IFRS 16 Leases
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Background
IFRS 16 replaces old ‘Lease’ standard IAS 17 and related interpretations wherein it
changes the accounting substantially for lessees. The new Standard eliminates a
lessee’s classification of leases as either operating leases or finance leases.
According to new standard, almost all leases shall be ‘capitalised’ by
recognising a lease liability and right-of-use asset on the balance sheet of
lessee. There is little change for lessors.
Why
this change was required? - Historically, assets that were used but not owned
(lease) were not shown on the statement of financial position and therefore any
associated liability was also left out of the statement which was known as ‘off
balance sheet’ finance and was a way that companies were able to keep their
liabilities low, thus distorting gearing and other key financial ratios. This
form of accounting did not faithfully represent the transaction.
IFRS
16 will increase visibility of companies’ lease commitments and better reflect
economic reality. The Standard will also make it easier for users of financial
statements to compare companies that lease their assets with companies that
borrow money to buy their assets, creating a more level playing field.
Applicability
IFRS
16 Leases was issued in January 2016 and is effective 1 January 2019,
with earlier application permitted.
IFRS 16 has the following transition provisions:
Existing finance leases: continue to be treated as finance leases.
Existing operating leases: option for full or limited retrospective
restatement to reflect the requirements of IFRS 16.
Objective
The
objective of IFRS 16 is to report information that;
(a)
Faithfully represents lease transactions and
(b)
Provides a basis for users of financial statements to assess the amount, timing
and uncertainty of cash flows arising from leases. To meet that objective, a
lessee should recognise assets and liabilities arising from a lease.
Scope
The
standard shall apply to all leases, including leases of right-of-use assets in
a sublease, except for:
(a)
leases to explore for or use minerals, oil, natural gas and similar
non regenerative resources;
(b)
leases of biological assets within the scope of IAS 41 Agriculture held by a
lessee;
(c)
service
concession arrangements within the scope of IFRIC 12 Service Concession
Arrangements;
(d)
licences
of intellectual property granted by a lessor within the scope of IFRS 15 Revenue from Contracts with Customers; and
(e)
rights
held by a lessee under licensing agreements within the scope of IAS 38
Intangible Assets for such items as motion picture films, video recordings,
plays, manuscripts, patents and copyrights. A lessee may, but is not required
to, apply this Standard to leases of intangible assets other than those
described here.
Key definitions:
Commencement
date
The
date on which a lessor makes an underlying asset available for use by a lessee.
Economic
life
Either
the period over which an asset is expected to be economically usable by one or
more users or the number of production or similar units expected to be obtained
from an asset by one or more users.
Fair value
For
the purpose of applying the lessor accounting requirements in this Standard,
the amount for which an asset could be exchanged, or a liability settled,
between knowledgeable, willing parties in an arm’s length transaction.
Lease
A
contract, or part of a contract, that conveys the right to use an asset (the
underlying asset) for a period of time in exchange for consideration
Lessee
An
entity that obtains the right to use an underlying asset for a period of
time in exchange for consideration.
Lessor
An
entity that provides the right to use an underlying 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.
Recognition
Exemption
A
lessee may elect not to apply the requirements;
(a)
leases with a lease term of 12 months or less and containing no
purchase options – this election is made by class of underlying asset; and
(b)
leases where the underlying asset has a low value* when new (such as
personal computers or small items of office furniture) – this election can be
made on a lease-by-lease basis.
In
this case, the lessee shall recognise the lease payments associated with those
leases as an expense on either a straight-line basis over the lease term or
another systematic basis.
*Low
Value- The assessment of low value is performed on an absolute
basis. The assessment is not affected by the size, nature or circumstances of
the lessee. An underlying asset can be of low value only if: (a) the lessee can
benefit from use of the underlying asset on its own or together with other
resources that are readily available to the lessee; and (b) the underlying
asset is not highly dependent on, or
highly interrelated with, other assets.
Identifying
a Lease
A
contract is a lease if it conveys the right
to control the use of an identified asset for a period of time in exchange for
consideration. Control is conveyed
where the customer has both;
ü the right to
direct the identified asset’s use and
ü to obtain substantially all the economic
benefits from that use.
Reassessment of any
contact is required if there is any change in terms and conditions.
Separating
components of a contract: For multiple-element arrangements that contain a lease, lessors
must perform an assessment to identify whether there are multiple lease
components using the IFRS 16 guidance. Any non-lease components are assessed
under IFRS 15 for separate performance obligations
An
entity shall account for each lease component within the contract as a lease,
separately from non-lease components of the contract, unless the entity applies
the practical expedient
Allocation
of consideration:
·
In the books of Lessee:
A contract that contains a lease component and one or more additional lease or
non-lease components, a lessee shall allocate the consideration in the contract
to each lease component on the basis
of;
o
the relative stand-alone price of the lease component and
o
the aggregate stand-alone
price of the non-lease components
The prices are determined based on the price a lessor or similar
supplier would charge for that component separately. If observable prices are
not readily available, a lessee should estimate the price maximising the use of
observable information.
