IFRS 16 Leases

1. IFRS 16 LEASES
Learning objectives
• Development of IFRS 16
• Objectives and scope of IFRS 16
• What is a lease?
• Does the arrangement contains a lease?
• Lease accounting both lessee and lessor perspective
• Sale and leaseback
• Examples for better understanding….
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2. IFRS 16 LEASES
Development of IFRS 16
IAS 17 was originally issued in 1982 and it was the first standard that applied the concept of substance over form and PV basis of measurement (discounting
techniques etc). In 2016 IASB issued new IFRS 16, almost after a 9 year of replacement project.
1982: IAS 17 originally issued
Substance over form PV (discounting techniques)
2016: IFRS 16 issued by IASB
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3. IFRS 16 LEASES
Development of IFRS 16
Main change in IFRS 16 is that it makes no distinction b/w Operating and Finance Lease for lessees.
Instead, lessee will recognise an asset that is in fact is right to use the leased asset for the lease term and also the liability to make the lease payment.
Both Lessor and lessee will show the leases differently in the financial statements.
Operating v Finance lease Concept or Right to use Different reporting in FSs’
 w.e.f. 01 January 2019
 IAS 17 Leases will no longer apply
 Early application only if IFRS 15 applied within the organisation
2016: New standard IFRS 16
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4. IFRS 16 LEASES
Objectives and scope of IFRS 16
Objective is to specify the principles for recognition, measurement, presentation and disclosure of LEASES.
In other words, The objective is to prescribe accounting treatment for PPE so that users of the FSs can discern information about an entity’s investment in
its PPE and changes in such investment.
Scope: IFRS 16 applies to all leases except for:
Leases to explore for / use of minerals, oil, natural gas and similar
Leases of biological assets (IAS 41)
Intellectual property licenses (IFRS 15)
Service concession arrangements (IFRIC 12)
Rights under licensing agreements (IAS 38)
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5. IFRS 16 LEASES
What is a lease?
A contract, or part of contract, that conveys the right to use an asset for a period of time in exchange for consideration.
Period of time = LEASE TERM
In exchange for consideration =LEASE PAYMENT
Asset
Contract Lessor Lessee
Consideration
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6. IFRS 16 LEASES
What is a lease?
We should assess the existence of lease at the inception of the contract!!
In most arrangements it is very straightforward and easy.
In some arrangements it is not such easy and judgement might be necessary to assess.
So, how can we determine that an arrangement contains a lease??????
Well, arrangement contains a lease if throughout the period of use, the customer has both of the rights
to the identified asset:
The right to obtain substantially all of the Economic Benefits from the use of
identified asset. E.g.,
1.Exclusive right of use,
2. When the customer has the right to get not only primary output of the
asset use but also by-product
The right to direct the use of identified asset. It means the customer make
decisions about why and how the asset is used!
There can be some restrictions e.g., Protective rights do not limit the right to
direct the use
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7. IFRS 16 LEASES
Example: (Protective rights do not limit the right to direct the use)
If you rent a car and you can use it only within certain territory and not in other places, that is the protective right!! But you can still decide why and how to use the car but may be the most important is
to determine the identified asset because if there is no identified asset then there is no lease!!!
In most cases it is easy as asset is identified Explicitly(e.g., car, it specified brand, color, number plate, engine number etc.)
Asset can be identified Implicitly too (when explicit specification is not possible at the inception). (e.g., asset hasn’t built yet). Very often the customer can lease certain capacity of an asset and in this
case Capacity portion can be identified as identified asset if :
• When capacity is physical distinct.
Example- You want to rent storage space in warehouse and if your contract specifies the Specific unit/ area you will be renting out and no one else can use that area then your contract contains a LEASE.
But, if your contract specifies the area e.g., 100 sq. meter of the warehouse and the warehouse manager can re-arrange the space and offer any 100 sq. meter in the warehouse, then contract doesn’t
contain a LEASE (as no identified asset)
• Sometimes, capacity portion is not physically distinct but, still an identified asset. Its when you substantially all of the capacity of the asset. For example, you want use of pipeline to transfer gas or
oil. You entre into the contract for right to use of 90% of the pipeline capacity over the contract term. Though capacity is not physically distinct but 90% is almost all of pipeline capacity and this is
considered as identified asset under IFRS 16. But, if you rent out just 50% then it wont be classified as an identified asset (as not physically distinct and not substantially all of the asset) and hence
not considered as LEASE.
