IFRS 16 LEASES SUMMARY REPORT

Overview

  1. All companies need to follow from 1 January 2019.
  2. IAS 17 Leases will no longer apply.
  3. Early application only with IFRS 15 (new revenue standard) which is applicable from 1 January 2018.
  4. These two standards IFRS 16 and IFRS 15 are closely related.

Objective

  1. To specify the principles for recognition, measurement, presentation and disclosure of leases.

IFRS 16 does NOT apply to:

  1. Leases to explore for / use of minerals, oil, natural gas and similar.
  2. Leases of biological assets (IAS 41).
  3. Intellectual property licenses (IFRS 16).
  4. Service concession arrangements (IFRIC 12).
  5. Rights under licensing agreements (IAS 38).

Optional Exemptions: The Company can choose

  1. Lease term < 1 year with no purchase option. Valid for all class of underlying assets. Example – all motor vehicles under one class.
  2. Underlying asset of low value when new. Example – personal computers. It is done one by one basis and not for the whole class.
  3. For optional exemptions, need to account for lease payments on a straight line (or another systematic) basis.

At the inception:

  1. Assess whether the contract is or contains lease or not.
  2. A contact contains a lease if it conveys the right to control the use of an identified asset for a specified period of time in exchange for consideration and under the standard clarifies how to determine the lease term, how to separate non lease components and other issues.

Leases: Accounting for Lessee

  1. No classification of lease. The big change in IFRS 16 in comparison with older IAS17 is that the lessee does not classify the leases into finance lease and operating lease.
  2. Lessee needs to account for all leases in the same way except the above two exemptions mentioned previously.
  3. At the commencement of the lease the lessee recognizes as follows:
  • Debit Right-of-use           $$$
  • Credit Lease Liability              $$$
  1. Big difference: Even if the lease is operating according to previous definitions, lessee always recognizes some asset. Previously, when it was an operating lease, lessee would recognize all payments under operating leases straight in profit or loss.

Right-of-use asset will be equal to the sum of the following:

  1. Amount of lease liability which is at initial measurement of present value.
  2. Lease payments before or on commencement date less lease incentives.
  3. Initial direct costs.
  4. Estimation of dismantling and removing costs of the underlying assets, unless those costs are incurred to produce inventories. Restoring cost of the site needs to be considered as stated by the terms and conditions of the lease.

Lease liability

  1. Payments not paid at the commencement date discounted to present value using the interest rate implicit in the lease (or incremental borrowing rate if not possible).
  2. Payments not paid at the commencement date contains the sum of the following items:
  • Fixed payments, less any lease incentives received.
  • Variable payments depending on index rate such as CPI and LIBOR.
  • Residual value guarantees (amount expected to be paid).
  • Exercise price of purchase option if lessee will exercise it.
  • Penalties payment for terminating (if lessee assumes early termination).

Subsequently after the commencement of the lease – Lessee

  1. Right-of-use asset
  • Debit Depreciation (P/L) $$$
  • Credit Right-of-use – Accumulated Depreciation $$$
  1. Need to consider
  • Cost Model (IAS16 – PPE) – the above for PPE
  1. The company can also apply the following:
  • Fair value model (IAS 40 – investment property), or
  • Revaluation model (IAS 16) – Depending on what the company applies for PPE and investment property and what the right of use asset is.
  • Need to consider Impairment Testing (IAS 36).
  1. Lease Liability
  2. Lessee need to account for the following:
  3. Interest on the lease liability using constant period interest rate:
  • Debit Interest (P/L)           $$$
  • Credit Lease Liability            $$$
  1. Plus lessee need to Reduce the Lease liability by the payments made:
  • Debit Lease Liability                   $$$
  • Credit Cash or Bank account          $$$
  1. Lessee needs to adjust lease liability for modification of contract if applicable.

Leases: Accounting for Lessors

  1. No major change.

Classification of lease

  1. The principal question is: Are substantially all rewards and risks of ownership of the lease asset transferred to the lessee or not?
  • If Yes – Finance Lease.
  • If No – Operating Lease.
  1. Need to consider the classification right at the inception of the lease.
  2. Any one of the five (5) situations is required to satisfy for the lease to be a finance lease:
  • Ownership transferred by the end of the lease term from lessor to lessee.
  • Lessee has the option to purchase the asset at price < fair value at end of the lease term and at the inception of the lease it is almost sure that the option will be exercised.
  • Lease term is for the major part of economic life of asset even if the title is not transferred.
  • Present value of lease payments is close to fair value of the leased asset.
  • Leased asset are of specialized nature and only lessee can use it without major modifications.

Finance Lease

  1. Same as IAS 17
  2. At the commencement of the lease:
  3. Lease Receivable $$$
  4. Lease receivable is the net investment in the lease which is the total of:
  • Fixed payments.
  • Variable payments (based on index).
  • Residual value guarantees (expected amount).
  • Exercise price of purchase option (if lessee will exercise it).
  • Penalties payment for terminating (if lessee assumes early termination).
  1. All these items are payments not paid at the commencement date. They should be discounted and lessor should add the initial direct cost to the investment in the lease.
  2. Property, plant & Equipment (underlying asset) $$$

Subsequent Measurement – Finance Lease

  1. Need to consider lease payments of lease Receivables.
  2. Need to split the lease payments to:
  • Reduction of finance lease receivables.
  • Finance income.
  1. Journal entries for lease payments should be:
  • Debit Cash                                 $$$
  • Credit Lease Receivable               $$$
  • Credit Interest income – P/L          $$$
  1. Constant periodic rate of return needs to be maintained.

Operating Lease

  1. Lease payments received from the lessee are recognized as a revenue in the P/L on a straight-line basis (or other systematic basis).
  2. Lessor keeps the asset in its own financial statements and appreciates it.

Sale & Leaseback Transaction

  1. Transaction in which the seller sells the asset to the buyer and then leases the same asset back. The asset does not move. The seller becomes lessee as he takes the asset back under lease and the buyer is the lessor.
  2. Sale and leaseback transaction depends on whether:
  3. Is the transfer of asset a sale under IFRS 15 Revenue from Contract with Customers?
  4. If Yes, then it means that control of asset was transferred, then:
  5. Seller (lessee):
  • Recognizes a right-of-use asset at proportion of the previous carrying amount of that asset relating to the right of use of retained by the seller.
  • Recognize gain or loss related to the transferred right only to the buyer.
  1. Buyer (lessor):
  • Recognizes a purchase of an asset under other applicable standards; and
  • Accounts for the lease under IFRS 16.
  1. If No, then it means that control of asset was not transferred, then:
  2. Seller (lessee):
  • Continues to recognize an asset; and
  • The accepted payment is accounted for as a financial liability under IFRS 9 (financial instruments) so it is a form of financing arrangement.
  1. Buyer (lessor):
  • Recognizes a financial asset under IFRS 9 (financial instruments).

Citation:

“Leases.” IFRS, http://www.ifrs.org/projects/2016/ifrs-16-leases/#published-documents.

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