2022

IFRS 16 Leases

Gaborone Campus Plot No:50661, Fairgrounds International, P/Bag 137, Gaborone, Botswana Tel: (+267)3953 062 Fax: (+267)3919 118
Francistown Plot No:31403, Moffat Street, P/Bag 137, Francistown, Botswana Tel: (+267)2410 558 Fax:(+267)2410 534
 Introduction

• International Financial Reporting Standard

(IFRS®) 16 – Leases - was issued in January
2016
• Replaces, International Accounting Standard
(IAS®) 17

• Focus on leasing transactions reported in

the financial statements of lessees.
Context

 A lease is an agreement whereby the lessor (the legal

owner of an asset) conveys to the lessee (the user of
the asset) the right to use an asset for an agreed
period of time in return for a payment or series of
payments.

 IAS 17 was to distinguish between two types of leases.

• Leases that transfer substantially all the risks and
rewards of ownership of an asset were classified as
finance leases.
• All other leases were classified as operating leases.
• The lease classification set out in IAS 17 was subjective
Definition

IFRS 16 defines a lease as “A contract, or part of a

contract, that conveys the right to use an asset for a
period of time in exchange for consideration”.

In order for such a contract to exist the user of the

asset needs to have the right to:
1. Obtain substantially all of the economic benefits
from the use of the asset.
2. The right to direct the use of the asset.
An Identified Asset

 One essential feature of a lease is that there is an

‘identified asset’.
 This normally takes place through the asset being
specified in a contract, or part of a contract.
 For the asset to be ‘identified’ the supplier of the asset
must not have the right to substitute the asset for an
alternative asset throughout its period of use.
 The fact that the supplier of the asset has the right or the
obligation to substitute the asset when a repair is
necessary does not preclude the asset from being an
‘identified asset’.
 Example – An identified asset

Under a contract between local council (L) and a private company

(P), P provides L with 20 trucks to be used for refuse collection on
behalf of L for a 6-year period. The trucks, which are owned by P, are
specified in the contract. L determines how they are used in the
refuse collection process. When the trucks are not in use, they are
kept at L’s premises. L can use the trucks for another purposes if it so
chooses. If a particular truck needs to be serviced or repaired, P is
required to substitute a truck of the same type. Otherwise, P cannot
retrieve the trucks during the six-year period.

Is this contract a lease contract?

Solution

The contract is a lease. L has the right to use

the 20 trucks for six years which are identified
and explicitly specified in the contract.

Once delivered to L, the trucks can be

substituted only when they need to be
serviced or repaired.
 The right to direct the use of the asset

IFRS 16 states that a customer has the right to direct the

use of an identified asset if either:
o The customer has the right to direct how and for
what purpose the asset is used throughout its
period of use; or
o The relevant decisions about use are pre-
determined and the customer has the right to
operate the asset throughout the period of use
without the supplier having the right to change
these operating instructions.
 Example - The right to direct the use of the
asset
A customer (C) enters into a contract with a road haulier (H) for
the transportation of goods from Gaborone to Francistown on a
specified truck. The truck is explicitly specified in the contract
and H does not have substitution rights. The goods will occupy
substantially all of the capacity of the truck. The contract
specifies the goods to be transported on the truck and the
dates of pickup and delivery.

H operates and maintains the truck and is responsible for the

safe delivery of the goods. C is prohibited from hiring another
haulier to transport the goods or operating the truck itself.

Does this contract contain a lease?

 Solution

• This contract does not contain a lease.

• There is an identified asset.
• The truck is explicitly specified in the contract and H does
not have the right to substitute that specified truck.
• C does have the right to obtain substantially all of the
economic benefits from use of the truck over the contract
period.
• However, C does not have the right to control the use of the
truck because C does not have the right to direct its use.
• C does not have the right to direct how and for what
purpose the truck is used.
• C has the same rights regarding the use of the truck as if it
were one of many customers transporting goods using the
truck.
Accounting for leases

• With a very few exceptions, IFRS 16 abolishes the distinction

between an operating lease and a finance lease in the
financial statements of lessees.

