Understanding Ifrs 16 Summary Leases Requirements

IFRS 16 Summary Leases Requirements can be overwhelming, but breaking it down makes it more manageable.

The new standard requires lessees to recognize almost all leases on their balance sheet.

Lessees can elect to use the 'right-of-use' model, which allows them to recognize a right-of-use asset and a lease liability for all leases.

This model is more complex, but provides more transparency and comparability.

The 'right-of-use' model is a significant change from the previous standard, which only required lessees to disclose information about leases.

Lessee accounting is more prominent under IFRS 16, with lessees required to recognize both the asset and liability on their balance sheet.

IFRS 16 is a lease accounting standard issued by the IFRS Foundation and the International Accounting Standards Board (IASB).

This standard sets out the accounting treatment for leases, including recognition, measurement, presentation, and disclosure. The IFRS 16 standard was created to provide a unified approach to lease accounting.

A single lessee accounting model is established under IFRS 16, requiring lessees to recognize assets and liabilities for all leases, with limited exceptions. This eliminates the previous classification of leases as either operating or finance under IAS 17.

Leases are classified as either finance leases or operating leases under IFRS 16. A finance lease transfers substantially all of the risks and rewards of ownership of the underlying asset to the lessee.

To classify a lease, you need to determine if the risks and rewards of ownership have transferred to the lessee. This is a key provision of IFRS 16.

A right-of-use asset is an intangible asset that represents the lessee's right to use the underlying asset for the lease term. The right-of-use asset is measured at the present value of the lease payments, discounted at the lessee's incremental borrowing rate.

The right-of-use asset is amortized over the lease term on a straight-line basis. This means that the asset is depreciated evenly over the lease period.

Interest expense on the lease liability is recognized over the lease term using the effective interest method. This ensures that the interest expense is accurately reflected in the financial statements.

Here are the key provisions of IFRS 16 summarized in a table:

All leases in the scope of IFRS 16 must be recognized on the balance sheet. This is a significant change from the previous accounting standard, IAS 17/AASB 117.

The lessee must recognize a right-of-use asset and a lease liability for all leases. The right-of-use asset is measured at the present value of the lease payments, discounted at the lessee's incremental borrowing rate.

The lease liability is measured at the present value of the lease payments, discounted at the lessee's incremental borrowing rate.

Leases are classified as either finance leases or operating leases, with finance leases transferring substantially all of the risks and rewards of ownership to the lessee.

Finance leases are accounted for as if the lessee had purchased the asset, with lease payments treated as both interest expense and depreciation expense. Operating leases, on the other hand, do not transfer substantially all of the risks and rewards of ownership, and are accounted for on a straight-line basis with lease payments treated as rent expense.

To account for a finance lease, the lessee must recognize a right-of-use asset on its balance sheet, which represents the lessee's right to use the underlying asset for the lease term. The right-of-use asset is measured at the present value of the lease payments, discounted at the lessee's incremental borrowing rate.

Here's a summary of the key differences between finance and operating leases:

Classification is a crucial step in accounting for a lease under IFRS 16. To classify a lease, you need to determine whether it's a finance lease or an operating lease.

A finance lease transfers substantially all of the risks and rewards of ownership to the lessee, making them effectively the owner of the asset. This is in contrast to an operating lease, which doesn't transfer these risks and rewards to the lessee.

Here's how to distinguish between the two:

The right of use asset is a crucial concept in accounting for leases under IFRS 16. It represents the lessee's right to use the underlying asset for the lease term, and is measured at the present value of the lease payments.

The right of use asset is an intangible asset that is recognized on the lessee's balance sheet for finance leases. It is calculated as the present value of the lease payments, discounted at the lessee's incremental borrowing rate.

The majority of the value attributed to the right of use asset comes from the lease liability value, with other inputs such as the make good provision, direct costs, and lease payments also being considered.

The right of use asset is amortized over the lease term on a straight-line basis, with a depreciation expense recognized each period equal to the cost of the right of use asset divided by the lease term.

Here's a step-by-step guide to calculating the right of use asset balance:

1. Determine the lease liability value.

2. Consider the make good provision, direct costs, and lease payments made at or before the commencement date.

3. Calculate the right of use asset balance, which starts from the lease liability balance and is impacted by the other inputs.

For example, if the lease liability balance is $11,637, and there are no other inputs applicable, the right of use asset value will match the lease liability.

The right of use asset will depreciate to zero over the lease term, with the depreciation amount calculated using a straight-line method.

The right-of-use asset is amortized over the lease term on a straight-line basis, meaning a depreciation expense is recognized each period equal to the cost of the asset divided by the lease term.

This approach ensures that the asset is depreciated evenly over its useful life, providing a clear picture of its value. The straight-line method is a straightforward and widely accepted method for depreciating assets.

Interest expense on the lease liability is recognized over the lease term using the effective interest method, which means interest expense is recognized each period equal to the carrying amount of the lease liability multiplied by the lessee's incremental borrowing rate.

The right-of-use asset is amortized over the lease term on a straight-line basis, which means the lessee recognizes a depreciation expense each period equal to the cost of the right-of-use asset divided by the lease term.

This approach is straightforward and easy to apply, as seen in Example 1, where the lessee simply divides the cost of the right-of-use asset by the lease term to determine the depreciation expense.

To calculate the depreciation expense, you can use the following formula: Depreciation Expense = (Cost of ROU Asset / Lease Term).

For instance, if the cost of the right-of-use asset is $100,000 and the lease term is 5 years, the annual depreciation expense would be $20,000 ($100,000 / 5 years).

The depreciation expense is calculated for each period of the lease term, and it's essential to ensure that the right-of-use asset depreciates to zero by the end of the lease term.

