IFRS 16: LEASE ACCOUNTING

IFRS 15: Revenue from Contracts with Customers
July 20, 2018
IFRS 9: Recognition, Measurement & Impairment of Financial Instruments
July 20, 2018

IFRS 16: LEASE ACCOUNTING

IFRS 16-LEASE ACCOUNTING

OVERVIEW
IFRS 16 specifies how an IFRS reporter will recognize, measure, present and disclose leases. The standard provides a single lessee accounting model, requiring lessees to recognize assets and liabilities for all leases unless the lease term is 12 months or less or the underlying asset has a low value. Lessors continue to classify leases as operating or finance, with IFRS 16’s approach to lessor accounting substantially unchanged from its predecessor, IAS 17.

OBJECTIVE
The objective of IFRS 16 is to ensure that lessees and lessors provide relevant information in a manner that faithfully represent their lease transactions in their financial statements.

SCOPE
One of the most notable aspects of IFRS 16 is that the lessee and Lessor accounting model are asymmetrical. While the IASB has retained IAS 17’s finance lease/operating lease distinction for lessors(and carried into IFRS 16 the related requirements virtually intact), the distinction is no longer relevant to lessees.

DEFINITION OF KEY TERMS
A ‘lease’ is a contract, or part of a contract, that conveys the right to control the use of identified property, plant or equipment(an identified asset) for a period of time in exchange for consideration.
Lessor-The owner of the asset.
Lessee-An individual or a corporation who has the right of use of something of value, gained through a lease agreement with the real owner of the property.

LEASE TERM
Defined as the non-cancellable period for which a lessee has the right to use an underlying asset.

EXCEPTIONS
An entity shall apply this standard to all leases including sub-leases, except for:
– Leases to explore for the of use minerals, oil, natural gas and similar non-regenerative resources.
– Leases of biological assets within the scope of IAS 41 Agriculture held by a lessee
– Service concession arrangements within the scope of IFRIC 12 service Concession Arrangements:
– Licenses of intellectual property granted by a lessor

EFFECTIVE DATE
Leases was issued by the IASB in January 2016. It will replace IAS 17 Leases for reporting periods beginning on or after 1 January 2019.It can be applied by the entities that also apply IFRS 15 Revenue from Contracts with Customer.

WHY CHANGE

  • Increase comparability and transparency among entities
  • Decade-long project with IASB(International Accounting Standard Board)
  • Represent fully the actual substance of leasing transactions; namely recognizing assets and liabilities arising from operating lease transactions
  • Lessor accounting remained relatively unchanged

LEASES-IMPACT
– Compliance with contractual agreements
– Loan covenants
– Banking agreements
– Financial statement ratios
– Identification of a lease-an identified asset/right to control the use during the lease term
– Contracts that could contain a leasing component
– Evaluation of tax reporting consequences as new book/tax differences will be created.
– This may also affect franchise and/or property tax bases for the recorded assets/lease obligations.

TRANSACTION IMPLEMENTATION

– Leases are required to be recognized and measured for the earliest period presented using a modified retrospective transition approach.
– Lease liability is measured at the present value of the lease payment payable the lease term discounted at rate implicit in the lease.

CHANGES TO LEASES
1. New guidance retains the distinction between finance leases and operating leases. The treatment is substantially similar to the previous guidance distinctions between capital and operating leases.
2. Under lessee accounting, the effect on the income statement and statement of cash flows remains largely unchanged.
3. Previous lease accounting focused on the distinction between capital and operating leases.
4. New guidance focuses on whether or not a contract contains or is a lease.

ACCOUNTING BY LESSEES
1. Upon lease commencement a lessee recognizes a right-of-use asset and a lease liability.
2. The right-of-use asset is initially measured at the amount of the lease liability plus any initial direct costs incurred by the lessee.      3.Adjustments may also be required for lease incentives, payments at or prior to commencement and restoration obligations or similar. 4. After lease commencement, a lessee shall measure the right-of-use asset using a cost model.
5. Under the cost model a right-of-use asset is measured at cost less accumulated depreciation and accumulated impairment.

ACCOUNTING BY LESSORS
1. Lessors shall classify each lease as an operating lease or a finance lease.
2. 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.
3. Upon lease commencement, a lessor shall recognize assets held under a finance lease as a receivable at an amount equal to the net investment in the lease.

SALE AND LEASEBACK TRANSACTIONS
1. To determine whether the transfer of an asset is accounted for as a sale an entity applies the requirements of IFRS 15 for determining when a performance obligation is satisfied.
2. If an asset transfer satisfies IFRS 15’s requirements to be accounted for as a sale the seller measures the right-of-use asset at the proportion of the previous carrying amount that relates to the right of use retained. Accordingly, the seller only recognises the amount of gain or loss that relates to the rights transferred to the buyer.
3. If the fair value of the sale consideration does not equal the asset’s fair value, or if the lease payments are not market rates, the sales proceeds are adjusted to fair value, either by accounting for prepayments or additional financing.

12-MONTH POLICY
For a lease with a term of 12months or less, a lessee is permitted to make an accounting policy election not to recognize lease assets and liabilities.
If a lessee makes this election, it should recognize lease expense for such leases generally on a straight-line basis over the lease term.

RIGHT TO CONTROL THE USE OF IDENTIFIED ASSET
– The right to substantially control or benefit from all the economic benefits from use of the asset
– The right to direct the use of the identified asset
– Lessee has right to direct how and for what purpose the asset is used, OR
– Relevant decisions about how and for what purpose are predetermined, AND
– Lessee has right to operate without supplier changing instructions, OR
– Lessee designed the asset in a way that in a way that predetermines how and for what purpose the asset will be used.

LEASE PAYMENTS CONSIDERATION
Determine at the commencement date and include(initial measurement)
1.Fixed payments, including in substance payments, less any lease incentives
2.Variable lease payments that depend on an index or rate
3. Exercise price of an option to purchase the underlying asset
4.Payments for penalties for terminating the lease
5. Residual value guarantees-amounts probable of being owed(lessees only)

LESSOR ACCOUNTING-MINIMAL CHANGES
When contracts include both lease and non lease components(i.e. purchases of goods and services), the non-lease component are accounted for separately using appropriate GAAP
Lessees allocate consideration in the contract to lease and non-lease components on a relative stand-alone price basis.

SEGREGATING LEASE COMPONENT
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 a 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.

DISCLOSURES
The objective of IFRS 16’s disclosures is for information to be provided in the notes that, together with information provided in the statement of financial position, statement of profit or loss and statement of cash flows, gives a basis for users to assess the effect that leases have.

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