·
In the books of Lessor:
For a contract that contains a lease component and one or more additional lease
or non-lease components, a lessor allocate consideration in accordance with IFRS 15, on the basis of stand-alone selling prices.
Lease term
An
entity shall determine the lease term as the non-cancellable period of a lease,
together with both:
(a)
periods covered by an option to extend the lease if the lessee is reasonably certain* to exercise that
option; and
(b)
periods covered by an option to terminate the lease if the lessee is reasonably certain* not to exercise that
option.
*
Reasonably certain- An entity shall
consider all relevant facts and circumstances that create an economic incentive
for the lessee to exercise (or not exercise) the option.
In the books
of Lessee
Recognition: At the
commencement date, a lessee shall recognise a right-of-use asset and a lease
liability.
Measurement: Refer
following for initial and subsequent measurement:
Initial measurement-
Initial
measurement of the right-of-use asset: At the commencement date, a lessee shall
measure the right-of-use asset at cost which comprises following:
(a)
the amount of the initial measurement of the lease liability;
(b)
any lease payments made at or before the commencement date, less any lease
incentives received;
(c)
any initial direct costs incurred by the lessee; and
(d)
an estimate of costs to be incurred by the lessee in dismantling and
removing the underlying asset, restoring the site on which it is located or
restoring the underlying asset to the condition required by the terms and
conditions of the lease, unless those costs are incurred to produce
inventories. The lessee incurs the obligation for those costs either at the
commencement date or as a consequence of having used the underlying asset
during a particular period.
Initial
measurement of the lease liability: At the
commencement date, a lessee shall measure the lease liability at the present value of the lease payments that
are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the
lease, if that rate can be readily determined. If that rate cannot be readily
determined, the lessee shall use the lessee’s incremental borrowing rate.
The
lease liability comprises the following payments for the ‘right to use’ the
underlying asset that are not paid at the commencement date:
(a)
fixed lease payments, less any lease
incentives receivable;
(b) variable lease payments that depend on
an index or a rate, initially measured using the index or rate as at the
commencement date;
(c)
amounts expected to be payable by the lessee under residual value guarantees;
(d)
the exercise price of a purchase
option if the lessee is reasonably certain to exercise that option; and
(e)
payments of penalties for
terminating the lease, if the lease term reflects the lessee exercising an
option to terminate the lease.
Subsequent measurement-
Subsequent
measurement of the right-of-use asset: After the commencement date, a lessee shall
measure the right-of-use asset applying a cost model,
unless:
Ø If lessee
applies the fair value model in IAS 40 Investment property, it shall apply the
same for right of use assets.
Ø If right of
use assets relates to PPE which applies revaluation model under IAS 16, lessee
may elect the same revaluation model to all right of use assets.
Cost Model - To apply a
cost model, a lessee shall measure the right‑of‑use asset at cost:
(a)
less any accumulated depreciation and any accumulated impairment losses; and
(b)
adjusted for any remeasurement of the lease liability
Note-
Lessee shall apply the depreciation and impairment on right of use asset per
IAS 16 (PPE) and IAS 36 (Impairment) respectively.
Subsequent
measurement of the lease liability: After the commencement date, a lessee shall
measure the lease liability by:
(a)
increasing the carrying amount to reflect interest on the lease liability;
(b)
reducing the carrying amount to reflect the lease payments made; and
(c)
remeasuring the carrying amount to reflect any reassessment or lease modifications
(define below)
After
the commencement date, a lessee shall recognize the below in profit or loss (unless
the costs are included in the carrying amount of another asset applying other
applicable Standards):
(a)
interest on the lease liability; and
(b)
variable lease payments not included in the measurement of the lease liability
in the period in which the event or condition that triggers those payments
occurs.
Reassessment
of the lease liability
After
the commencement date, lessees are required to remeasure the lease liability to
reflect changes to the lease payments arising from changes in the index or
rate. Any re-measurement is generally adjusted against the right-of-use asset.
Lessees
reassess the lease liability by discounting the revised lease payments in the
following scenarios.
Lease
Modification
A
lessee shall account for a lease modification as a separate lease if both:
(a)
the modification increases the scope of the lease by adding the right to use one
or more underlying assets; and
(b)
the consideration for the lease increases by an amount commensurate with the
stand-alone price for the increase in scope and any appropriate adjustments to
that stand-alone price to reflect the circumstances of the particular contract
Recognition
and measurement of modification that is not
accounted for as a separate lease:
In the books
of Lessor
Classification
of leases:
A
lessor shall classify each of its leases as either an operating lease or a
finance lease.
