

It has material impact on:
- Statement of financial position (increase in assets and liabilities).
- Statement of profit or loss (shift from rental expense to depreciation + interest).
- Key ratios (gearing, EBITDA, ROA).
It involves multi‑step calculations, ideal for exam questions (e.g. present value calculations, amortisation schedules).
It tests multiple skills simultaneously:
- Identification of a lease,
- Measurement and journal entries,
- Reassessment and modification,
- Disclosures and interpretation.

Typical SA exam formats:

UNISA FAC3703 / FAC3704:
- 10–20 mark questions involving lease recognition at inception plus subsequent measurement for 1–2 years.
- Integrated questions with PPE and borrowing costs.
UNISA CTA (e.g. FAC4861 series):
- Complex scenarios with:
  - Variable lease payments,
  - Modifications,
  - Foreign currency leases,
  - Subleases.
CUT / UJ / NWU undergrad:
- Fundamental application of IFRS 16 lessee model,
- Step‑by‑step PV calculation and schedules.

1.3 Key Definitions to Memorise

These definitions are regularly examined at South African universities, often for theory marks in questions labelled “Discuss”, “Explain”, or “Define”.

Lease: A contract that conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
Right‑of‑use asset: An asset that represents a lessee’s right to use an underlying asset for the lease term.
Lease liability: A lessee’s obligation to make lease payments for the right to use the underlying asset.
Lease term:
- Non‑cancellable period of a lease, plus:
- periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option, and
- periods covered by an option to terminate if the lessee is reasonably certain not to exercise that option.
Short‑term lease: Lease term of 12 months or less at commencement and no purchase option.
Low‑value asset: An underlying asset of low value when new (examples: laptops, small office equipment); not defined numerically in the standard but often interpreted around USD 5,000 equivalent.

1.4 Lessee vs Lessor – High‑Level Summary

In many UNISA and CUT exam notes, a basic comparison table helps to quickly recall the differences:

Aspect	Lessee under IFRS 16	Lessor under IFRS 16
Model	Single model (ROU asset + liability)	Dual model (finance vs operating lease)
Initial recognition	PV of lease payments	Finance lease: net investment in lease
	ROU asset + lease liability	Operating lease: underlying asset
Income statement impact	Depreciation + interest expense	Finance lease: finance income
	(instead of rental expense)	Operating lease: rental income
Off-balance sheet?	Generally no, except exemptions	Similar to IAS 17 treatment

1.5 Common Exam Traps in the South African Context

Lecturers at UNISA, CUT, and NWU consistently highlight the following traps:

Confusing lease term:
- Not considering extension or termination options properly.
- Ignoring economic incentives, penalties, or customisation that make renewal reasonably certain.
Incorrect discount rate:
- Using prime rate or repo rate without considering:
  - the interest rate implicit in the lease (if readily determinable), or
  - lessee’s incremental borrowing rate.
Ignoring initial direct costs and restoration obligations:
- Understating the ROU asset at inception.
Mixing up depreciation method:
- Depreciating over lease term instead of useful life when purchase option is reasonably certain.
Not distinguishing variable vs fixed lease payments:
- Including purely performance‑based variable payments in lease liability (this is incorrect).
Presentation errors:
- Misclassifying lease liability between current and non‑current.
- Mislabeling depreciation and interest vs rental expense.

Being able to spot and correct these traps is crucial for scoring well in FAC3703 exam questions and CTA IFRS case studies.

2. Identifying a Lease and Determining the Lease Term

Correctly identifying what qualifies as a lease, and how long the lease term is, is the foundation of any IFRS 16 question.

2.1 Is There an Identified Asset?

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.

An identified asset is typically:

Explicitly specified in the contract (e.g. “Machine A”, “Vehicle with registration XYZ123”); or
Implicitly specified (e.g. only one asset is capable of being used to fulfil the contract).

However, there is no lease if:

The supplier has a substantive substitution right, meaning it can substitute the asset during the period of use and would benefit economically from doing so.

Exam angle: Many UNISA and CUT questions give a scenario about outsourcing, IT hosting, or transport services and ask whether this constitutes a lease.

Example – Hosting arrangement (UNISA FAC3703 style):

Company DataCloud (Pty) Ltd enters into a 3‑year contract with a data centre provider to host its servers.
The provider uses a specific rack of servers in its Johannesburg data centre, but the contract does not specify that rack.
The provider can move DataCloud’s software between racks/pods freely and would benefit from doing so (e.g. for load balancing).

Conclusion:

Even if a particular rack is used in practice, the supplier has a substantive right to substitute without customer approval and benefits economically from doing so.
No identified asset, therefore no lease under IFRS 16.
This would be accounted for as a service contract under IFRS 15 / expense as incurred.

2.2 Right to Control the Use of the Asset

Having an identified asset is not sufficient. The customer (lessee) must also have:

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

Right to obtain benefits:

Examples: using, holding, subleasing, changing output, deciding how and for what purpose the asset is used.
If the supplier can direct how and for what purpose the asset is used, there is no lease.

