ifrs 16: leases

OVERVIEW


IFRS 16 was issued in January 2016 to replace the old leas standard (IAS 17). This standard was developed jointly with the Financial Accounting Standard Board of the United States of America (FASB) to adopt a new approach to lease accounting by lessees. In summary:


=> Lessees are required to recognize all the assets and liabilities created under the lease agreement and the distinction between the finance lease and operating lease created by IAS 17 is removed also by IFRS 16.

=> The IASB believes that this approach will provide a more faithful representation of the lessee’s financial position and will also provide greater transparency.

=> For the lessor, there is a little change in the requirements, and the distinction between the finance lease and operating lease is retained for the lessor and therefore it is carried forward from IAS 17 to this new standard.

=> The main objective of the IFRS 16 is to provide a complete and accurate picture of the leasing activities of an entity.


The previous lease standard (IAS 17) was criticized because it does not require the lessee to recognize the assets and liabilities for the operating lease so the users were provided with incomplete information about the leasing activities. However, IFRS 16 is developed to address this criticism.

Key Takeaway Points


=> IFRS 16 was issued in January 2016 to replace the old leas standard (IAS 17). This standard was developed jointly with the Financial Accounting Standard Board of the United States of America (FASB) to adopt a new approach to lease accounting by lessees.


=> Lessees are required to recognize all the assets and liabilities created under the lease agreement and the distinction between the finance lease and operating lease created by IAS 17 is removed also by IFRS 16.


=> For the lessor, there is a little change in the requirements, and the distinction between the finance lease and operating lease is retained for the lessor and therefore it is carried forward from IAS 17 to this new standard.


=> The main objective of the IFRS 16 is to provide a complete and accurate picture of the leasing activities of an entity.


=> The previous lease standard (IAS 17) was criticized because it does not require the lessee to recognize the assets and liabilities for the operating lease so the users were provided with incomplete information about the leasing activities. However, IFRS 16 is developed to address this criticism.


=> The lease payments shall be discounted to present value using the interest implicit in the lease. If the interest implicit in the lease is not available then the lessee’s incremental borrowing rate should be used for the calculation of the present value of the lease payments.


=> The incremental borrowing rate is the rate at which the lessee borrow fund to purchase similar assets under the same terms and conditions.


LEASE ACCOUNTING BY LESSEES


IFRS 16 defines the lease as the contract that conveys the right to a party to use assets in exchange for consideration for a specific period of time. This standard requires that the lessee is required to recognize the right of use asset and lease liability at the commencement of the lease.


Right of use asset means the asset that represents the lessee’s right to use the asset for the specified lease term.


The requirements to recognize the right of use asset and lease liability apply to all types of leases. However, the following are some exceptions to it:


=> The lease is for short term I-e the lease period is less than 12 months, and

=> The underlying lease asset is of low value.


If the above two conditions exist then there will be no right of use asset and lease liability and the lease payments shall be spread over the total lease term under the straight-line basis.


The term low value is not defined in IFRS 16. However, the basis for conclusion for IFRS 16 (which is not actually part of the standard) suggests that asset(s) with a value not exceeding five thousand US dollars might be regarded as a low-value asset(s).


THE INITIAL MEASUREMENT OF THE RIGHT OF USE ASSET AND LEASE LIABILITY


The right of use asset shall be measured at cost initially while adding together the following elements:


=> The amount of the initial measurement of the lease liability.

=> Any lease payments made before the commencement of the lease.

=> Any initial direct cost incurred by the lessee in connection with the lease

=> The estimated cost of removing or dismantling an asset at the end of the lease term.


The lease liability which is recognized at the commencement of the lease shall be measured at the present value of the lease payments which falls due after that date.


The lease payments shall be discounted to present value using the interest implicit in the lease. If the interest implicit in the lease is not available then the lessee’s incremental borrowing rate should be used for the calculation of the present value of the lease payments.


The incremental borrowing rate is the rate at which the lessee borrow fund to purchase similar assets under the same terms and conditions.


