About

IFRS 16 Leases is to be adopted for accounting periods starting on or after 1 January 2019. It can be adopted earlier but only if the entity has already adopted IFRS 15 Revenue from contracts with customers.

The new standard on leases is replacing the old standard (IAS 17) where the existence of operating leases meant that significant amounts of finance were held off the balance sheet. In adopting the new standard all leases will now be brought on to the statement of financial position, except in the following circumstances:

  • 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
  • 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.

The accounting for low value or short-term leases is done through expensing the rental through profit or loss on a straight-line basis.

 

Objectives

  1. This Standard sets out the principles for the recognition, measurement, presentation and disclosure of leases. The objective is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents those transactions. This information gives a basis for users of financial statements to assess the effect that leases have on the financial position, financial performance and cash flows of an entity.             
  2. An entity shall consider the terms and conditions of contracts and all relevant facts and circumstances when applying this Standard. An entity shall apply this Standard consistently to contracts with similar characteristics and in similar circumstances.

Scope

  1. An entity shall apply this Standard to all leases, including leases of right-of-use assets in a sublease, except for:
    1. leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
    2. leases of biological assets within the scope of IAS 41 Agriculture held by a lessee;
    3. service concession arrangements within the scope of IFRIC 12 Service Concession Arrangements;
    4. licences of intellectual property granted by a lessor within the scope of IFRS 15 Revenue from Contracts with Customers; and
    5. 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.

  2. A lessee may, but is not required to, apply this Standard to leases of intangible assets other than those described in paragraph 3(e).

Recognition

When applying IFRS 16, the initial recognition, subsequent measurement, and disclosure & reporting are crucial aspects that need to be carefully considered. Here is a detailed explanation of each aspect along with practical examples:

  1. Initial Recognition:

    • Lease Liability: The lease liability is initially recognized at the present value of lease payments to be made over the lease term. This includes fixed payments, variable payments linked to an index or rate, residual value guarantees, and optional renewal periods.

    • Right-of-Use Asset: The right-of-use asset is recognized at the same amount as the lease liability, adjusted for any lease payments made at the commencement of the lease and initial direct costs.

Practical Example: Company ABC enters into a lease agreement for an office space with lease payments of $1,200 per month for 5 years. The present value of these lease payments, discounted using the incremental borrowing rate, amounts to $60,000. Both the lease liability and the right-of-use asset would be recognized at $60,000 on the balance sheet.

  1. Subsequent Measurement:

    • Lease Liability: The lease liability is subsequently measured using the effective interest method, with interest expense calculated based on the carrying amount of the liability and the discount rate used at initial recognition.

    • Right-of-Use Asset: The right-of-use asset is depreciated over the lease term, reflecting the pattern of consumption of the asset's economic benefits.

Practical Example: Following the initial recognition example, if after one year Company ABC has made lease payments totaling $10,000, the lease liability would be reduced to $50,000 ($60,000 - $10,000). Meanwhile, the right-of-use asset would be depreciated over the remaining lease term.

  1. Disclosure & Reporting:
    • Companies are required to provide detailed disclosures in the financial statements about their lease arrangements, including the nature of their lease obligations, maturity analysis of lease liabilities, and amounts recognized in the financial statements related to leases.

Practical Example: Company ABC would disclose in its financial statements the nature of the lease arrangements entered into, total lease liabilities and right-of-use assets recognized, lease expenses recognized in the income statement, and any additional information necessary to provide a clear understanding of the company's leasing activities.

By following these steps for initial recognition, subsequent measurement, and disclosure & reporting under IFRS 16, companies can ensure compliance with the standard and provide transparent information to stakeholders about their lease obligations and related assets.