Example – Transport services (typical exam twist):

TransCo Ltd contracts Trucks SA (Pty) Ltd to transport goods between Durban and Johannesburg for 4 years.
The contract specifies 10 trucks and states they must meet certain capacity and safety requirements.
Trucks SA decides:
- Which specific trucks to use each day,
- When and on which route they travel (within agreed delivery times),
- How the loads are scheduled.
TransCo’s rights:
- Specify delivery destination and time windows,
- Set quality and safety specifications.

Analysis:

Trucks SA directs how and for what purpose the trucks are used (routing, scheduling, etc.).
TransCo does not control use; it only specifies the output (transport services).
Conclusion: This is a service contract, not a lease.

2.3 Lease Term – Non‑Cancellable Period Plus Options

Determining lease term often carries easy marks but is frequently done incorrectly under exam pressure.

The lease term comprises:

Non‑cancellable period, plus
Periods covered by a renewal option if the lessee is reasonably certain to exercise, plus
Periods covered by a termination option if the lessee is reasonably certain not to terminate.

Key factors to assess reasonable certainty:

Significant leasehold improvements made by lessee.
The importance of the underlying asset to the lessee’s operations.
Penalties for early termination.
Favourable terms in renewal period (e.g. below market rent).
Costs of relocating or replacing the asset.
Past practice and business strategy.

Exam hint (South African context):

Lecturers often provide details such as:

“The lessee historically renews such leases.”
“The lessee will incur significant relocation costs if the lease is not renewed.”
“The renewal rentals are substantially below market rates.”

These clues push the conclusion towards including renewal options in the lease term.

2.4 Case Study: Office Building Lease (UNISA / CUT Style)

Scenario – CityOffice (Pty) Ltd

On 1 January 20X1, CityOffice (Pty) Ltd signs a lease for office space in Bloemfontein.
Initial non‑cancellable period: 5 years.
The lessee has a renewal option for further 3 years at rentals significantly lower than market rates.
CityOffice incurs R1 200 000 in leasehold improvements, expected to be used for at least 8 years.
If the lease is not renewed:
- CityOffice must relocate its operations, incurring estimated relocation costs of R800 000.
Management has a strategy of maintaining a long‑term presence in Bloemfontein and has renewed similar leases in the past.

Question: Determine the lease term under IFRS 16.

Analysis:

Non‑cancellable period: 5 years.
Renewal period: 3 years.
Indicators of reasonable certainty to exercise renewal option:
- Significant leasehold improvements (R1 200 000) with useful life beyond 5 years.
- High relocation costs (R800 000).
- Renewal rentals below market.
- Long‑term presence strategy and historical renewal behaviour.

Conclusion:

CityOffice is reasonably certain to exercise the renewal option.
Lease term = 8 years (5 + 3).

This will affect:

Depreciation of the ROU asset (over 8 years).
Inclusion of lease payments over 8 years in the lease liability’s present value.

2.5 Changes in Lease Term – Reassessment

IFRS 16 requires reassessment of the lease term if:

There is a significant event or change in circumstances within the lessee’s control, that:
- affects whether the lessee is reasonably certain to exercise (or not to exercise) a renewal or termination option.

Example triggers:

Major restructuring leading to closure of the leased facility.
Significant modification of the underlying asset.
Decision to expand or downsize operations.

Exam application:

A later question may mention that a lessee decides not to renew a lease that had previously been considered reasonably certain to renew.
The student must:
1. Recalculate the lease liability based on revised lease term.
2. Adjust the ROU asset.
3. Recognise any differences in profit or loss (if appropriate).

Handling reassessment is more common in CTA and advanced FAC3704 level questions, but some FAC3703 exam papers have incorporated simpler remeasurement scenarios.

3. Initial Measurement of Lease Liability and Right‑of‑Use Asset

This section focuses on the core calculation steps heavily examined in UNISA FAC3703 / CTA and CUT Financial Reporting modules.

3.1 Components of Lease Payments

To calculate the lease liability, one must identify lease payments that are included in the measurement:

Included:

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, LIBOR), initially based on the index/rate at commencement date.
Amounts expected to be payable under residual value guarantees.
Exercise price of a purchase option if the lessee is reasonably certain to exercise it.
Payments of penalties for terminating the lease if the lease term reflects the lessee exercising that option.

Excluded from lease liability (expensed as incurred):

Variable lease payments linked solely to usage or performance (e.g. 2% of sales, R10 per unit produced, R5 per km driven), unless they are in‑substance fixed.

3.2 Discount Rate

The lease liability is measured at the present value of lease payments, discounted using:

The interest rate implicit in the lease, if readily determinable; or
The lessee’s incremental borrowing rate if the implicit rate is not readily determinable.

Interest rate implicit in the lease is the rate that causes the present value of:

lease payments, plus
unguaranteed residual value

to equal the sum of:

fair value of the underlying asset, plus
initial direct costs of the lessor.

In many exam questions (especially at UNISA), the implicit rate is either:

Directly given (e.g. “The implicit rate is 9%”) or
Not determinable, and the question clearly states “Use an incremental borrowing rate of 10%”.

Students must be careful to not randomly pick the South African prime rate; they must use the rate specified in the question.