SUBSEQUENT MEASUREMENT


In most cases, the leased asset shall be subsequently measured at cost less accumulated depreciation and accumulated impairment losses. The leased asset shall be depreciated as per IAS 1- Property, Plant, and Equipment, and impairment losses shall be dealt with as per IAS 36 –Impairment of assets.


However, it should be noted that if the lessee is provided with an option to purchase the leased asset at the end of the lease term or have the rights to exercise the purchase option then the leased asset shall be depreciated up to the useful life of a leased asset.


If the lessee has no option to purchase the leased asset at the end of the lease term then the asset shall be depreciated up to the earlier of the end of the lease term and end of the useful life of the right of use asset.


The lessee has the choice to treat the leased asset either under the revaluation model as per IAS 16 – Property, Plant, and Equipment or under the investment property as per IAS 40 – Investment Property.


The lease liability shall be apportioned between the interest/finance charges element and the amount which reduces the outstanding lease liability. IFRS 16 requires that interest on the liability shall be calculated in such a way as to produce a constant periodic rate of interest on the remaining balance of the lease liability. The interest rate applied should be the discount rate that was used initially to recognize and measure the lease liability. Unlike IAS 17, IFRS 16 does not seem to permit the use of approximations such as a sum of digits methods in the calculation of interest/ finance charges on lease.


PRESENTATION AND DISCLOSURE REQUIREMENT FOR LESSEE


IFRS 16 requires extensive disclosures requirements for the lessee. However, the lessee should disclose the following information at the end of the reporting period:


=> The depreciation charge for the right of use assets.

=> The interest expense on the lease liability.

=> The expense relating to the lease of short-term assets for which the lessee elected not to recognize the right of use asset and a lease liability.

=> The expense relating to the lease of low-value leased assets for which the lessee elected not to recognize the right of use asset and a lease liability.

=> The carrying amount of the right of use assets at the end of the reporting period.

=> The maturity analysis of the lease liabilities.


In addition to the above information, the lessee shall provide any additional information related to leasing which could affect the financial position, financial performance, and cash flows of an entity.


LEASE ACCOUNTING BY THE LESSOR


For the accounting treatment of the lease by the lessor, the requirements of the IAS 17 are carried forward into IFRS 16 and the distinction between the finance lease and operating lease is retained for the lessor. In summary:


Lessor has the choice to treat the lease as either a finance lease or an operating lease. The definitions for the lease under the IFRS 16 are very similar to the definitions given in IAS 17. A finance lease is defined by IFRS 16 as the lease which substantially transfers all the risks and rewards of the asset to the lessee at the end of the lease term while operating lease does not transfer the risk and rewards of the assets to the lessee at the end of the lease term.


At the commencement of the lease, the lessor is required to recognize a receivable equal to the net investment in the lease. The net investment in the lease is the present value of the future lease payments receivable by the lessor using the interest rate implicit in the lease. The interest implicit rate is the discount rate that causes the present value of the lease payments to be equal to the fair value of the underlying asset plus any initial direct cost incurred by the lessor in connection with the lease.


The income element received by the lessor from the lease shall be recognized as finance income in the statement of comprehensive income. The remainder of the lease payments reduces the amount owed by the lessee.


In the case of the operating lease, the underlying asset shall be presented in the statement of financial position of the lessor and shall be depreciated in a normal manner. The lease payments made by the lessee shall be recognized as income on a straight-line basis over the period of the lease term. Any direct cost incurred by the lessor shall be added to the carrying value of the underlying asset and it shall be written off over the lease term.


DISCLOSURE REQUIREMENT FOR LESSOR


The main disclosures requirements for lessor as per IFRS 16 are as follows:


=> The amount of profit or loss on the sale of disposal through a finance lease.

=> The finance income earned from finance lease.

=> The amount of income earned from the operating lease.

=> The nature of the lessor leasing activities.

=> The way in which the lessor manages the risks attached with the underlying leased asset.

=> Maturity analysis of the lease payments receivables under the finance lease, showing the amounts receivable in the coming five years and the amount of lease payments receivables after the period of five years. A similar maturity analysis shall be done for the operating lease payments.