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IFRS 16 – LEASES
BY SABI AKTHER 1
 What to focus on?

• Definitions

• Identifying a lease

• Lessee accounting

• Lessor accounting

• Sale and leaseback

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 Definitions

A lease is a contract, or part of a contract, that conveys the right to use an underlying asset for a period of
time in exchange for consideration.

The lessor is the entity that provides the right-of-use asset and, in exchange, receives consideration.

The lessee is the entity that obtains use of the right-of-use asset and, in exchange, transfers consideration.

A right-of-use asset is the lessee's right to use an underlying asset over the lease term.

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 Identifying a lease

• IFRS 16 Leases requires lessees to recognise an asset and a liability for all leases, unless they are
short-term or of a minimal value. As such, it is vital to assess whether a contract contains a lease, or
whether it is simply a contract for a service.

• A contract 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‘

The customer controls the asset’s use if it has:

• the right to substantially all of the identified asset's economic benefits, and

• the right to direct the identified asset's use.

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 Identifying a lease

• The right to direct the use of the asset can still exist if the lessor puts restrictions on its use within a
contract (such as by capping the maximum mileage of a vehicle, or limiting which countries an asset
can be used in). These restrictions define the scope of a lessee's right of use, rather than preventing
them from directing use.

• IFRS 16 says that a customer does not have the right to use an identified asset if the supplier has the
practical ability to substitute the asset for an alternative and if it would be economically beneficial for
them to do so.

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 Lessee Accounting

• At the commencement of the lease, IFRS 16 requires that the lessee recognises a lease liability and a
right-of-use asset.

A ‘right-of-use’ asset meets Conceptual Framework’s definition of assets, because the lessee determines
how the asset is used during the lease term. This use will generate economic benefits for the lessee.

A lease liability meets Conceptual Framework’s definition of liabilities because the lessee has an
obligation to transfer consideration to the lessor once the asset has been made available.

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 Lessee Accounting
Initial measurement

The liability

The lease liability is initially measured at the present value of the lease payments that have not yet been paid.

IFRS 16 states that lease payments include the following:

• Fixed payments

• Variable payments that depend on an index or rate, initially valued using the index or rate at the lease
commencement date

• Amounts expected to be payable under residual value guarantees

• Options to purchase the asset that are reasonably certain to be exercised

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• Termination penalties, if the lease term reflects the expectation that these will be incurred
 Lessee Accounting

A residual value guarantee is when the lessor is promised that the underlying asset at the end of the lease
term will not be worth less than a specified amount.

The discount rate should be the rate implicit in the lease. If this cannot be determined, then the entity
should use its incremental borrowing rate (the rate at which it could borrow funds to purchase a similar
asset).

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 Lessee Accounting

The right-of-use asset

The right-of-use asset is initially recognised at cost.

IFRS 16 says that the initial cost of the right-of-use asset comprises:

• The amount of the initial measurement of the lease liability (see above)

• Lease payments made at or before the commencement date

• Initial direct costs

• The estimated costs of removing or dismantling the underlying asset as per the conditions of the lease

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 Lessee Accounting

The lease term

To calculate the initial value of the liability and right-of-use asset, the lessee must consider the length of
the lease term. IFRS 16 says that the lease term comprises:

• Non-cancellable periods

• Periods covered by an option to extend the lease if reasonably certain to be exercised

• Periods covered by an option to terminate the lease if reasonably certain not to be exercised.

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 Lessee Accounting

Subsequent measurement

The liability

• The carrying amount of the lease liability is increased by the interest charge.

• This interest is also recorded in the statement of profit or loss:

Dr Finance costs (P/L) X

Cr Lease liability X

The carrying amount of the lease liability is reduced by cash repayments:

Dr Lease liability X

Cr Cash X 11
 Lessee Accounting

Subsequent measurement

The right-of-use asset

The right-of-use asset is measured using the cost model (unless another measurement model is chosen).
This means that it is measured at its initial cost less accumulated depreciation and impairment losses.

