IFRS 16

LEASES

MR. MOHAMED ASHAM

Why was IFRS 16 issued?
➢ The previous IAS 17 did not require lessees to recognise assets and liabilities arising from operating
leases, and as such, did not reflect the substance of the transaction or ensure the faithful
representation.
➢ IFRS 16 replaces IAS 17. IFRS 16 sets out the principles for the recognition, measurement,
presentation and disclosure of leases. The objective is to ensure that lessees and lessors provide
relevant information in a manner that faithfully represents those transactions.
➢ IFRS 16 requires a lessee to recognise assets and liabilities for all long-term leases (more than 12
months), unless the underlying asset is of low value. For short-term leases or low value assets, the
lease payments are simply charged to profit or loss as an expense. IFRS 16 requires a lessor to classify
leases into finance and operating leases.

Identifying a lease
♣ An entity must identify whether a contract contains a lease, which is the case if the contract conveys the
right to control the use of an identified asset for a period of time in exchange for consideration.
The right to control the use of an identified asset depends on the lessee having:
(a) The right to obtain substantially all of the economic benefits from use of the identified asset, and
(b) The right to direct the use of the identified asset.

Recognition exemptions
IFRS16 provides an optional exemption from the full requirements of the standard for:

(a) Short-term leases. (b) Low value leases.

If the entity elects to take the exemption, lease payments are recognised as an expense on a straight-line basis
over the lease term or another systematic basis, if more representative of the pattern of the lessee's benefits.

Lessee accounting

Recognition and measurement

The lessee recognises

A lease liability A right-of-use asset

Lease liability
① The lease liability is initially measured at the present value of lease payments not paid at the
commencement date, discounted at the interest rate implicit in the lease. If that rate cannot be readily
determined, the lessee's incremental borrowing rate should be used.
② After the commencement date the carrying amount of the lease liability is increased by interest charges
on the outstanding liability and reduced by lease payments made.

Interest charges

Lease payments
made

Right of use asset

① The right-of-use asset is initially measured at cost, which includes:
(a) The amount of the initial measurement of the lease liability.
(b) Any lease payments made at/before the commencement date, less any lease incentives received
(c) Any initial direct costs (eg legal costs) incurred by the lessee.
(d) Any costs which the lessee will incur for dismantling and removing the underlying asset or restoring the
site at the end of the lease term.

The preset value of lease liability payments not paid

Lease liability payments made

Right of use asset

Costs

Incentives
 ② Subsequently measurement

The cost model The revaluation model The fair value model

❖ The cost model of IAS 16

The right-of-use asset is normally measured at cost less accumulated depreciation and impairment losses
in accordance with the cost model of IAS 16 Property, plant and equipment.
- The right-of-use asset is depreciated from the commencement date to the earlier of the end of its useful life or
the end of the lease term.
- However, if ownership of the underlying asset is expected to be transferred to the lessee at the end of the
lease, the right-of-use asset should be depreciated over the useful life of the underlying asset.
❖ The revaluation model of IAS 16
This is optional if the right-of-use asset relates to the property, plant and equipment.
❖ The fair value model of IAS 40
This is compulsory if the right-of-use asset relates to the invest property.

Allocating the finance charge (interest charge)

- IFRS 16 requires the finance charge to be allocated to periods during the lease term so as to produce a
constant periodic rate of interest on the remaining balance of the liability for each period, ie applying the interest
rate implicit in the lease.
- The lessee's incremental borrowing rate may be used if the interest rate implicit in the lease cannot be
determined.

Calculation of the lease liability

The calculation of the lease liability to be included in the financial statements can be summarised as follows:

If lease payments are made in arrears: $

1.1.X1 Lease liability (present value of future lease payments) XX
1.1.X1-31.12.X1 Interest at x% X
31.12.X1 Instalment in arrears (XX)
31.12.X1 Liability carried down XX
1.1.X2-31.12.X2 Interest at x% X
31.12.X2 Instalment in arrears (XX)
31.12.X2 Liability due in more than 1 year XX
 If lease payments are made in advance: $
1.1.X1 Lease liability (present value of future lease payments) XX
1.1.X1-31.12.X1 Interest at x% X
31.12.X1 Liability carried down XX
1.1.X2 Instalment in advance (XX)
Liability due in more than 1 year XX

Presentation
- In the statement of financial position right-of-use assets can be presented on a separate line under noncurrent
assets or they can be included in the total of corresponding underlying assets and disclosed in the notes.
- Lease liabilities should be either presented separately from other liabilities or disclosed in the notes.
- IFRS 16 does not specify that lease liabilities should be split between non-current and current liabilities, but
this should be done as best practice.

