International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards
Page 334
Lessor accounting for a finance lease ............................................. 1748
Example 24.20:
Classification of a sublease ............................................................... 1754
Example 24.21:
Subleases (IFRS 16 Illustrative Examples 20 and 21) ................... 1755
Example 24.22:
Sale and leaseback transaction (IFRS 16 Illustrative
Example 24) ......................................................................................... 1759
Example 24.23:
Accounting for lease contracts at transition using the full
retrospective and modified retrospective approaches ............... 1764
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Chapter 24
Leases (IFRS 16)
1 INTRODUCTION
IFRS 16 – Leases – requires lessees to recognise assets and liabilities for most leases.
The IASB issued the standard after joint deliberations with the US FASB, which issued
a similar standard. However, there are significant differences between the IASB and
FASB standards (e.g. lessees classify leases as finance or operating leases under the
FASB standard). These differences will result in certain transactions being accounted
for differently under IFRS and US GAAP.
The lease accounting requirements in IAS 17 – Leases, have been criticised for failing
to meet the needs of users of the financial statements, particularly because IAS 17 does
not require lessees to recognise assets and liabilities arising from operating leases.
IFRS 16 addresses those criticisms by requiring lessees to recognise most leases on their
statements of financial position and providing enhanced disclosures. The IASB believes
this will result in a more faithful representation of lessees’ assets and liabilities and
greater transparency about lessees’ financial obligations and leasing activities. Under
IFRS 16, leases are accounted for based on a ‘right-of-use model’. The model reflects
that, at the commencement date, a lessee has a financial obligation to make lease
payments to the lessor for its right to use the underlying asset during the lease term. The
lessor conveys that right to use the underlying asset at lease commencement, which is
the time when it makes the underlying asset available for use by the lessee.
Entities will need to focus on whether an arrangement contains a lease or a service
agreement because there are significant differences in the accounting. Although IFRS 16
changes how the definition of a lease is applied, we believe that the assessment of
whether a contract contains a lease will be straightforward in most arrangements.
However, judgement may be required in applying the definition of a lease to certain
arrangements, particularly those that include significant services.
For lessees, the income statement presentation and expense recognition pattern is
similar to finance leases under IAS 17 (i.e. separate interest and depreciation expense
with higher periodic expense in the earlier periods of a lease).
Lessor accounting is substantially unchanged from current accounting. Lessors classify
all leases using the same classification principle as in IAS 17 and distinguish between
operating and finance leases.
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IFRS 16 is effective for annual periods beginning on or after 1 January 2019. Early
application is permitted, provided the new revenue standard, IFRS 15 – Revenue from
Contracts with Customers – has been applied, or is applied at the same date as IFRS 16.
IFRS 16’s transition provisions permit lessees to use either a full retrospective or a
modified retrospective approach for leases existing at the date of initial application of
the standard (i.e. the beginning of the annual reporting period in which an entity first
applies the standard), with options to use certain transition reliefs.
2
OBJECTIVE AND SCOPE OF IFRS 16
2.1
Objective of IFRS 16
IFRS 16 sets out the principles for the recognition, measurement, presentation and
disclosure of leases. The objective is to ensure that lessees and lessors provide
relevant information in a manner that faithfully represents those transactions. This
information 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 an
entity. [IFRS 16.1].
IFRS 16 requires an entity to consider the terms and conditions of contracts and all
relevant facts and circumstances, and to apply the standard consistently to contracts
with similar characteristics and in similar circumstances. [IFRS 16.2].
2.2
Scope of IFRS 16
IFRS 16 applies to all leases, including leases of right-of-use assets in a sublease, except for:
(a) Leases to explore for or use minerals, oil, natural gas and similar non-regenerative
resources;
(b) Leases of biological assets within the scope of IAS 41 – Agriculture – held by a lessee;
(c) Service concession arrangements within the scope of IFRIC 12 – Service
Concession Arrangements;
(d) Licences of intellectual property granted by a lessor within the scope of IFRS 15; and
(e) Rights held by a lessee under licensing agreements within the scope of IAS 38 –
Intangible Assets – for such items as motion picture films, video recordings, plays,
manuscripts, patents and copyrights. [IFRS 16.3].
A lessee may, but is not required to, apply IFRS 16 to leases of intangible assets other
than those described in (e) above. [IFRS 16.4].
2.3 Recognition
exemptions
A lessee can elect not to apply the recognition requirements to:
(a) Short term leases; and
(b) Leases for which the underlying asset is of low value. [IFRS 16.5].