Here's a simple table to illustrate the calculation:

As you can see, the depreciation expense remains the same each year, resulting in a total depreciation of $100,000 by the end of the lease term.

Interest Expense is a crucial component of financial reporting, particularly for companies with lease liabilities.

Interest Expense on lease liabilities is recognized over the lease term using the effective interest method. This method requires the lessee to recognize interest expense each period equal to the carrying amount of the lease liability multiplied by the lessee's incremental borrowing rate.

To apply the discount rate, you'll need to use a formula like the XNPV formula, which takes into account the rate, values, and dates of the lease payments.

The discount rate is a crucial input for this calculation, and it's typically the lessee's incremental borrowing rate. This rate is used to determine the present value of the lease payments.

For example, if the rate is 7% and the lease payments are $1,000 each, the present value calculation will result in a specific amount, such as $11,637.

The XNPV formula will take into account the dates of the lease payments, which in this case are from 2021-01-01 to 2021-12-31. This will ensure that the present value calculation is accurate and reflects the timing of the lease payments.

Termination of a lease can be a complex process, and it's essential to understand the rules. If a lease is terminated before the end of the lease term, the lessee must recognize a loss on termination.

The loss on termination is calculated as the difference between the carrying amount of the lease liability and the present value of the remaining lease payments, discounted at the lessee's incremental borrowing rate.

Modification accounting can get quite tricky, especially with a decrease in scope calculation. A change to the lease calculation inputs can result from either a modification to the contract's terms and conditions or the lessee exercising an option within the contract.

To illustrate this, consider the following inputs required for the XNPV function in Excel, used to calculate the lease liability:

Termination of a lease can be a complex process, but it's essential to understand the financial implications.

If a lease is terminated before the end of the lease term, the lessee must recognize a loss on termination.

The loss on termination is calculated as the difference between the carrying amount of the lease liability and the present value of the remaining lease payments.

To calculate the present value of the remaining lease payments, the lessee must use their incremental borrowing rate, which is the interest rate they would pay if they borrowed the same amount of money.

This means that the lessee must consider their own financial situation and creditworthiness when determining the incremental borrowing rate.

The lessee must then discount the remaining lease payments at this rate to determine the present value.

The loss on termination is the difference between the carrying amount of the lease liability and the present value of the remaining lease payments.

Modification accounting can be a complex and nuanced topic, especially when it comes to changes in lease calculation inputs. A change to the lease calculation inputs can result from a modification to the contract's terms and conditions or the lessee exercising an option within the contract.

Lease payments and lease term are the two inputs that determine the calculation of the lease liability. Modification accounting occurs when there is a change to either of these inputs.

A decrease in scope calculation can make modification accounting even trickier. The devil is indeed in the detail.

The lessee must recalculate the lease liability and the right of use asset when a modification occurs. This requires a thorough understanding of the lease calculation methodology.

IFRS 16 requires lessees to disclose information in the notes that gives a basis for users of financial statements to assess the effect that leases have on the financial position, financial performance, and cash flows of the lessee.

The standard mandates that lessees disclose the depreciation amount for right-of-use assets by class, the expense relating to short-term leases, and the expense relating to leases of low-value assets.

Lessee companies must also disclose the interest expense on lease liabilities, the expense relating to variable lease payments not included in measuring lease liabilities, and all income from subleasing right-of-use assets.

The total cash outflow for leases, additions to right-of-use assets, and any gains or losses from sale and leaseback transactions must also be disclosed.

Here is a list of the required disclosures:

Transition to IFRS 16 is mandatory for lessees starting from annual periods beginning on or after January 1, 2019, but early adoption is allowed. If you adopt IFRS 16 early, you must apply the standard retrospectively.

To calculate the lease liability and right of use asset, you'll need to understand the time value of money and how to calculate the present value. You should also be familiar with recognizing a lease liability and right of use asset when entering a lease.

To make calculations easier, lease payments can be performed daily, which ensures flexibility, especially if a lease modification occurs. This approach is more accurate and flexible compared to monthly calculations.

Here are the prerequisites to follow the practical examples:

To perform the calculations, you'll need the date of the payment and the amount of the payment.

The transition to IFRS 16 is a significant change for lessees, requiring them to adopt the standard for annual periods beginning on or after January 1, 2019.

Early adoption is permitted, but lessees must apply the standard retrospectively if they choose to adopt it early.

The effective date for IFRS 16 is January 1, 2019, marking a significant change from previous accounting standards.

Previous accounting standards only required lessees to recognize a lease liability for finance leases, whereas IFRS 16 requires lessees to recognize a right-of-use asset and a lease liability for all leases with a term of more than 12 months.

To facilitate the transition, it's essential to understand the prerequisites for calculating the lease liability and right of use asset, which include understanding the time value of money and how to calculate the present value.

You should also be familiar with recognizing a lease liability and right of use asset when entering a lease, as well as the unwinding of the lease liability to zero upon completion of the lease.

Here's a summary of the key dates and events to keep in mind:

IFRS 16 brings significant changes to lease accounting, and lessees must adopt the standard for annual periods beginning on or after January 1, 2019.

Early adoption is permitted, but if a lessee adopts IFRS 16 early, it must apply the standard retrospectively.

Lease agreements can be complex, but to calculate the lease liability, you only need to extract three main inputs: the commencement date of the lease, the lease term, and the end date of the lease payments.

These inputs determine the future lease payments, which the lessee is required to present value.

The discount rate is the final input used to calculate the present value of the known future lease payments, but it's not extracted from the lease agreement.

Determining the lease term requires judgment, and the lessee should select the most reasonably likely end date of the lease, which may or may not include renewals.

Here's a summary of the lease payment types and whether they're included in the lease liability calculation:

Lessees must recognize a right-of-use asset and a lease liability for all leases with a term of more than 12 months under IFRS 16.