• Lessees will recognise a right of use asset and an associated

liability at the inception of the lease.

• IFRS 16 requires that the ‘right of use asset’ and the lease
liability should initially be measured at the present value of
the minimum lease payments.

• The discount rate used to determine present value should be

the rate of interest implicit in the lease.
Recording the asset

The ‘right of use asset’ would include the following amounts,

where relevant:
1. Any payments made to the lessor at, or before, the
commencement date of the lease, less any lease incentives
received.
2. Any initial direct costs incurred by the lessee.
3. An estimate of any costs to be incurred by the lessee in
dismantling and removing the underlying asset, or restoring
the site on which it is located (unless the costs are incurred to
produce inventories, in which case they would be accounted
for in accordance with IAS 2 – Inventories).
Accounting for leases

• Depreciation
 The right of use asset is subsequently depreciated.
 Depreciation is over the shorter of the useful life of the
asset and the lease term
 If the title to the asset transfers at the end of the lease
term, depreciation is over the useful life.

• Lease liability
 The lease liability is effectively treated as a financial
liability
 Measured at amortised cost, using the rate of interest
implicit in the lease as the effective interest rate (or the
Internal Rate of Return (IRR)).
Example

A lessee enters into a 20-year lease of one floor of a building, with an option
to extend for a further five years. Lease payments are P80,000 per year
during the initial term and P100,000 per year during the optional period, all
payable at the end of each year. To obtain the lease, the lessee incurred
initial direct costs of P25,000

At the commencement date, the lessee concluded that it is not reasonably

certain to exercise the option to extend the lease and, therefore, determined
that the lease term is 20 years. The interest rate implicit in the lease is 6%
per annum. The present value of the lease payments is P917,600.

At the commencement date, the lessee incurs the initial direct costs and
measures the lease liability P917,600.
Solution

Right of use asset after these entries is P942,600 (P917,600 + P25,000) and
consequently the annual depreciation charge will be P47,130 (P942,600 x
1/20).

The lease liability will be measured using amortised cost principles. We

measure the lease liability up to and including the end of year ten. This is
done in the following table:

Balance Finance cost

Balance c/f
b/f (6%) Rental
P
Year P P P

1 917,600 55,056 (80,000) 892,656

2 892,656 53,559 (80,000) 866,215

 Solution – Continued

• Right to use asset: At the end of year one, the carrying amount of the right
of use asset will be P895,470 (P942,600 less P47,130 depreciation).

• Interest cost of P55,056 will be taken to the statement of profit or loss as a

finance cost.

• Total lease liability at the end of year one will be P892,656. As the lease is
being paid off over 20 years, some of this liability will be paid off within a
year and should therefore be classed as a current liability.

• Non-current lease liability is P866,215, being the amount of the P892,656

which will still be outstanding in over a year.

• Current liability element is therefore P26,441. This represents the P80,000

paid in year two less year two’s finance costs of P53,559 (or P892,656-
P866,215).
Short-term or low-value leases

• A short-term lease is a lease that, at the date of

commencement, has a term of 12 months or less.

• A lease that contains a purchase option cannot be

a short-term lease.

• Lessees can elect to treat short-term leases by

recognising the lease rentals as an expense over
the lease term rather than recognising a ‘right of
use asset’ and a lease liability.
 Short-term or low-value leases

An underlying asset can be of low value only if:

(a) The lessee can benefit from use of the underlying asset on its own or
together with other resources that are readily available to the lessee; and

(b) The underlying asset is not highly dependent on, or highly interrelated
with, other assets.

A lease of an underlying asset does not qualify as a lease of a low-value asset

if the nature of the asset is such that, when new, the asset is typically not of
low value. For example, leases of cars would not qualify as leases of low-value
assets because a new car would typically not be of low value.

Examples of low-value underlying assets can include tablet and personal

computers, small items of office furniture and telephones.
The end

Thank you!

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