Day 10: IFRS 16 – Leases (Part 1)
As we continue our journey through the world of International Financial Reporting Standards (IFRS), we arrive at Day 10, where we delve into the intricacies of IFRS 16, Leases. In this post, we will explore the fundamental concepts of lessee vs. lessor accounting, right-of-use assets, and lease liabilities.
Introduction to IFRS 16
IFRS 16 was issued by the International Accounting Standards Board (IASB) in January 2016. It replaces the previous lease accounting standard, IAS 17, and provides a single model for lessee accounting. The standard is effective for annual periods beginning on or after January 1, 2019.
Lessee vs. Lessor Accounting
IFRS 16 introduces a single model for lessee accounting, which replaces the dual model in IAS 17. Under IFRS 16, a lessee recognizes a right-of-use asset and a lease liability for all leases, except for short-term leases and leases of low-value assets.
Lessee accounting involves the following steps:
- Identify the lease: Determine whether a contract contains a lease, by assessing whether the contract conveys the right to use an identified asset for a period of time in exchange for consideration.
- Determine the lease term: Identify the period of time for which the lessee has the right to use the underlying asset.
- Calculate the lease liability: Measure the lease liability at the present value of the lease payments, using a discount rate.
- Recognize the right-of-use asset: Recognize the right-of-use asset at the amount of the lease liability, plus any initial direct costs, and minus any lease incentives.
On the other hand, lessor accounting remains largely unchanged from IAS 17. A lessor continues to classify leases as either finance leases or operating leases, and recognizes revenue and expenses accordingly.
Right-of-use Assets
A right-of-use asset represents the lessee’s right to use the underlying asset for the lease term. The right-of-use asset is recognized at the commencement of the lease, and is measured at the amount of the lease liability, plus any initial direct costs, and minus any lease incentives.
The right-of-use asset is depreciated over the shorter of the lease term or the useful life of the underlying asset, using a depreciation method that reflects the pattern of benefits expected to be derived from the asset.
Lease Liabilities
A lease liability represents the lessee’s obligation to make lease payments to the lessor. The lease liability is recognized at the commencement of the lease, and is measured at the present value of the lease payments, using a discount rate.
The lease liability is remeasured whenever there is a change in the lease payments, or a change in the discount rate. Any changes to the lease liability are recognized in profit or loss.
Example
Suppose a company enters into a 5-year lease for a piece of equipment, with annual lease payments of $10,000. The interest rate implicit in the lease is 6%. The company would recognize a right-of-use asset and a lease liability at the commencement of the lease, as follows:
- Right-of-use asset: $41,390 (present value of lease payments, using a discount rate of 6%)
- Lease liability: $41,390 (present value of lease payments, using a discount rate of 6%)
The company would then depreciate the right-of-use asset over the lease term, using a depreciation method that reflects the pattern of benefits expected to be derived from the asset.
Short-term Leases
IFRS 16 provides an exemption for short-term leases, which are leases with a term of 12 months or less. For short-term leases, a lessee is not required to recognize a right-of-use asset and a lease liability. Instead, the lessee recognizes the lease payments as an expense on a straight-line basis over the lease term.
Leases of Low-value Assets
IFRS 16 also provides an exemption for leases of low-value assets, which are assets with a value of $5,000 or less. For leases of low-value assets, a lessee is not required to recognize a right-of-use asset and a lease liability. Instead, the lessee recognizes the lease payments as an expense on a straight-line basis over the lease term.
Presentation and Disclosure
IFRS 16 requires lessees to present and disclose information about their leases in a way that provides users of the financial statements with a clear understanding of the lease arrangements. The presentation and disclosure requirements include:
- A reconciliation of the opening and closing balances of the right-of-use assets and lease liabilities
- A maturity analysis of the lease liabilities
- A description of the lease terms and conditions
- A description of the underlying assets and their carrying amounts
Lessor Accounting
As mentioned earlier, lessor accounting remains largely unchanged from IAS 17. A lessor continues to classify leases as either finance leases or operating leases, and recognizes revenue and expenses accordingly.
For finance leases, the lessor recognizes a finance lease receivable at the commencement of the lease, and measures it at the present value of the lease payments, using a discount rate. The lessor then recognizes interest income on the finance lease receivable over the lease term.
For operating leases, the lessor recognizes the lease payments as revenue on a straight-line basis over the lease term.
Example of Lessor Accounting
Suppose a company enters into a 5-year lease for a piece of equipment, with annual lease payments of $10,000. The interest rate implicit in the lease is 6%. The company would recognize a finance lease receivable at the commencement of the lease, as follows:
- Finance lease receivable: $41,390 (present value of lease payments, using a discount rate of 6%)
The company would then recognize interest income on the finance lease receivable over the lease term, using a discount rate of 6%.
Conclusion
In conclusion, IFRS 16 provides a single model for lessee accounting, which replaces the dual model in IAS 17. The standard requires lessees to recognize a right-of-use asset and a lease liability for all leases, except for short-term leases and leases of low-value assets. The standard also provides exemptions for short-term leases and leases of low-value assets, and requires lessees to present and disclose information about their leases in a way that provides users of the financial statements with a clear understanding of the lease arrangements.
Additional Resources
For more information on IFRS 16, please refer to the following resources:
- IFRS 16: Leases (International Accounting Standards Board)
- IFRS 16: Leases (Deloitte)
- IFRS 16: Leases (KPMG)
- IFRS 16: Leases (PwC)
FAQs
Q: What is the effective date of IFRS 16?
A: The effective date of IFRS 16 is January 1, 2019.
Q: What is the difference between a finance lease and an operating lease?
A: A finance lease is a lease where the lessee has substantially all the benefits and risks of ownership, while an operating lease is a lease where the lessor retains substantially all the benefits and risks of ownership.
Q: How do I calculate the present value of lease payments?
A: The present value of lease payments can be calculated using a discount rate, which is the interest rate implicit in the lease.
Q: What is the purpose of the right-of-use asset?
A: The right-of-use asset represents the lessee’s right to use the underlying asset for the lease term.
Q: How do I depreciate the right-of-use asset?
A: The right-of-use asset is depreciated over the shorter of the lease term or the useful life of the underlying asset, using a depreciation method that reflects the pattern of benefits expected to be derived from the asset.
Glossary
- Lease: A contract that conveys the right to use an identified asset for a period of time in exchange for consideration.
- Lessee: The party that has the right to use the underlying asset.
- Lessor: The party that grants the right to use the underlying asset.
- Right-of-use asset: An asset that represents the lessee’s right to use the underlying asset for the lease term.
- Lease liability: A liability that represents the lessee’s obligation to make lease payments to the lessor.
- Finance lease: A lease where the lessee has substantially all the benefits and risks of ownership.
- Operating lease: A lease where the lessor retains substantially all the benefits and risks of ownership.
References
- International Accounting Standards Board. (2016). IFRS 16: Leases.
- Deloitte. (2019). IFRS 16: Leases.
- KPMG. (2019). IFRS 16: Leases.
- PwC. (2019). IFRS 16: Leases.
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