CAF-6 · Chapter 3
IFRS 16 Leases MCQs with Answers
15 multiple-choice questions on IFRS 16 Leases for CAF-6 Corporate Reporting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
Zenith Ltd enters into a contract for the use of a specialized generator. The supplier has the practical ability to substitute the generator throughout the period of use and would economically benefit from doing so. Is this a lease under IFRS 16?
- A) Yes, because it involves a specific asset.
- B) No, because the supplier has a substantive right of substitution.
- C) Yes, because Zenith Ltd has physical possession.
- D) No, because generators are low-value items.
Show answer & explanation
Answer: B) No, because the supplier has a substantive right of substitution.
An asset is not considered identified if the supplier has a substantive right of substitution. This exists when the supplier can practically replace the asset and would benefit economically from doing so.
Question 2
Proton Corp leases a warehouse for 5 years. The contract includes an option to extend for another 3 years. Proton is reasonably certain to exercise this option. What is the lease term?
- A) 3 years
- B) 5 years
- C) 8 years
- D) 10 years
Show answer & explanation
Answer: C) 8 years
The lease term includes the non-cancellable period plus periods covered by an extension option if the lessee is reasonably certain to exercise it. Therefore, 5 years plus the 3-year extension equals 8 years.
Question 3
A lessee acquires a machine with a 4-year lease term. The machine has a 6-year useful life. There is no transfer of ownership or purchase option at the end of the term. Over what period should the right-of-use asset be depreciated?
- A) 2 years
- B) 4 years
- C) 5 years
- D) 6 years
Show answer & explanation
Answer: B) 4 years
If the lease does not transfer ownership and there is no purchase option, the asset is depreciated over the shorter of the useful life and the lease term. Here, 4 years is shorter than 6 years.
Question 4
At commencement, Titan Ltd recognizes a lease liability of Rs. 500,000. It also pays initial direct costs of Rs. 20,000 and receives a lease incentive of Rs. 5,000. What is the initial cost of the right-of-use asset?
- A) Rs. 500,000
- B) Rs. 515,000
- C) Rs. 520,000
- D) Rs. 525,000
Show answer & explanation
Answer: B) Rs. 515,000
The cost of the right-of-use asset includes the initial lease liability plus initial direct costs, less any lease incentives received. Calculation: 500,000 + 20,000 - 5,000 = Rs. 515,000.
Question 5
A company leases a high-end laptop for 10 months at a cost of Rs. 8,000 per month. There is no purchase option. How can the company choose to account for this under IFRS 16?
- A) Must recognize a right-of-use asset and lease liability.
- B) Must recognize it as an intangible asset.
- C) Can elect to recognize lease payments as an expense on a straight-line basis.
- D) Must capitalize it as property, plant, and equipment.
Show answer & explanation
Answer: C) Can elect to recognize lease payments as an expense on a straight-line basis.
Lessees can choose to apply a recognition exemption for short-term leases, which are leases with a term of 12 months or less and no purchase option. In such cases, payments are recognized as an expense over the lease term.
Question 6
Under IFRS 16, which of the following items is EXCLUDED from the initial measurement of a lease liability?
- A) Variable lease payments based on an index.
- B) Exercise price of a reasonably certain purchase option.
- C) Residual value guarantees expected to be payable.
- D) Variable lease payments based on the lessee's future sales.
Show answer & explanation
Answer: D) Variable lease payments based on the lessee's future sales.
Lease liabilities include fixed payments and variable payments that depend on an index or rate. Variable payments that depend on future performance or use (like sales) are excluded and recognized in profit or loss when the triggering event occurs.
Question 7
A lessor classifies a lease as a finance lease if:
- A) The lease term is for less than 25% of the asset's life.
- B) It does not transfer substantially all risks and rewards of ownership.
- C) It transfers substantially all risks and rewards incidental to ownership.
- D) The asset is of a common nature used by many companies.
Show answer & explanation
Answer: C) It transfers substantially all risks and rewards incidental to ownership.
