IFRS 16 – LEASES

IFRS 16 is the outcome of a ten-year project run by the International Accounting Standards Board (IASB) together with the US Financial Accounting Standards Board.

Under IFRS 16 all leased assets will be shown on the lessees’ balance sheets. As per IAS 17, leased assets were reported on-balance sheet for the lessee if they are finance leases but operating leases were instead reported in the notes to the accounts.

The Standard brings fundamental changes to lease accounting that replaces previous accounting that is considered no longer fit for purpose. IFRS 16 requires a lessee to recognize assets and liabilities for all leases with a term of more than 12 months and for which the underlying asset is not of low value.

Exactly What Has Changed?

The headline change is that the number of assets shown on the balance sheet will dramatically increase under IFRS 16 which means greater clarity around companies’ financial statements. The following changes will be seen after IFRS 16.

• Almost all operating leases will be accounted for as finance leases and need to be shown on the balance sheet.
• The new standard will significantly impact company ratios and measures including EBITDA, cash flows, operating profit, net income, interest cover, & gearing ratios.
• Small tickets and short-term leases may be exempt.
• Lease categorization will be based on Right of Use (ROU) rather than risk and reward.
• IFRS 16 has more focus on who has the right to use the asset but IAS 17 was concerned with who bears the risks and the rewards of the lease.

IFRS 16 applies to all leases, including subleases, except for:

• leases to explore for or use minerals, oil, natural gas, and similar non-regenerative resources;
• leases of biological assets held by a lessee;
• service concession arrangements;
• licenses of intellectual property granted by a lessor; and
• rights held by a lessee under licensing agreements for items such as films, videos, plays, manuscripts, patents, and copyrights within the scope of IAS 38 intangible Assets.

A lessee can elect to apply IFRS 16 to leases of intangible assets, other than those items listed above.

Industries impacted

IFRS 16 is expected to have a wide impact across most industries in particular those industries with numerous leases. The following industries are particularly likely to be impacted:

• Property and construction,
• Health care industry,
• Government and Not-for-Profit sector,

Recognition Exemptions

Instead of applying the recognition requirements of IFRS 16 described below, a lessee may elect to account for lease payments as an expense on a straight-line basis over the lease term or another systematic basis for the following two types of leases:

• leases with a lease term of 12 months or less and containing no purchase options, and
• leases where the underlying asset has a low value such as personal computers or office furniture.

Identifying a lease:

A contract is, or contains, 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 the right to direct the identified asset’s use and to obtain substantially all the economic benefits from that use.

However, where a supplier has a substantive right of substitution throughout the period of use, a customer does not have a right to use an identified asset. A supplier’s right of substitution is only considered substantive if the supplier has both the practical ability to substitute alternative assets throughout the period of use and they would economically benefit from substitution.

A capacity portion of an asset is still an identified asset if it is physically distinct (e.g., a floor of a building). A capacity or other portion of an asset that is not physically distinct (e.g., a capacity portion of a fiber optic cable) is not an identified asset unless it represents substantially all the capacity such that the customer obtains substantially all the economic benefits from using the asset.

Separating Components of Contract

For a contract that contains a lease component and additional lease and non-lease components, such as the lease of an asset and the provision of maintenance service, lessees shall allocate the consideration payable on the basis of the relative stand-alone prices, which shall be estimated if observable prices are not readily available.

As a practical expedient, a lessee may elect, by class of underlying asset, not to separate non-lease components from lease components and instead account for all components as a lease.

Lessors shall allocate consideration in accordance with IFRS 15 Revenue from Contracts with Customers.

The initial measure of the right-of-use asset will be as below

1. Payments made less incentives/discounts received,
2. Initial direct costs incurred by the lessee such as installation,
3. Cost for dismantling.

Lease accounting: Please view my blog here:  https://accountingblogger.com/ifrs-16-leases-accounting-treatment/

ABOUT THE AUTHOR

Humayun Atif | CMA, CPA, CA (FIN), MS-IT, CA Articles from Big 4, Certified Forensic Accountant (USA), Six Sigma & Oracle Certified.

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