3.3 Initial Measurement – Lease Liability

The general process:

Identify the lease term.
Determine the lease payments to be included.
Select the discount rate (implicit or incremental borrowing rate).
Calculate present value of lease payments (usually using:
- annuity tables,
- present value factors, or
- basic calculator functions).

Example – Basic Lessee PV Calculation (UNISA FAC3703-style)

Scenario – EduPrint (Pty) Ltd

Lease of printing equipment.
Commencement date: 1 January 20X1.
Lease term: 4 years (no renewal options).
Annual lease payments: R120 000, payable in arrears (end of each year).
No residual value guarantees.
No purchase option.
Incremental borrowing rate: 10% per annum.
No initial direct costs, no lease incentives.

Step 1: Identify lease payments:

R120 000 per year for 4 years (fixed).
No adjustments.

Step 2: Discount rate: 10%.

Step 3: Present value of annuity (payments in arrears):

PV factor (annuity, 10%, 4 years) can be calculated as:

[
PVAF_{10%,4} = \frac{1 – (1.10)^{-4}}{0.10}
]

[
(1.10)^{-4} \approx 0.6830
]

[
PVAF_{10%,4} \approx \frac{1 – 0.6830}{0.10} = \frac{0.3170}{0.10} = 3.170
]

Therefore:

[
\text{Lease liability at commencement} = 120,000 \times 3.170 = R380,400
]

(Rounding differences acceptable in exams; ensure consistency within solution.)

Step 4: Lease liability is R380 400 at 1 January 20X1.

3.4 Initial Measurement – Right‑of‑Use Asset

The ROU asset is initially measured at:

Initial measurement of the lease liability, plus:
- Any lease payments made at or before commencement, less any lease incentives received,
- Any initial direct costs incurred by the lessee,
- Estimated restoration or dismantling costs (obligation recognised under IAS 37).

Formula:

[
\text{ROU asset} = \text{Lease liability} + \text{Lease payments at/before commencement} – \text{Lease incentives} + \text{Initial direct costs} + \text{Restoration provision}
]

Example – ROU Asset with Initial Direct Costs and Restoration

Extend the EduPrint example:

EduPrint pays an additional R15 000 to a consultant to negotiate the lease (initial direct cost).
EduPrint is obliged to restore the printing area to its original condition at the end of the lease, estimated present value of R20 000 (accounted for as a provision under IAS 37).

Then:

Lease liability (from earlier): R380 400.
Lease payments at or before commencement: none (all in arrears).
Lease incentives: none.
Initial direct costs: R15 000.
Restoration provision: R20 000.

[
\text{ROU asset} = 380,400 + 0 – 0 + 15,000 + 20,000 = R415,400
]

3.5 Initial Recognition – Journal Entries (Lessee)

Using the EduPrint extended example:

At commencement date (1 January 20X1):

Recognise lease liability and ROU asset:

Dr Right-of-use asset – Printing equipment     415 400
     Cr Lease liability                                  380 400
     Cr Provision for restoration                        20 000
     Cr Bank (initial direct cost)                       15 000

If the initial direct cost (R15 000) was paid earlier, the entry at commencement would:

Dr Right-of-use asset – Printing equipment     415 400
     Cr Lease liability                                  380 400
     Cr Provision for restoration                        20 000
     Cr Bank (or payables, if unpaid)                   15 000

Exam tip:

UNISA and CUT markers often award method marks for clearly structured entries.
Use descriptive account names (e.g. “ROU asset – Office building”); avoid vague labels like “Asset”.

3.6 Depreciation of the Right‑of‑Use Asset

The depreciation period depends on whether ownership is expected to transfer:

If ownership transfers by the end of the lease term (or the lessee is reasonably certain to exercise a purchase option), depreciate over useful life of the asset.
Otherwise, depreciate over the lease term.

Example – Depreciation with and without transfer of ownership

Using EduPrint (Pty) Ltd:

ROU asset at commencement: R415 400.
Lease term: 4 years.
Suppose ownership does not transfer, and there is no purchase option.

Then:

Depreciation method: straight-line over 4 years.
Annual depreciation = R415 400 / 4 = R103 850.

If, alternatively, ownership does transfer at end of 4 years and useful life is 5 years:

Depreciation period = 5 years (useful life).
Annual depreciation = R415 400 / 5 = R83 080.

3.7 Lease Liability – Subsequent Measurement (Amortisation Schedule)

After initial recognition, the lease liability is:

Increased by interest,
Decreased by lease payments made,
Reassessed if lease term or lease payments change (e.g. index).

EduPrint – Amortisation Schedule (simplified)

Assume:

Lease liability at 1 Jan 20X1: R380 400.
Annual payments: R120 000 in arrears.
Interest rate: 10% per annum.

Year 1 (20X1):

Opening balance: R380 400.
Interest expense (10%): R38 040.
Payment: R120 000.
Closing balance: 380 400 + 38 040 − 120 000 = R298 440.

Year 2 (20X2):

Opening balance: R298 440.
Interest expense (10%): R29 844.
Payment: R120 000.
Closing balance: 298 440 + 29 844 − 120 000 = R208 284.