Depreciation is calculated as follows:

• If ownership of the asset transfers to the lessee at the end of the lease term then depreciation should be
charged over the asset's remaining useful life

• Otherwise, depreciation is charged over the shorter of the useful life and the lease term (as defined
previously). 12
 Lessee Accounting

Subsequent measurement

Other measurement models

If the lessee measures investment properties at fair value then IFRS 16 requires that right-of-use assets that
meet the definition of investment property should also be measured using the fair value model (e.g. right-
of-use assets that are sub-leased under operating leases in order to earn rental income).

If the right-of-use asset belongs to a class of property, plant and equipment that is measured using the
revaluation model, an entity may apply the IAS 16 Property, Plant and Equipment revaluation model to all
right-of-use assets within that class.
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 Lessee Accounting

Separating components

• A contract may contain a lease component and a non-lease component.

• Unless an entity chooses otherwise, the consideration in the contract should be allocated to each
component based on the stand-alone selling price of each component.

• Entities can, if they prefer, choose to account for the lease and non-lease component as a single lease.
This decision must be made for each class of right-of-use asset. However this choice would increase the
lease liability recorded at the inception of the lease, which may negatively impact perception of the
entity's financial position.
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 Lessee Accounting

Reassessing the lease liability

If changes to lease payments occur then the lease liability must be re-calculated and its carrying amount
adjusted. A corresponding adjustment is posted against the carrying amount of the right-of-use asset.

IFRS 16 says that the lease liability should be re-calculated using a revised discount rate if:

• the lease term changes

• the entity's assessment of an option to purchase the underlying asset changes.

The revised discount rate should be the interest rate implicit in the lease for the remainder of the lease
term. If this cannot be readily determined, the lessee’s incremental borrowing rate at the date of
reassessment should be used. 15
 Lessee Accounting

Short-term leases and low value assets

If the lease is short-term (twelve months or less at the inception date) or of a low value then a simplified
treatment is allowed.

IFRS 16 does not specify a particular monetary amount below which an asset would be considered ‘low
value’ but instead gives the following examples of low value assets:

• tablets

• small personal computers

• telephones

• small items of furniture 16

 Lessee Accounting

Short-term leases and low value assets

The assessment of whether an asset qualifies as having a ‘low value’ must be made based on its value
when new. Therefore, a car would not qualify as a low value asset, even if it was very old at the
commencement of the lease.

In these cases, the lessee can choose to recognise the lease payments in profit or loss on a straight line
basis. No lease liability or right-of-use asset would therefore be recognised

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 Lessee Accounting

Lessee disclosures

If right-of-use assets are not presented separately on the face of the statement of financial position then
they should be included within the line item that would have been used if the assets were owned. The
entity must disclose which line item includes right-of-use assets.

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 Lessee Accounting

Lessee disclosures

IFRS 16 requires lessees to disclose the following amounts:

• The depreciation charged on right-of-use assets

• Interest expenses on lease liabilities

• The expense relating to short-term leases and leases of low value assets

• Cash outflows for leased assets

• Right-of-use asset additions

• The carrying amount of right-of-use assets

• A maturity analysis of lease liabilities. 19

 Lessor Accounting

• lessor must classify its leases as finance leases or operating leases

• A finance lease is a lease where substantially all of the risks and rewards of the underlying asset
transfer to the lessee.

• An operating lease is a lease that does not meet the definition of a finance lease

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 Lessor Accounting

How to classify a lease

IFRS 16 Leases states that a lease is probably a finance lease if one or more of the following apply:

Ownership is transferred to the lessee at the end of the lease

• The lessee has the option to purchase the asset for less than its expected fair value at the date the option
becomes exercisable and it is reasonably certain that the option will be exercised

• The lease term (including any secondary periods) is for the major part of the asset's economic life

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 Lessor Accounting

How to classify a lease

• At the inception of the lease, the present value of the lease payments amounts to at least substantially
all of the fair value of the leased asset

