Quantitative Examples: Change from Going Concern to Liquidation Basis for Liabilities Under IFRS 16, Including Repossession

Introduction

Under IFRS 16, the recognition and measurement of lease liabilities can significantly change when an entity transitions from a going concern to a liquidation basis. This report provides three quantitative examples to illustrate how the recognition and measurement of lease liabilities change during this transition, including scenarios involving repossession of leased assets.

Example 1: Office Lease

Going Concern Basis

A company has a lease for office space with an annual lease payment of R200,000. The lease term is 5 years, and the company applies a discount rate of 5% to measure the lease liability.

Calculation (Going Concern):

• Present Value of Lease Payments (Discounted at 5%):

• PV = R200,000 / (1+5%) + R200,000 / (1+5%)^2 + R200,000 / (1+5%)^3 + R200,000 / (1+5%)^4 + R200,000 / (1+5%)^5

• PV = R190,476 + R181,406 + R172,768 + R164,540 + R156,705

• PV = R865,895

Liquidation Basis

Upon deciding to liquidate, the company negotiates an early termination of the lease. The early termination penalty is R100,000.

Calculation (Liquidation Basis):

• Early Termination Penalty = R100,000

• Total Settlement Amount = Early Termination Penalty

• Total Settlement Amount = R100,000

Summary

• Carrying Value (Going Concern): R865,895

• Liquidation Value: R100,000

Adjustment Needed: Decrease in lease liability recognition by R765,895 (from R865,895 to R100,000).

Example 2: Equipment Lease

Going Concern Basis

A company leases equipment with an annual lease payment of R50,000 for a term of 4 years. The company uses a discount rate of 6% to measure the lease liability.

Calculation (Going Concern):

• Present Value of Lease Payments (Discounted at 6%):

• PV = R50,000 / (1+6%) + R50,000 / (1+6%)^2 + R50,000 / (1+6%)^3 + R50,000 / (1+6%)^4

• PV = R47,170 + R44,500 + R41,981 + R39,610

• PV = R173,261

Liquidation Basis

In liquidation, the company agrees with the lessor to terminate the lease early for a penalty of R20,000.

Calculation (Liquidation Basis):

• Early Termination Penalty = R20,000

• Total Settlement Amount = Early Termination Penalty

• Total Settlement Amount = R20,000

Summary

• Carrying Value (Going Concern): R173,261

• Liquidation Value: R20,000

Adjustment Needed: Decrease in lease liability recognition by R153,261 (from R173,261 to R20,000).

Example 3: Vehicle Lease

Going Concern Basis

A logistics company leases delivery vehicles with annual lease payments of R30,000 for a term of 3 years. The company uses a discount rate of 4% to measure the lease liability.

Calculation (Going Concern):

• Present Value of Lease Payments (Discounted at 4%):

• PV = R30,000 / (1+4%) + R30,000 / (1+4%)^2 + R30,000 / (1+4%)^3

• PV = R28,846 + R27,737 + R26,682

• PV = R83,265

Liquidation Basis

The company negotiates an early termination of the vehicle lease, incurring a penalty of R10,000.

Calculation (Liquidation Basis):

• Early Termination Penalty = R10,000

• Total Settlement Amount = Early Termination Penalty

• Total Settlement Amount = R10,000

Summary

• Carrying Value (Going Concern): R83,265

• Liquidation Value: R10,000

Adjustment Needed: Decrease in lease liability recognition by R73,265 (from R83,265 to R10,000).

Impairment Issues Under IFRS 16

When an entity transitions from a going concern to a liquidation basis, it must also assess the impairment of its right-of-use assets. Under IFRS 16, the impairment model in IAS 36 applies. This requires entities to assess whether there is any indication that a right-of-use asset may be impaired.

Example 4: Office Lease Right-of-Use Asset

Going Concern Basis

A company recognizes a right-of-use asset for its office lease. The carrying value of the right-of-use asset is R800,000. The company assesses the asset for impairment and finds no indications of impairment.

Calculation (Going Concern):

• Carrying Value of Right-of-Use Asset = R800,000

Liquidation Basis

With the decision to liquidate, the company re-evaluates the right-of-use asset and determines that it will no longer derive economic benefits from it. The recoverable amount of the right-of-use asset is estimated to be R200,000 (net realizable value).

Calculation (Liquidation Basis):

• Recoverable Amount = R200,000

• Impairment Loss = Carrying Value - Recoverable Amount

• Impairment Loss = R800,000 - R200,000 = R600,000

Summary

• Carrying Value (Going Concern): R800,000

• Carrying Value (Liquidation Basis): R200,000

Adjustment Needed: Recognition of impairment loss of R600,000.

Example 5: Equipment Lease Right-of-Use Asset

Going Concern Basis

A company recognizes a right-of-use asset for its equipment lease. The carrying value of the right-of-use asset is R300,000. The company assesses the asset for impairment and finds no indications of impairment.

Calculation (Going Concern):

• Carrying Value of Right-of-Use Asset = R300,000

Liquidation Basis

Upon deciding to liquidate, the company determines that it will no longer use the leased equipment. The recoverable amount of the right-of-use asset is estimated to be R50,000.

Calculation (Liquidation Basis):

• Recoverable Amount = R50,000

• Impairment Loss = Carrying Value - Recoverable Amount

• Impairment Loss = R300,000 - R50,000 = R250,000

Summary

• Carrying Value (Going Concern): R300,000

• Carrying Value (Liquidation Basis): R50,000

Adjustment Needed: Recognition of impairment loss of R250,000.

Repossession of Leased Assets

When an entity is in liquidation, lessors may repossess leased assets to mitigate their losses. This can affect the financial statements of the lessee, particularly regarding lease liabilities and right-of-use assets.

Example 6: Repossession of Leased Vehicles

Going Concern Basis

A logistics company has a lease liability and right-of-use asset for delivery vehicles. The carrying value of the lease liability is R200,000, and the right-of-use asset is R180,000.

Calculation (Going Concern):

• Carrying Value of Lease Liability = R200,000

• Carrying Value of Right-of-Use Asset = R180,000

Liquidation Basis and Repossession

The lessor repossesses the leased vehicles due to the liquidation. The company no longer has to make future lease payments but incurs a repossession fee of R10,000. The right-of-use asset is derecognized.

Calculation (Liquidation Basis):

• Repossession Fee = R10,000

• Remaining Lease Liability = R200,000 (no longer payable)

• Derecognized Right-of-Use Asset = R180,000

• Net Gain/Loss from Repossession = Derecognized Lease Liability - Repossession Fee - Derecognized Right-of-Use Asset

• Net Gain/Loss = R200,000 - R10,000 - R180,000 = R10,000 (Gain)

Summary

• Carrying Value (Going Concern): Lease Liability: R200,000; Right-of-Use Asset: R180,000

• Liquidation Value: Lease Liability: R0; Right-of-Use Asset: R0; Gain: R10,000

Adjustment Needed: Recognition of a gain of R10,000 from the repossession and derecognition of both the lease liability and right-of-use asset.

Conclusion

The transition from a going concern basis to a liquidation basis under IFRS 16 significantly impacts the recognition, measurement, and impairment of lease liabilities and right-of-use assets. The examples provided demonstrate how liabilities are adjusted to reflect their expected settlement amounts during liquidation, including any early termination penalties and repossession scenarios. These adjustments ensure that financial statements provide a true and fair view of an entity’s financial position during liquidation, complying with the principles of IFRS 16 and IAS 36.

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