Year 3 (20X3):

Opening: 208 284.
Interest (10%): 20 828 (rounded).
Payment: 120 000.
Closing: 208 284 + 20 828 − 120 000 = R109 112.

Year 4 (20X4):

Opening: 109 112.
Interest (10%): 10 911.
Payment: 120 000.
Closing: 109 112 + 10 911 − 120 000 = R23 (rounding difference; can be adjusted in final year).

Exam practice: Many UNISA and CUT exams accept small rounding differences; however, clearly label and reconcile.

Journal entries – Year 1 (EduPrint)

Recognise interest:

Dr Interest expense                         38 040
     Cr Lease liability                              38 040

Lease payment at year-end:

Dr Lease liability                        120 000
     Cr Bank                                        120 000

Depreciation of ROU asset (assuming 4-year lease term):

Dr Depreciation expense – ROU asset      103 850
     Cr Accumulated depreciation – ROU asset      103 850

Exam questions often require numerical schedule plus journal entries for one or two years.

4. Subsequent Measurement, Reassessments, and Special Topics

Beyond the basics, IFRS 16 questions in UNISA CTA, FAC3704, and CUT postgraduate accounting often explore reassessments, modifications, variable lease payments, foreign currency, and special exemptions.

4.1 Remeasurement of Lease Liability

The lease liability is remeasured when:

There is a change in future lease payments due to:
- a change in an index or rate (e.g. CPI, interest rate),
- a change in amounts payable under residual value guarantees.
A change in the lease term (reassessed as reasonably certain to extend/terminate).
A change in the assessment of purchase option being reasonably certain to be exercised.
A lease modification that is not accounted for as a separate lease.

Remeasurement process:

Recalculate the present value of revised lease payments using a suitable discount rate:
- For changes related to index/rate: use original discount rate (unless modification).
- For lease term or purchase option changes: use a revised discount rate.
Adjust the carrying amount of the ROU asset by the same amount as the remeasurement of the lease liability, unless the carrying amount of the ROU asset is reduced to zero. Any excess over zero is recognised in profit or loss.

4.2 Variable Lease Payments Linked to an Index or Rate

Variable lease payments that depend on an index or rate (e.g. CPI, JIBAR) are:

Included in lease liability based on current index/rate at commencement.
Subsequently adjusted when the index/rate changes, with a remeasurement of lease liability.

Example – CPI-linked rent (UNISA CTA scenario)

Scenario – RetailLease (Pty) Ltd

RetailLease enters into a 5‑year lease for retail space.
Annual lease payments:
- First year: R200 000.
- Thereafter: payments increase each year based on CPI at the anniversary date of the lease.
At commencement (1 Jan 20X1), CPI is 100.
Incremental borrowing rate: 9%.

Initial measurement:

Use CPI = 100 for all years to estimate payments at commencement, i.e. assume flat R200 000 per year for PV calculation.
Lease liability = PV of R200 000 p.a. for 5 years at 9%.

Subsequent measurement:

At 1 Jan 20X2, CPI is 104.
Lease payment for 20X2 = 200 000 × (104 / 100) = R208 000.
Recalculate future lease payments using new CPI for remaining term and adjust lease liability accordingly.

The exam will often provide:

initial CPI index,
revised CPI index,
instructions to remeasure at specific date.

4.3 Variable Payments Dependent on Usage or Performance

Variable payments linked purely to usage or performance (e.g. percentage of sales, hours used) are not included in lease liability initially.

Recognise them as an expense in profit or loss when incurred.

Example – Sales-based rent (common in retail)

Lessee pays fixed R100 000 per year plus 2% of sales.
Only the fixed R100 000 is included in lease liability.
2% of sales (variable) is expensed as incurred.

Exam trick: Students often incorrectly capitalise variable usage‑based payments; this is not allowed unless they are in‑substance fixed.

4.4 Short‑Term and Low‑Value Lease Exemptions

IFRS 16 permits lessees to elect not to apply the ROU model to:

Short‑term leases: Lease term of 12 months or less and no purchase option.
Leases of low‑value assets: e.g. small IT equipment, office furniture when new is low value.

Accounting under exemption:

Recognise lease payments as expense on a straight‑line basis or other systematic basis.
Off-balance sheet; no lease liability or ROU asset.

South African exam application:

Some questions provide a fleet of short‑term vehicle leases (e.g. 9‑month contracts) and test whether they qualify for exemption.
Students must:
- Determine whether election is made (stated in question).
- Show correct straight‑line expense and disclosure.

4.5 Lease Modifications

A lease modification is a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions.

Examples:

Adding or terminating the right to use one or more underlying assets.
Extending or shortening the contractual lease term.
Changing lease payments.

Accounting distinction:

Modification that increases the scope of the lease by adding one or more underlying assets and increases the consideration by an amount commensurate with the stand‑alone price for the additional right‑of‑use:
- Accounted for as a separate lease.
All other modifications:
- Adjust the existing lease:
  - Recalculate lease liability using:
    - revised lease payments and
    - revised discount rate.
  - Adjust ROU asset by the same amount.

Example – Space expansion (CTA‑style)

Scenario – OfficeExtend (Pty) Ltd

Initially leased one floor of a building for 5 years.
At end of year 2, it modifies the lease to add another floor for the remaining 3 years.
Additional consideration is at stand‑alone market rate.