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8. IFRS 16 LEASES
No Classification b/w Operating and Finance leases (i.e., account for all the leases in the same way)
Initial Recognition
Lessee recognises both
• Amount of lease liability, Lease payments not paid at commencement date
• Lease payments made before or on discounted to PV using the
Commencement date – lease incentives received, if any interest rate implicit in LEASE
• Initial direct cost incurred by lessee, Note: if the rate implicit in the lease can’t be determined the lessee shall
• Estimated cost of dismantling asset use their incremental borrowing rate.
Leaes Accounting ; Lessee Perspective
At the Commencement date
Right of use Asset Lease Liability
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9. IFRS 16 LEASES
No Classification b/w Operating and Finance leases (i.e., account for all the leases in the same way)
Lessee recognises both
Exceptions (0ptional): choose whether you like to apply IFRS 16 to below optional exemptions
1.. Lease term < 1 year with no purchase option
2. Underlying asset of low value when new, such as PC(and done on one by one basis)
The accounting for low value or short-term leases is donethrough expensing the rental through profit or loss on a straight-linebasis.
Leaes Accounting ; Lessee Perspective
At the Commencement date
Right of use Asset Lease Liability
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10. IFRS 16 LEASES
Subsequent measurement - After commencement date, lessee needs to take care about both elements recognized initially:
Normally, a lessee needs to measure the right-of-use asset using a cost model under IAS 16.. It basically means to depreciate the asset over the lease term: (Cost less Accumulated depreciation)
Dr P/L (Dep’n Charge) Cr Acc Dep’n of Right of use asset
A lessee needs to recognize an interest on the lease liability, Also, the lease payments are recognized as a reduction of the lease liability. If there is a change in the lease term, lease payments, discount rate
or anything else, then the lease liability must be re-measured to reflect all the changes. (Financial liability at amortised cost)
Dr P/L (Int expense) Cr Lease Liability => Recognition of interest on Lease liability
Dr Lease liability Cr Bank/ Cash => Payment of lease
Leaes Accounting ; Lessee Perspective
1. Right of use Asset
2.Lease Liability
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11. IFRS 16 LEASES
Example 1: On 1 January 2019, Plum entered into a five year lease of machinery. The machinery has a useful life of six years. The annual lease payments are $5,000 per annum, with the first payment
made on 1 January 2019. To obtain the lease Plum incurs initial direct costs of $1,000 in relation to the arrangement of the lease but the lessor agrees to reimburse Pear $500 towards the costs of the
lease. The rate implicit in the lease is 5%. The present value of the minimum lease payments is $22,730. Demonstrate how the lease will be accounted in the financial statements over the five year period.
• Lessee takes asset under the lease: Dr Right of use Asset Cr Lease liability => $22.,730
• Lessee pays the legal fees Dr Right of use Asset Cr Suppliers / Bank / Cash =>$1,000 (i.e., initial direct cost)
• Incentive payments received Dr Cash Cr Right of use asset => $500
• Lessee remove an asset/ restore the site after the end of the lease term
Dr Right of use Asset Cr Provision of asset removal (IAS 37) =>N/A
Right of use asset = $22,,730 + $1,000 - $500 = $23,230
Leaes Accounting ; Lessee Perspective
Initial recognition
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12. IFRS 16 LEASES
Example 1: On 1 January 2019, Plum entered into a five year lease of machinery. The machinery has a useful life of six years. The annual lease payments are $5,000 per annum, with the first payment
made on 1 January 2019. To obtain the lease Plum incurs initial direct costs of $1,000 in relation to the arrangement of the lease but the lessor agrees to reimburse Pear $500 towards the costs of the
lease. The rate implicit in the lease is 5%. The present value of the minimum lease payments is $22,730. Demonstrate how the lease will be accounted in the financial statements over the five year period.
• Depreciate the asset over the earlier lease term of 5 years.
