IFRS 16 – LEASES

This is part 2 of our blog on IFRS 16 – Leases and here we will explain accounting treatment in the books of both lessee and lessor.

Please also view my first blog on Leases here: https://accountingblogger.com/ifrs-16-leases/

ACCOUNTING BY LESSEES

The distinction between finance leases and operating leases for lessees under the IFRS 16 has been removed. This means a lessee will be required to account for most leases (including those currently accounted for as operating leases) on-balance sheet in a similar way to the current accounting treatment for finance leases. There are optional exemptions for leases of low-value assets and short-term leases (i.e., leases of 12 months or less).

• Upon lease commencement a lessee recognizes a right-of-use asset and a lease liability.
• The right-of-use asset is initially measured at the amount of the lease liability plus any initial direct costs incurred by the lessee. Adjustments may also be required for lease incentives, payments at or prior to commencement, and restoration obligations or similar.

After lease commencement, a lessee shall measure the right-of-use asset using a cost model, unless:

1. the right-of-use asset is an investment property and the lessee fair values its investment property under IAS 40; or
2. the right-of-use asset relates to a class of PPE to which the lessee applies IAS 16’s revaluation model, in which case all right-of-use assets relating to that class of PPE can be revalued.

Under the cost model, a right-of-use asset is measured at cost less accumulated depreciation and accumulated impairment.

The lease liability is initially measured at the present value of the lease payments payable over the lease term.

The lease liability is subsequently re-measured to reflect changes in:

• the lease term (using a revised discount rate);
• the assessment of a purchase option (using a revised discount rate);
• the amounts expected to be payable under residual value guarantees (using an unchanged discount rate); or
• future lease payments resulting from a change in an index or a rate used to determine those payments (using an unchanged discount rate).

The re-measurements are treated as adjustments to the right-of-use asset.

Lease modifications may also prompt re-measurement of the lease liability unless they are to be treated as separate leases.

ACCOUNTING BY LESSORS

The lessor accounting model under IFRS 16 is largely unchanged from the requirements in IAS 17. The lessor is still required to apply the same principles as under IAS 17 distinguish between finance leases and operating leases, and apply the relevant accounting requirements accordingly.

Lessors shall classify each lease as an operating lease or a finance lease.

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, a lease is classified as an operating lease.

Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are:

• the lease transfers ownership of the asset to the lessee by the end of the lease term,
• the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than fair value,
• the lease term is for the major part of the economic life of the asset, even if the title is not transferred,
• at the inception of the lease, the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset,
• the leased assets are of a specialized nature such that only the lessee can use them without major modifications being made.

Upon lease commencement, a lessor shall recognize assets held under a finance lease as receivable at an amount equal to the net investment in the lease.

A lessor recognizes finance income over the lease term of a finance lease.

A lessor recognizes operating lease payments as income on a straight-line basis.

ABOUT THE AUTHOR

Humayun Atif | CMA, CPA, CA (FIN), MS-IT, Oracle Certified, CA Articles from Big4

Atif is passionate about Business, Tech, and the written word. He is the author of the book ‘IFRS Made Easy’. He is a Tax and IFRS coach and the founder of accountingblogger.com