Accounting:

Treat the modification as a separate lease for the additional floor (new ROU asset and lease liability).
Original lease continues as before.

Alternative scenario: If consideration is not at stand‑alone price (e.g. discounted bundle), treat it as a modification of existing lease, remeasure lease liability and adjust ROU asset.

4.6 Foreign Currency Leases (Advanced CTA Focus)

Some South African companies (especially JSE-listed) lease assets in foreign currencies (e.g. USD). CTA and some advanced undergraduate modules may test:

Measurement of lease liability in functional currency.
Subsequent foreign exchange differences.

Key principles:

At commencement, measure lease liability at the spot exchange rate between foreign currency and lessee’s functional currency.
Subsequently:
- Adjust lease liability for:
  - interest,
  - payments,
  - and foreign exchange differences (IAS 21).
- Recognise exchange differences in profit or loss (unless part of net investment in foreign operation).

Example exam treatment:

Provide USD lease payments,
Provide ZAR/USD exchange rates at:
- commencement,
- year‑end.
Require calculation of:
- interest,
- FX differences,
- closing lease liability in ZAR.

4.7 Presentation and Disclosure (Frequently Tested Theory)

Presentation (Lessee):

Statement of financial position:
- ROU assets presented either:
  - separately, or
  - within the same line item as underlying assets (e.g. “Property, plant and equipment”), with disclosure.
- Lease liabilities presented separately or grouped with other liabilities (e.g. “Borrowings”), with disclosure of lease‑related amounts.
Statement of profit or loss:
- Depreciation of ROU assets presented within:
  - “Depreciation and amortisation”.
- Interest on lease liabilities presented within:
  - “Finance costs”.

Statement of cash flows:

Lease payments split into:
- Interest portion: operating or financing cash flow, depending on accounting policy.
- Principal portion: financing cash flow.

Disclosure highlights:

Maturity analysis of lease liabilities.
Expense related to:
- short‑term leases,
- low‑value assets,
- variable lease payments not included in measurement.
Additions to ROU assets.
Depreciation charge for ROU assets by class of underlying asset.

Exam questions, especially theory sections in UNISA FAC3703 and CTA, may ask for:

“Discuss the presentation of lease liability and ROU asset.”
“List key disclosures required by IFRS 16 for a lessee.”

5. Integrated Case Studies – South African University Exam Style

This section presents integrated case studies in the style of UNISA FAC3703 exam notes, UNISA CTA IFRS 16 case studies, and CUT Financial Reporting exams, working through both calculations and likely exam requirements.

5.1 Case Study 1 – Basic Lessee Accounting (UNISA FAC3703 / CUT BCom)

Scenario – CampusTech (Pty) Ltd

CampusTech (Pty) Ltd, based in Pretoria, enters into a lease for computer equipment used in its training labs.

Commencement date: 1 March 20X1.
Lease term: 5 years, non‑cancellable.
Annual lease payments: R150 000, payable in advance on 1 March each year.
No purchase option; ownership does not transfer.
No residual value guarantees.
Incremental borrowing rate: 8% per annum.
Initial direct costs paid by lessee: R10 000.
No restoration obligations.
CampusTech has a 31 December year‑end.

Required (typical exam requirements):

Determine the initial measurement of the lease liability and ROU asset on 1 March 20X1.
Prepare the lease amortisation schedule for the first 2 years.
Prepare journal entries in CampusTech’s books for the year ended 31 December 20X1.
Show extracts of statement of financial position and profit or loss at 31 December 20X1.

5.1.1 Step 1: Lease Payments and Discounting

Lease payments:

R150 000 per year, in advance (1 March each year) for 5 years.
Payment dates:
- 1 Mar 20X1
- 1 Mar 20X2
- 1 Mar 20X3
- 1 Mar 20X4
- 1 Mar 20X5

Because payments are in advance:

The payment on 1 March 20X1 occurs at commencement; it is not discounted.
The lease liability at commencement is the PV of remaining 4 payments from 1 Mar 20X2 to 1 Mar 20X5, discounted at 8%.

Compute PV of payments from 1 Mar 20X2 to 1 Mar 20X5 (4 payments, in arrears relative to 1 Mar 20X1):

[
PVAF_{8%,4} = \frac{1 – (1.08)^{-4}}{0.08}
]
[
(1.08)^{-4} \approx 0.7350
]
[
PVAF_{8%,4} \approx \frac{1 – 0.7350}{0.08} = \frac{0.2650}{0.08} = 3.3125
]

PV of 4 payments:

[
150,000 \times 3.3125 = R496,875
]

Thus:

Initial lease liability at 1 Mar 20X1 = R496 875.

5.1.2 Step 2: Initial ROU Asset

ROU asset = Lease liability + payment at/before commencement + initial direct costs

Lease liability: R496 875.
Payment at commencement (1 Mar 20X1): R150 000.
Initial direct costs: R10 000.