Sale and leaseback

The key question in determining the accounting treatment is:
Does the transaction constitute a sale?
This is determined by considering when the performance obligation is satisfied in accordance with IFRS 15
Revenue from contracts with customers.

Transfer is a sale
If the transfer satisfies the IFRS 15 requirements to be accounted for as a sale,
① The seller/lessee measures the right-of-use asset arising from the leaseback at the proportion of the
previous carrying amount of the asset that relates to the right of use retained by the seller/lessee.
This is calculated as:
present value of lease payments
Right of use asset = Carrying amount x
fair Value
② The seller/lessee only recognises the amount of any gain or loss on the sale that relates to the rights
transferred to the buyer.
This can be calculated in three stages:
Stage 1: Calculate the total gain Total gain
Total gain = fair value - carrying amount
Stage 2: Calculate the gain that relates to the rights retained
present value of lease payments
Gain relating to the tight retained = gain x
fair Value
Stage 3: The gain relating to rights transferred is the balancing figure
Gains relating to the rights transferred = total gain (Stage 1) - gain on rights retained (Stage 2)
 Transaction not on market terms

If the fair value of the consideration for the sale does not equal the fair value of the asset, or if the lease
payments are not at market rates, the following adjustments should be made:
Any below-market terms should be accounted for as a prepayment of lease payments (the shortfall In
consideration received from the lessor is treated as a lease payment made by the lessee)
Any above-market terms are accounted for as additional financing provided by the buyer/lessor (the
additional amount paid by the lessor is treated as additional liability, not as gain on the sale)

Transfer is not a sale

If the transfer does not satisfy the IFRS 15 requirements to be accounted for as a sale,
The seller continues to recognise the transferred asset, and the transfer proceeds are treated as a financial
liability, accounted for in accordance with IFRS 9. The transaction is more in the nature of a secured loan.

Lessor accounting
For lessor accounting IFRS 16 retains the IAS 17 distinction between

Finance leases Operating leases

Finance leases

Definition
- A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an
underlying asset.
- When we talk of risks here, we specifically mean the risks of ownership, not other types of risk. Risks of
ownership include the possibility of losses from idle capacity or technological obsolescence, or variations in
return due to changing economic conditions.
- The rewards are represented by the expectation of profitable operation over the assets economic life, and also
any gain from appreciation in value or realisation of a residual value.

Accounting treatment
- IFRS 16 requires the amount due from the lessee under a finance lease to be recorded in the statement of
financial position of a lessor as a receivable at the amount of the net investment in the lease.
- The recognition of finance income under a finance lease should normally be based on a pattern to give a
constant periodic rate of return on the lessor's net investment outstanding in respect of the finance lease
in each period.
Operating leases

Definition
- An operating lease is a lease that does not transfer substantially all the risks and rewards incidental to
ownership of an underlying asset.

Accounting treatment
- An asset held for use in operating leases by a lessor should be recorded as a long-term asset and
depreciated over its useful life.
- Income from an operating lease, excluding charges for services such as insurance and maintenance, should
be recognised on a straight line basis over the period of the lease, unless another systematic and rational basis
is more representative of the time pattern in which the benefit from the leased asset is receivable.
- A lessor who is a manufacturer or dealer should not recognise any selling profit on entering into an operating
lease because it is not the equivalent of a sale.

Subleases
- A lessee, L, may sublease an asset which it in turn leases from another lessor, H. In this situation, H is the
'head lessor' who ultimately owns the asset from a legal perspective. L then becomes an 'intermediate lessor'.
- An intermediate lessor must assess whether the sublease is a finance or operating lease in the context of the
right-of-use asset being leased, not the actual underlying asset.

H
Head lessor
Lessor

Lessee

L
Intermediate lessor
Lessor

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