A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset. Otherwise, it is an operating lease.
Question 8
Nova Motors (a dealer) leases a car to a client. The car's cost is Rs. 2M, its fair value is Rs. 2.5M, and the PV of lease payments is Rs. 2.3M. At what amount should Nova Motors recognize 'Sales'?
- A) Rs. 2,000,000
- B) Rs. 2,300,000
- C) Rs. 2,500,000
- D) Rs. 4,500,000
Show answer & explanation
Answer: B) Rs. 2,300,000
For a manufacturer or dealer lessor, sales revenue is recognized at the lower of the fair value of the asset and the present value of the lease payments. Here, Rs. 2.3M is lower than Rs. 2.5M.
Question 9
Where should a lessee present the interest expense on a lease liability in the Statement of Comprehensive Income?
- A) As part of depreciation expense.
- B) Within administrative expenses.
- C) Separately as a component of finance costs.
- D) Within other comprehensive income.
Show answer & explanation
Answer: C) Separately as a component of finance costs.
IFRS 16 requires interest expense on the lease liability to be presented separately from the depreciation of the right-of-use asset, specifically as a component of finance costs.
Question 10
In the Statement of Cash Flows, a lessee should classify the principal portion of lease payments as:
- A) Operating activities
- B) Investing activities
- C) Financing activities
- D) Non-cash transactions
Show answer & explanation
Answer: C) Financing activities
Lessees classify cash payments for the principal portion of the lease liability within financing activities in the statement of cash flows.
Question 11
An entity leases an office printer with a new value of Rs. 40,000. The lease is for 3 years. This asset would likely be classified as a:
- A) Finance lease
- B) Right-of-use asset only
- C) Lease of a low-value item
- D) Non-identifiable asset
Show answer & explanation
Answer: C) Lease of a low-value item
Leases of low-value items, such as telephones or small office equipment, are eligible for a recognition exemption regardless of the lease term. This applies if the asset is typically of low value when new.
Question 12
At the end of a 4-year lease, a company pays a penalty of Rs. 50,000 because it chose to terminate the lease early as allowed in the contract. If this was expected at commencement, the penalty should have been:
- A) Expensed only when paid.
- B) Included in the initial measurement of the lease liability.
- C) Disclosed as a contingent liability.
- D) Ignored in the 5-step model.
Show answer & explanation
Answer: B) Included in the initial measurement of the lease liability.
Lease payments include payments of penalties for terminating the lease if the lease term reflects the lessee exercising an option to terminate.
Question 13
What is 'Net investment in the lease' from a lessor's perspective?
- A) The total undiscounted lease payments.
- B) Gross investment in the lease minus unearned finance income.
- C) The fair value of the asset at the end of the term.
- D) Only the guaranteed residual value.
Show answer & explanation
Answer: B) Gross investment in the lease minus unearned finance income.
Net investment in the lease is defined as the gross investment (undiscounted lease payments plus unguaranteed residual value) discounted at the interest rate implicit in the lease. This equals gross investment minus unearned finance income.
Question 14
A lessor under an operating lease should recognize lease income:
- A) Only when cash is received.
- B) On a straight-line basis over the lease term.
- C) In full at the commencement of the lease.
- D) Based on the interest rate implicit in the lease.
Show answer & explanation
Answer: B) On a straight-line basis over the lease term.
For operating leases, lessors recognize lease income on a straight-line basis over the lease term unless another systematic basis is more representative of the benefit usage.
Question 15
Which of the following is an indicator that a lease might be a finance lease for a lessor?
- A) The lease term is for 10% of the asset's economic life.
- B) The lessee can cancel the lease without any penalty.
- C) The asset is specialized and can only be used by the lessee without major modification.
- D) The fair value of the asset is significantly higher than the PV of rentals.
Show answer & explanation
Answer: C) The asset is specialized and can only be used by the lessee without major modification.
One of the situations that normally leads to a finance lease classification is when the leased asset is of such a specialized nature that only the lessee can use it without major modifications.