[
\text{ROU asset} = 496,875 + 150,000 + 10,000 = R656,875
]

5.1.3 Step 3: Journal Entries at Commencement (1 March 20X1)

Recognise lease liability and ROU asset, plus initial direct costs:

Dr Right-of-use asset – Computer equipment      656 875
     Cr Lease liability                                  496 875
     Cr Bank (lease payment at commencement)            150 000
     Cr Bank (initial direct costs)                      10 000

(Note: Some examiners prefer splitting entries; method is acceptable if logically presented.)

5.1.4 Step 4: Depreciation – Year Ended 31 December 20X1

Lease term: 5 years.
Ownership does not transfer; no purchase option.
Depreciation method: straight‑line over 5 years.

Annual depreciation:

[
\frac{656,875}{5} = R131,375 \text{ per annum}
]

For year ended 31 Dec 20X1:

The ROU asset is used from 1 Mar 20X1 to 31 Dec 20X1 = 10 months.
Depreciation for 10 months:

[
131,375 \times \frac{10}{12} = R109,479 \text{ (rounded)}
]

5.1.5 Step 5: Interest and Lease Liability – Year 1

We need an amortisation schedule starting after the first payment:

1 Mar 20X1:
- Lease liability initially: R496 875.
- Payment: R150 000 (already factored into ROU).

From 1 Mar 20X1 to 31 Dec 20X1:

Time period = 10 months.
Interest at 8% per annum for 10 months:

[
\text{Interest} = 496,875 \times 8% \times \frac{10}{12}
= 496,875 \times 0.08 \times 0.8333
\approx 496,875 \times 0.06667
\approx R33,125
]

At 31 Dec 20X1:

Lease liability closing balance:

[
496,875 + 33,125 = R530,000
]

This will be the opening balance on 1 Jan 20X2, before the next payment on 1 Mar 20X2.

5.1.6 Step 6: Journal Entries for Year Ended 31 December 20X1

Interest expense for 10 months:

Dr Interest expense                           33 125
     Cr Lease liability                                33 125

Depreciation for ROU asset:

Dr Depreciation expense – ROU asset          109 479
     Cr Accumulated depreciation – ROU asset         109 479

There are no additional lease payments in 20X1 (since first payment already made at commencement).

5.1.7 Step 7: Statement Extracts – 31 December 20X1

Statement of financial position:

Non‑current assets:
- Right‑of‑use asset – computer equipment = Cost (R656 875) – Accumulated depreciation (R109 479) = R547 396.
Non‑current liabilities:
- Lease liability – non‑current portion: computed by splitting next 12 months payments vs remainder. For brevity here, note:
  - Total lease liability at 31 Dec 20X1: R530 000.
  - Next payment of R150 000 due 1 Mar 20X2:
    - The portion of R150 000 that reduces principal can be considered current; interest for 2 months (Jan–Feb) is also current.
  - In exam answers, prepare a detailed split; marks are awarded for correct approach.

Statement of profit or loss (20X1):

Depreciation expense – ROU asset: R109 479.
Interest expense (lease): R33 125.

Total effect on profit or loss: R142 604, compared to what would have been R125 000 (10/12 of a R150 000 straight‑line rental under old IAS 17) – illustrating IFRS 16’s front‑loaded expense profile.

5.2 Case Study 2 – Lease with Residual Value Guarantee and Purchase Option (Advanced UNDERGRAD / CTA)

Scenario – AutoDrive (Pty) Ltd

AutoDrive (Pty) Ltd leases a fleet of vehicles for 3 years from 1 January 20X1.

Lease term: 3 years, non‑cancellable.
Annual lease payments: R400 000, payable in arrears (31 Dec each year).
At end of year 3, AutoDrive guarantees that the residual value of the fleet will be at least R150 000; if not, it will pay the shortfall to the lessor.
The expected value of the shortfall (probability‑weighted) at commencement is estimated at R90 000.
AutoDrive has an option to purchase the fleet at the end of year 3 for R120 000.
Management is not reasonably certain to exercise the purchase option based on current plans.
Implicit rate in the lease: 9% per annum (determinable).
No initial direct costs, no restoration obligations.

Required:

Determine the initial lease liability.
Determine the initial ROU asset.
Explain how the residual value guarantee and purchase option affect the calculation.

5.2.1 Initial Lease Liability

Components included:

Fixed lease payments: R400 000 each year for 3 years.
Residual value guarantee: expected payment under guarantee = R90 000.
Purchase option: not included because lessee is not reasonably certain to exercise.

Compute PV of fixed payments:

Annuity – 3 years, 9%:

[
PVAF_{9%,3} = \frac{1 – (1.09)^{-3}}{0.09}
]
[
(1.09)^{-3} \approx 0.7722
]
[
PVAF_{9%,3} \approx \frac{1 – 0.7722}{0.09} = \frac{0.2278}{0.09} \approx 2.531
]

PV of lease payments:

[
400,000 \times 2.531 \approx R1,012,400
]

PV of residual value guarantee (single sum at end of year 3):

[
PV = 90,000 \times (1.09)^{-3} \approx 90,000 \times 0.7722 = R69,498
]

Total initial lease liability:

[
1,012,400 + 69,498 = R1,081,898 \ (\text{rounded})
]

5.2.2 Initial ROU Asset

No initial direct costs, no lease incentives, no restoration obligations.
No payments at commencement (all in arrears).