• Expense per annum = $22,230 / 5 = $4,646
• Record fin lease payments and interest using the rate implicit in the lease
Leaes Accounting ; Lessee Perspective
Subsequent measurement
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13. IFRS 16 LEASES
I. FINANCE LEAES
Initial Recognition
At the commencement of lease term – lessor should recognise LEASE RECEIVABLES ( = Net Investment in LEASE)
Net investment in lease equals to the PV of payments not paid at the commencement date…plus initial direct costs
Journal will be as: Dr Lease Receivables Cr PPE (underlying asset)
Subsequent Measurement
1. Recognition of finance income on Lease Receivables Dr Lease Receivables Cr P/L – Finance income
2. Cash received and reduction in lease receivables Dr Bank/ Cash Cr Lease Receivables
II. OPERATING LEASE
• Lessor keeps recognising the leased asset in his FS’s
• Lease income from OL recognised as an income on SL basis (or another systematic basis) over the lease term
Leaes Accounting ; Lessors Perspective
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14. IFRS 16 LEASES
A sale and leaseback transaction occurs when one entity (seller) transfers an asset to another entity (buyer) who then leases the asset back to the original seller (lessee).
In this situation a seller becomes lessee and a buyer becomes a lessor
Accounting treatment of sale and leaseback transactions depends on the whether the transfer of an asset is a sale under IFRS 15 Revenue from contracts with customers.
If transfer is not a sale:
• Seller (lessee) : 1. continue to recognize the asset
2. account for cash received as for a financial liability (under IFRS 9 Financial Instruments)
• Buyer (lessor): 1. don’t recognize the asset
2. recognizes the financial asset (= proceeds) (under IFRS 9 Financial instruments)
Sale and Leaseback
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15. IFRS 16 LEASES
If transfer is a sale:
• Seller (lessee) : 1. derecognise the asset, recognize the sale at Fair value
2. recognise the lease liability (PV of lease rentals)
3. recognise a right-of-use asset, as a prop. of the previous carrying value of underlying asset
4. Gain/loss on rights transferred to the buyer
• Buyer (lessor): 1. recognise purchase of the asset
2. Apply lessor accounting 
Sale and Leaseback
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16. IFRS 16 LEASES
Example 1 : Apple required funds to finance a new ambitious rebranding exercise. It’s only possible way of raising finance is through the sale and leaseback of its head office building for a period of 10
years. The lease payments of $1 million are to be made at the end of the lease period The current fair value of the building is $10 million and the carrying value is $8.4 million. The interest rate implicit
in the lease is 5%. Advise Apple on how to account for the sale and leaseback in its financial statements if the office building were to be sold at the fair value of $10 million and:
(a) Performance obligations are not satisfied; or,
(b) Performance obligations are satisfied.
Sale and Leaseback
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17. IFRS 16 LEASES
If transfer is not a sale:
• Seller (lessee) : 1. continue to recognize the asset @ $8.4m and depreciate.
2. account for cash received as for a financial liability (under IFRS 9 Financial Instruments) @ transfer proceeds
of $10m
• Buyer (lessor): 1. don’t recognize the asset as it has not been sold to buyer
2. recognizes the financial asset (= proceeds) (under IFRS 9 Financial instruments) @ transfer proceeds of $10m
If transfer is a sale:
• Seller (lessee) : 1. derecognise the asset, recognize the sale at Fair value @ 8.4m
2. recognise the lease liability (PV of lease rentals)
3. recognise a right-of-use asset, as a prop. of the previous carrying value of underlying asset
4. Gain/loss on rights transferred to the buyer @ balancing figure
• Buyer (lessor): 1. recognise purchase of the asset @$10m (FV = proceeds)
2. Apply lessor accounting
Sale and Leaseback
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18. IFRS 16 LEASES
Journal : Dr Bank $10 m
Dr Right of use asset (WN – 2) $6.49 m
Cr Lease liability $7.72 m (WN – 1)
Cr PPE – Building $8.40 m
Cr Gain on transfer $ 0.36 m
Workings Notes
WN – 1: Lease Liability = PV of lease rentals at rate implicit in the lease = $1m X PVF for ordinary annuity for 10 years at 5%
= $1m X 7.722 = $7.722m
WN – 2: Fair Value Carrying Value
Right of use Asset $ 7.722m = 77.22% $8.4mX77.22% = $6.49m
Rights Transferred $ 2.278 m = 22..78% $1.91m
Total $ 10m = 100%
Sale and Leaseback
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19. IFRS 16 LEASES
Thanks for the patience…. Should you have any queries or require any guidance, please comment and shall return the call!
Have a great Year Ahead!!!
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