IFRS 16: Leases
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IFRS 16, issued in January 2016, changes lease accounting requirements for lessees. It requires all leases to be reported on the balance sheet as a right-of-use asset and corresponding lease liability. Previously, operating leases were reported off-balance sheet. The new standard aims to provide a more faithful representation of a company's financial position by bringing operating leases onto the balance sheet. For lessees, IFRS 16 eliminates the classification of leases as either operating or finance leases and requires lessees to recognize a right-of-use asset and a financial liability for all leases unless the lease term is 12 months or less or the underlying asset is of low value. Exemptions
IFRS 16: Leases
- 1. IFRS: An Opportunity Discussing IFRS 16: LEASES I have made an attempt to highlight few updates on the topic. From a finance perspective, these 3 decisions (Financing, Investing & Dividends) have always been critical to a company so as to maximize firm’s value. One of the important components of Financing Decision is “Leasing” and let me assure you, this time I will not be discussing it from a finance perspective. WHY IFRS 16 On my first paragraph I would like to answer the most sought question “Why IFRS 16? - What’s the problem with existing Standards!” Answer: There is A GAP in GAAPs. US GAAP runs around 30000 pages while IFRS runs for around 1000 pages. Leases being an important and flexible source of financing to the companies, over 85% of these lease commitments do not appear on balance sheet today. Because, the previous (old) model required lessees and lessors to classify their leases as either finance or operating leases and to account for those two types of leases differently. For operating leases there was no need to recognize Lease Assets & Lease Liabilities. The problem is transactions that were economically similar is being accounted very differently. As a result the existing standards (AS-19/IAS-17) are highly criticized as these model fails to make faithful representation of leasing transactions which makes investors and stakeholders difficult to get a clear picture of company’s lease assets and liabilities. Furthermore it’s difficult to compare the financial position of the companies that lease assets with those that buy assets. It’s a reality because operating lease is an off balance sheet item currently. Thus under IFRS 16 operating leases will be a balance sheet item. IFRS 16 ? The IFRS 16: Leases was issued in 13th January 2016 and applies to annual reporting periods beginning on or after 1st January 2019. Oh! Then is it too early to study. It’s better to study than not to study. Early application of IFRS 16 is permitted provided your entity applies for IFRS 15: Revenue from Contracts with Customers. So, if your company is highly affected by IFRS 15, then early application is desirable. When looked over the financial statements of two entities-one having financial lease and another having operating lease, it could hide the true gearing of the company of the company, as a result it also hampers comparability, and thus, IFRS comes into play. MAJOR CHANGES Remember! Major changes have been made from lessee's perspective, so I will be discussing the highlights only. Accounting for lease in the lessee’s financial statements changed and lessees do not classify the lease anymore. Instead they should account for all the leases in the same way. IFRS 16 requires a lessee to recognize the assets and liabilities for the rights and obligation created by leases. Hence, Operating Lease is no longer an off balance sheet item under IFRS 16. The lessees were able to hide certain liabilities resulting from leases and simply not present them on the face of the financial statements. Under the new standard, lessees will need to show all the leases in the statement of financial position instead of hiding them in notes to financial statements. Are there any exemptions?? Of course, a lessee is not required to account for lease assets and lease liabilities for all leases with a lease term up to or less than 12 months and for those leases where the underlying asset is of low value.
- 2. ACCOUNTING BY LESSEE A lease is defined as a contract or part of contract that conveys the right to use an asset (underlying asset) for a period of time in exchange for consideration. Again I repeat- There is no more classification of lease into Finance Lease and Operating Lease by the lessee A lessee measures Right OF Use Assets (ROU- Assets) similarly to other non financial assets like (Property, plant and equipment) and lease liabilities to other financial liabilities. As a result: a) he claims for depreciation b) books interest on lease liability c) classifies lease payments into principal portion and interest portion and presents in statement of cash flows. MEASUREMENT The right of use asset is measured initially in the amount of the lease liability and initial direct costs It is then adjusted by lease payments made before or on commencement date, lease incentives received and any estimate of dismantling and restoration costs. All payments not paid at the commencement date discounted to present value using the interest rate implicit in the lease (or incremental borrowing rate) LOGIC-ROU -ASSET Logic behind recognizing lessee’s right to use an underlying asset: AS AN ASSET IFRS defines an asset as “a present economic resource controlled by the entity as result of past events" Economic resource is a right that has the potential to produce economic benefits. Lessee's Right to use an underlying asset meets the definition of asset based on IASB's views, so such right is treated as an asset. Similarly, lessee's obligation to make lease payments meet the definition of liability as defined in IFRS. R LEASES & SERVICE CONTRACTS SAME? The answer is big NO. Because in service contracts, the customer receives the service only at the time when the service is rendered and thus the customer has to make the payment for the service availed. Service provider may require the use of some asset to provide a contracted service, but such contract does not allow making those assets available for use by customer. Note: The new definition of the lease can cause that some contracts previously treated as “service contracts” can now be treated as “lease contracts”. EXEMPTIONS DETAILED Short term leases: a) Lease term of maximum of 12 months or less b) Lessee can recognize the lease payments associated with short term leases as an expense over the lease term typically on straight line basis. c) Choice to be made on the basis of CLASS (group) of underlying assets d) If you rent a vehicle for 7 months, you can simply account for all payments made directly in SPL no need to create ROU Asset and lease liability Low value assets a) Choice to be made on Lease by Lease basis (asset wise) b) Low value is to be checked assuming as if the asset is new in all cases. (Lease of old car will not be a low value item, because when it was new it was not of low value) c) You can consider asset amounting $ 5000 as low value asset d) Lease with purchase option does not classify to be of low value asset e) Lease of IT equipment used by the individual employees, lease of office furniture. QUESTION 4 U Under IFRS (say for operating lease) Lessor keeps the Asset in BS & Lessee also keeps same asset in BS at different value. Both lessee and lessor recognize the asset in their statement of financial position. Is this correct? Thank you for reading!!! Niraj Thapa ([email protected])