Thus:

[
\text{ROU asset} = \text{Lease liability} = R1,081,898
]

5.2.3 Role of Residual Value Guarantee and Purchase Option

Residual value guarantee:
- Include expected payment (R90 000) in lease payments.
- Its present value (R69 498) is part of the lease liability.
- If actual amount payable differs, lease liability will be adjusted when payable.
Purchase option:
- Not included in lease liability because AutoDrive is not reasonably certain to exercise it.
- If later AutoDrive becomes reasonably certain to exercise, the lease liability is remeasured to include the exercise price at that point, with corresponding adjustment to ROU asset.

Exam answers must clearly reference “reasonably certain” language, as this is highly examinable.

5.3 Case Study 3 – Reassessment of Lease Term and Modification (CTA Level)

Scenario – RetailMall (Pty) Ltd

RetailMall (Pty) Ltd operates a chain of clothing stores across South Africa. It enters into a lease for store space in a mall in Bloemfontein.

Initial terms:

Commencement date: 1 January 20X1.
Non‑cancellable period: 6 years.
Renewal option: additional 4 years at below‑market rent.
At commencement, RetailMall is not reasonably certain to exercise the renewal.
Annual lease payments: R250 000, payable in arrears.
Incremental borrowing rate: 10%.
No purchase option or residual value guarantee.
ROU asset = lease liability at inception (no other adjustments).

The lease liability at 1 January 20X1 was correctly calculated at R1 064 000 (PV of R250 000 for 6 years at 10%; the exact PV factor used is not required here).

At end of year 3 (31 December 20X3):

RetailMall invests R600 000 in store refurbishments that significantly enhance the store and are specific to the current premises.
Due to improved performance and brand positioning, RetailMall now becomes reasonably certain to exercise the 4‑year renewal option.
The incremental borrowing rate at 1 January 20X4 is now 9%.

Required:

Explain whether the lease term should be reassessed.
Calculate the remeasurement of the lease liability at 1 January 20X4.
Show the journal entry for the remeasurement at 1 January 20X4.

5.3.1 Reassessment of Lease Term

At commencement, lease term = 6 years (no renewal assumed).

At 31 December 20X3:

Significant refurbishment (R600 000) that is specific to the leased premises.
RetailMall is now reasonably certain to renew for 4 years.

This constitutes a significant event or change in circumstances under IFRS 16 that:

Is within the control of the lessee, and
Affects the assessment of whether it is reasonably certain to exercise the renewal option.

Therefore, as from 1 January 20X4, RetailMall must reassess the lease term to include the renewal period:

New lease term total: 6 + 4 = 10 years.

5.3.2 Remeasurement of Lease Liability at 1 January 20X4

First, determine:

Lease payments remaining in original term.
Additional payments under renewal term.

Assume:

lease payments remain R250 000 per year (as stated), including during renewal period (even if below market).

Timeline:

Original term: 1 Jan 20X1 – 31 Dec 20X6.
As at 1 Jan 20X4, 3 years have passed (20X1–20X3), and 3 years remain (20X4–20X6) in original term.
Renewal option adds 4 more years (20X7–20X10).

Total remaining lease payments from 1 Jan 20X4:

7 payments of R250 000 (years 20X4 to 20X10 inclusive).

Under IFRS 16:

For changes in lease term, use a revised discount rate at date of reassessment: 9%.

Calculate PV of 7 payments at 9%.

[
PVAF_{9%,7} = \frac{1 – (1.09)^{-7}}{0.09}
]
[
(1.09)^{-7} \approx 0.547
]
[
PVAF_{9%,7} \approx \frac{1 – 0.547}{0.09} = \frac{0.453}{0.09} \approx 5.033
]

PV of 7 payments:

[
250,000 \times 5.033 = R1,258,250 \ (\text{approx.})
]

This is the new lease liability at 1 January 20X4.

However, we must know the carrying amount of the old lease liability at 1 January 20X4 to compute the adjustment.

Assume the exam provides or previously computed the schedule up to 31 December 20X3. For illustration, suppose:

Carrying amount at 1 Jan 20X4 (after three years of payments and interest) is R756 000 (a consistent illustrative figure for explanation; in an actual exam, this would be based on prior detailed calculation).

Remeasurement adjustment:

[
\Delta \text{Lease liability} = 1,258,250 – 756,000 = R502,250
]

5.3.3 Journal Entry – Remeasurement

IFRS 16 requires:

Adjust the ROU asset by the same amount as remeasurement of the lease liability.

Entry at 1 Jan 20X4:

Dr Right-of-use asset – Retail store       502 250
     Cr Lease liability                             502 250

The increased ROU asset will then be depreciated over the revised remaining term of the lease:

Remaining term as at 1 Jan 20X4: 7 years (20X4–20X10).

This case tests multiple IFRS 16 skills often examined in UNISA CTA and advanced FAC3704 exams:

Assessment of lease term.
Use of revised discount rates.
Proper adjustment to ROU asset.

