Leases (IFRS 16)
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. Low value is less than $5,000.
The accounting for low value or short-term leases is done through expensing the rental through profit or loss on a straight-line basis.
1 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 [IFRS16:9]
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. [IFRS 16:B9] However, if the supplier has a substantive right to substitute the asset during the period of use then the customer does not have the right of use of the asset and hence there is no lease.
2 Lease and non-lease components
A combined contract where part of the payment is for the lease of the asset and part of the payment is for the provision of additional services by the lessor (e.g. maintenance) then the lessee needs to split the rental into a lease component and non-lease component. The payment by the lessee is to be allocated based on the stand-alone prices of the components.
3 Lessee accounting
3.1 Initial recognition
At the start of the lease the lessee initially recognises a right-of-use asset and a lease liability. [IFRS 16:22]
Right of use asset | Lease liability |
Measured at the amount of the lease liability plus any initial direct costs incurred by the lessee. | Measured at the present value of the lease payments payable over the lease term, discounted at the rate implicit in the lease |
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Note: if the rate implicit in the lease cannot be determined the lessee shall use their incremental borrowing rate |
3.2 Subsequent measurement
Right of use asset | Lease liability |
Cost less accumulated depreciation | Financial liability at amortised cost |
Note: Depreciation is based on the earlier of the useful life and lease term, unless ownership transfers, in which case use the useful life. |
Settle the perspective before the numbers: is the entity the lessee or the lessor, and is a lease being accounted for at all? For a lease recognised under the normal lessee model, interest is charged on the outstanding liability, not on the annual payment, and the lease payments themselves are not the profit or loss expense. A present value given in the exhibit does not need recalculating.
3.3 Variable lease payments
If lease payments are, for example, linked to a price index, then the lease liability will change. There will be a corresponding change in the carrying amount of the right-of use asset.
So, if the lease liability increases by $1 million, the adjustment will be Dr Right-of-use asset Cr Lease liability with $1 million.
4 Lessor accounting
4.1 Classification of the lease
Finance lease if risks and rewards of ownership transferred to lessee.
Ownership passes at end of the lease term
Option to purchase asset at below fair value at end of lease and reasonably certain option will be exercised
Lease term represents the major part of assets economic life
PV of minimum lease payments represents substantially all of the asset’s fair value
Leased asset is specialised in nature
4.2 Operating lease accounting
Operating lease income receipts are recognised as income through profit or loss on a straight line basis.
Depreciation on the asset continues over its useful life.
4.3 Finance lease accounting
Derecognise asset and record a receivable (@ net investment in the lease”)
Record finance lease receipts as a reduction in the receivable
Record interest income on the receivable
Net investment in the lease = Gross investment in the lease discounted at the implicit rate of interest
Gross investment in the lease = Minimum lease payments receivable plus any unguaranteed residual value
5 Sale and leaseback
A sale and leaseback transaction occurs when one entity (seller) transfers PPE to another entity (buyer) who then leases the asset back to the original seller (lessee).
The companies are required to account for the transfer contract and the lease applying IFRS 16, however consideration is first given to whether the initial sale of the transferred asset is a sale under IFRS 15.
If the lease term is similar to the asset life, it is likely that the transaction is NOT a sale. It is in substance a loan secured on the PPE - as when you might raise a loan from a bank.
If the transfer of the asset is not a sale then the following rules apply:
Seller-Lessee | Buyer-Lessor |
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If the transfer of the asset is a sale then the following rules apply:
Seller-Lessee | Buyer-Lessor |
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Note: If the proceeds are less than the fair value of the asset or the lease payments are less than market rental the following adjustments to sales proceeds apply:
Any below-market terms should be accounted for as a prepayment of the lease payments; and,
Any above-market terms should be accounted for as additional financing provided to the lessee.
6 SUB-LEASES
Assume that a building has a life of 100 years, and that A leases the building to B for 90 years (HEAD-LEASE); B then sub-lets the building to C (SUB-LEASE).
How will B reflect these transactions its financial statements?
In terms of the HEAD-LEASE, B would normally recognise a right of use asset and a lease liability in its SFP, and depreciation and finance costs in its SPL.
Initial recording of the HEAD-LEASE would be:
Dr Right of use asset x Cr Lease liability x
But what is the impact of the SUB-LEASE?
Scenario 1 – B sub-lets the building for 90 years.
As the SUB-LEASE is for the majority of the asset’s life, B will treat the transaction as a finance lease. Therefore, B will recognise a lease receivable (‘net investment in finance lease’) in its SFP and finance income in its P&L. The right of use asset will be derecognised.
Initial recording of the lease would be:
Dr Lease receivable x Cr Right of use asset x
(Any difference between the lease receivable and the right of use asset would be recognised in the P&L).
Scenario 2 – B sub-lets the building for 10 years.
As the SUB-LEASE is not for the majority of the asset’s life, B will treat the transaction as an operating lease. Therefore, B will recognise rental income in its SPL. The right of use asset will not be derecognised.