As
lease is a finance lease or an operating lease depends on the substance of the transaction
rather than the form of the contract. Examples of situations that individually
or in combination would normally lead to a lease being classified as a finance
lease are:
(a)
the lease transfers ownership of the
underlying asset to the lessee by the end of the lease term;
(b)
the lessee has the option to purchase
the underlying asset at a price that is expected to be sufficiently lower
than the fair value at the date the option becomes exercisable for it to be
reasonably certain, at the inception date, that the option will be exercised;
(c)
the lease term is for the major part
of the economic life of the underlying asset even if title is not
transferred;
(d)
at the inception date, the present value of the lease payments amounts to at
least substantially all of the fair
value of the underlying asset; and
(e)
the underlying asset is of such a specialised
nature that only the lessee can use it without major modifications.
The
following situations (individually or in combination) also lead a lease
as a finance lease:-
(a) if the
lessee can cancel the lease, the lessor’s losses associated with the
cancellation are borne by the lessee;
(b) gains or losses from the fluctuation in the
fair value of the residual accrue to the lessee (for example, in the form of a
rent rebate equaling most of the sales proceeds at the end of the lease); and
(c) the lessee
has the ability to continue the lease for a secondary period at a rent that is
substantially lower than market rent.
Reassessment
of lease classification: As lease is classified at inception date and is reassessed only if
there is a lease modification.
Finance
Lease
Initial Recognition- At the
commencement date, a lessor shall recognise assets held under a finance lease
in its statement of financial position and present them as a receivable at an
amount equal to the net investment in the lease.
Net
investment in the lease equals to the payments not paid at the commencement
date discounted to present value (exactly the same as described in lessee’s
accounting) plus the initial direct costs.
Subsequent Measurement-
A
lessor shall recognise finance income over the lease term, based on a pattern
reflecting a constant periodic rate of return on the lessor’s net investment in
the lease.
A
lessor shall review regularly estimated unguaranteed residual values used in
computing the gross investment in the lease. If there has been a reduction in
the estimated unguaranteed residual value, the lessor shall revise the income
allocation over the lease term and recognise immediately any reduction in
respect of amounts accrued.
Note- A lessor
shall apply the derecognition and impairment requirements in IFRS 9 to the net
investment in the lease.
Lease
Modification
A
lessor shall account for a modification to a finance lease as a separate lease
per following:
If
modification is not a separate lease, lessor shall account that modification as
below:-
(a) if the lease would have been classified as
an operating lease had the modification been in effect at the inception date,
the lessor shall-
(i)
account for the lease modification as a new lease from the effective date of
the modification; and
(ii)
measure the carrying amount of the underlying asset as the net investment in
the lease immediately before the effective date of the lease modification.
(b)
otherwise, the lessor shall apply the requirements of IFRS 9.
Operating Lease
Recognition
and measurement -A lessor shall recognise lease payments from operating leases as
income on either a straight-line basis or another systematic basis. The lessor
shall apply another systematic basis if that basis is more representative of
the pattern in which benefit from the use of the underlying asset is
diminished.
Lease
modification- A lessor shall account for a modification to an operating lease
as a new lease from the effective date of the modification, considering any
prepaid or accrued lease payments relating to the original lease as part of the
lease payments for the new lease.
Sale and leaseback transactions
A
sale and leaseback transaction involves the sale of an asset and the
leasing the same asset back. In this situation, a seller becomes a lessee and a
buyer becomes a lessor.
If an entity
(the seller-lessee) transfers an asset to another entity (the buyer-lessor) and
leases that asset back from the buyer-lessor, both the seller-lessee and the
buyer-lessor shall account for the transfer contract under the clauses of ‘Sale
and leaseback transaction’.
Accounting
treatment
of sale and leaseback transactions depends on whether the transfer of an asset
is a sale under IFRS 15 Revenue from contracts with customers by determining when a
performance obligation is satisfied.
If a
transfer is a sale:
The
seller (lessee) accounts for the right-of-use asset at the proportion of
the previous carrying amount related to the right-of-use retained. Gain or
loss is recognized only to the extend related to the rights transferred.
The
buyer (lessor) accounts for a purchase of an asset under applicable standards
and for the lease under IFRS 16.
If a
transfer is NOT a sale:
The
seller (lessee) keeps recognizing transferred asset and accounts for the cash
received as for a financial liability
under IFRS 9 Financial Instruments.
The
buyer recognizes a financial asset
under IFRS 9 amounting to the cash paid.
You may also refer the following standards:-
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