5.4 Case Study 4 – Short‑Term Lease Exemption (CUT / Diploma Level)

Scenario – QuickHire (Pty) Ltd

QuickHire (Pty) Ltd, a Bloemfontein-based company, rents office equipment (printers and copiers) from a local supplier on 11‑month contracts with no renewal options and no purchase options.

Each contract is for 11 months.
Lease payments: R8 000 per month.
Equipment is not highly specialised.
QuickHire signs several such contracts during the year, all starting on different dates but all for 11 months each.
QuickHire’s policy is to apply the short‑term lease exemption for leases with terms of 12 months or less.

Required:

Explain how QuickHire accounts for these leases under IFRS 16.
Show the journal entry for one contract for the year ended 28 February 20X2 (QuickHire’s year‑end), assuming one contract starts on 1 June 20X1.

5.4.1 Accounting Treatment – Short‑Term Lease Exemption

Because each contract:

Has a lease term of 11 months or less,
Has no purchase option,

and QuickHire elects the short‑term lease exemption, QuickHire:

Does not recognise ROU asset or lease liability.
Recognises lease expense on a straight‑line basis over lease term (which in this case equals monthly payments).

5.4.2 Journal Entries – 1 Contract

For contract commencing 1 June 20X1:

Lease term: 1 June 20X1 to 30 April 20X2.
Monthly payments: R8 000.
For year ended 28 Feb 20X2, months within period:
- Jun, Jul, Aug, Sep, Oct, Nov, Dec, Jan, Feb = 9 months.

Total expense for 20X1/20X2 financial year:

[
9 \times 8,000 = R72,000
]

Monthly journal entry (for each month):

Dr Lease expense – office equipment       8 000
     Cr Bank                                         8 000

Or for summarised year‑end entry (if paid monthly throughout):

Dr Lease expense – office equipment      72 000
     Cr Bank                                        72 000

Exam note:

This demonstrates recognition of short‑term lease expense, not capitalisation.
It tests students’ understanding of lease exemptions and basic expense recognition.

5.5 Case Study 5 – Comparison: IFRS 16 vs IAS 17 Impact (Analytical Question)

Scenario – UniBooks (Pty) Ltd

UniBooks, a textbook distributor supplying universities including UNISA and CUT, leased a warehouse on 1 January 20X1 for 10 years.

Annual rent: R500 000, in arrears.
Incremental borrowing rate: 9%.
Under IAS 17, this would have been treated as an operating lease with R500 000 expense per year.
Under IFRS 16, recognise ROU asset and lease liability.

Question (typical CTA / advanced undergraduate analysis):

Explain qualitatively how the adoption of IFRS 16 affects UniBooks’:
- Statement of financial position,
- Statement of profit or loss,
- Key ratios (e.g. EBITDA, gearing, return on assets),
- Particularly in the early years of the lease.

5.5.1 Impact on Statement of Financial Position

Under IFRS 16:

Recognise ROU asset:
- At commencement, approximate equal to PV of lease payments.
Recognise lease liability:
- Higher initial liabilities, similar magnitude.

Overall effect:

Total assets increase (ROU asset).
Total liabilities increase (lease liability).
Equity initially unchanged, but subsequently affected by different pattern of expenses.

This contrasts with IAS 17, where leases would often be off‑balance sheet.

5.5.2 Impact on Profit or Loss

Under IAS 17:

Uniform rental expense of R500 000 per year.

Under IFRS 16:

Two separate expenses:
- Depreciation of ROU asset (straight‑line),
- Interest expense on lease liability (declining over time).

Total expense pattern:

Higher in early years (because interest on higher liability),
Lower in later years.

Therefore, in early years:

Profit before tax is lower under IFRS 16 than under IAS 17.
In later years:
- Profit before tax may be higher, as interest component falls.

5.5.3 Impact on Key Ratios

EBITDA (Earnings Before Interest, Tax, Depreciation, Amortisation):
- Under IAS 17:
  - Lease expense (R500 000) reduces EBITDA.
- Under IFRS 16:
  - Lease expense replaced with depreciation + interest.
  - Depreciation reduces EBITDA, but interest does not.
- Net effect: Higher EBITDA under IFRS 16, because rental expense is no longer part of operating expenses.
Gearing (Debt‑to‑Equity):
- Leases recognised as liabilities.
- Higher gearing (more debt on balance sheet).
Return on Assets (ROA):
- Assets increase (ROU asset).
- Profit in early years is slightly lower due to front‑loaded total expense.
- ROA may decrease initially.
Interest coverage ratio:
- Interest expense increases (including lease interest).
- EBITDA higher but interest also higher; net effect depends on specifics.

In South African CTA exams, candidates might be required to comment on how adoption of IFRS 16 affects covenant ratios, banking agreements, and investment analysis.

This comprehensive guide provides the conceptual explanations, detailed calculations, and integrated case studies that align closely with the question styles in UNISA FAC3703 exam notes, UNISA CTA IFRS 16 case studies, and CUT Financial Reporting and Accounting modules. Mastery of these principles, methods, and exam patterns is crucial for success in South African university assessments on IFRS 16: Leases, and for broader understanding within the “International Financial Reporting Standards (IFRS) Guides” series.