• The leased assets are of a specialised nature so that only the lessee can use them without major
modifications being made

• The lessee will compensate the lessor for their losses if the lease is cancelled

• Gains or losses from fluctuations in the fair value of the residual fall to the lessee (for example, by
means of a rebate of lease payments)

• The lessee can continue the lease for a secondary period in exchange for substantially lower than
market rent payments. 22
 Lessor Accounting
Finance leases

Initial treatment

At the inception of a lease, lessors present assets held under a finance lease as a receivable. The value of
the receivable is calculated as the present value of:

• Fixed payments

• Variable payments that depend on an index or rate, valued using the index or rate at the lease
commencement date

• Residual value guarantees

• Unguaranteed residual values

• Purchase options that are reasonably certain to be exercised

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• Termination penalties, if the lease term reflects the expectation that these will be incurred.
 Lessor Accounting

Subsequent treatment

The subsequent treatment of the finance lease is as follows:

• The carrying amount of the lease receivable is increased by finance income earned, which is also
credited to the statement of profit or loss.

• The carrying amount of the lease receivable is reduced by cash receipts

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 Lessor Accounting

Operating leases

• A lessor recognises income from an operating lease on a straight line basis over the lease term.

• Any direct costs of negotiating the lease are added to the cost of the underlying asset. The underlying
asset should be depreciated in accordance with IAS 16 Property, Plant and Equipment or IAS 38
Intangible Assets.

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 Lessor Accounting

Lessor disclosures

The underlying asset should be presented in the statement of financial position according to its nature.

For finance leases, IFRS 16 requires lessors to disclose:

• Profit or loss arising on the sale

• Finance income

• Data about changes in the carrying amount of the net investment in finance leases

• A maturity analysis of lease payments receivable.

For operating leases, lessors should disclose a maturity analysis of undiscounted lease payments
receivable. 26
 Sale & leaseback

If an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and then leases it back,
IFRS 16 requires that both entities assess whether the transfer should be accounted for as a sale.

For this purpose, entities must apply IFRS 15 Revenue from Contracts with Customers to decide whether a
performance obligation has been satisfied. This normally occurs when the customer obtains control of a
promised asset. Control of an asset refers to the ability to obtain substantially all of the remaining benefits.

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 Sale & leaseback

Transfer is not a sale

If the transfer is not a sale then IFRS 16 states that:

• The seller-lessee continues to recognise the transferred asset and will recognise a financial liability
equal to the transfer proceeds.

• The buyer-lessor will not recognise the transferred asset and will recognise a financial asset equal to the
transfer proceeds.

In simple terms, the transfer proceeds are treated as a loan. The detailed accounting treatment of financial
assets and financial liabilities

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 Sale & leaseback

Transfer is a sale

If the transfer does qualify as a sale then IFRS 16 states that:

• The seller-lessee must measure the right-of-use asset as the proportion of the previous carrying amount
that relates to the rights retained.

- This means that the seller-lessee will recognise a profit or loss based only on the rights
transferred to the buyer-lessor.

• The buyer-lessor accounts for the asset purchase using the most applicable accounting standard (such as
IAS 16 Property, Plant and Equipment). The lease is accounted for by applying lessor accounting
requirements.
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 Sale & leaseback

Transactions not at fair value

If the sales proceeds or lease payments are not at fair value, IFRS 16 requires that:

• below market terms (e.g. when the sales proceeds are less than the asset’s fair value) are treated as a
prepayment of lease payments

• above market terms (e.g. when the sales proceeds exceed the asset’s fair value) are treated as additional
financing.

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 Summary
Identifying a lease
A contract that coveys the right to control the use of an identified asset for a period of time
in exchange for consideration

Lessee Accounting
Recognize a lease liability & a right-of-use asset (unless the lease is short-term or of low
value)

Lessor Accounting
Classify the lease as a finance lease or an operating lease

Sale & leaseback

Determine whether the transfer qualifies as a ‘sale’
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Thank You for Watching!!

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