These recognition exemptions are discussed in further detail at 5.1.1 and 5.1.2 below.
Leases (IFRS 16) 1693
2.4 Definitions
The following table summarises the terms that are defined in IFRS 16. [IFRS 16 Appendix A].
Term Definition
Commencement date of The date on which a lessor makes an underlying asset available for use by
the lease
a lessee.
(commencement date)
Economic life
Either the period over which an asset is expected to be economically usable by
one or more users or the number of production or similar units expected to be
obtained from an asset by one or more users.
Effective date of the
The date when both parties agree to a lease modification.
modification
Fair value
For the purpose of applying the lessor accounting requirements in this Standard,
the amount for which an asset could be exchanged, or a liability settled,
between knowledgeable, willing parties in an arm’s length transaction.
Finance lease
A lease that transfers substantially all the risks and rewards incidental to
ownership of an underlying asset.
Fixed payments
Payments made by a lessee to a lessor for the right to use an underlying asset
during the lease term, excluding variable lease payments.
Gross investment in the The sum of:
lease
• The lease payments receivable by a lessor under a finance
lease; and
• Any unguaranteed residual value accruing to the lessor.
Inception date of the
The earlier of the date of a lease agreement and the date of commitment by the
lease (inception date)
parties to the principal terms and conditions of the lease.
Initial direct costs
Incremental costs of obtaining a lease that would not have been incurred if the
lease had not been obtained, except for such costs incurred by a manufacturer
or dealer lessor in connection with a finance lease.
Interest rate implicit in
The rate of interest that causes the present value of (a) the lease payments and
the lease
(b) the unguaranteed residual value to equal the sum of (i) the fair value of the
underlying asset and (ii) any initial direct costs of the lessor.
Lease
A contract, or part of a contract, that conveys the right to use an asset (the
underlying asset) for a period of time in exchange for consideration.
Lease incentives
Payments made by a lessor to a lessee associated with a lease, or the
reimbursement or assumption by a lessor of costs of a lessee.
Lease modification
A change in the scope of a lease, or the consideration for a lease, that was not
part of the original terms and conditions of the lease (for example, adding or
terminating the right to use one or more underlying assets, of extending or
shortening the contractual lease term).
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Term Definition
Lease payments
Payments made by a lessee to a lessor relating to the right to use an underlying
asset during the lease term, comprising the following:
(a) Fixed payments (including in-substance fixed payments), less any lease
incentives;
(b) Variable lease payments that depend on an index or a rate;
(c) The exercise price of a purchase option if the lessee is reasonably certain
to exercise that option; and
(d) Payments of penalties for terminating the lease, if the lease term reflects
the lessee exercising an option to terminate the lease.
For the lessee, lease payments also include amounts expected to be payable by
the lessee under residual value guarantees. Lease payments do not include
payments allocated to non-lease components of a contract, unless the lessee
elects to combine non-lease components with a lease component and to account
for them as a single lease component.
For the lessor, lease payments also include any residual value guarantees
provided to the lessor by the lessee, a party related to the lessee or a third party
unrelated to the lessor that is financially capable of discharging the obligations
under the guarantee. Lease payments do not include payments allocated to non-
lease components.
Lease term
The non-cancellable period for which a lessee has the right to use an underlying
asset, together with both:
(a) Periods covered by an option to extend the lease if the lessee is reasonably
certain to exercise that option; and
(b) Periods covered by an option to terminate the lease if the lessee is
reasonably certain not to exercise that option.
Lessee
An entity that obtains the right to use an underlying asset for a period of time
in exchange for consideration.
Lessee’s incremental
The rate of interest that a lessee would have to pay to borrow over a similar
borrowing rate
term, and with a similar security, the funds necessary to obtain an asset of a
similar value to the right-of-use asset in a similar economic environment.
Lessor
An entity that provides the right to use an underlying asset for a period of time
in exchange for consideration.
Net investment in the
The gross investment in the lease discounted at the interest rate implicit in
lease
the lease.
Operating lease
A lease that does not transfer substantially all the risks and rewards incidental
to ownership of an underlying asset.
Optional lease
Payments to be made by a lessee to a lessor for the right to use an underlying
payments
asset during periods covered by an option to extend or terminate a lease that are
not included in the lease term.
Period of use
The total period of time that an asset is used to fulfil a contract with a customer
(including any non-consecutive periods of time).
Residual value
A guarantee made to a lessor by a party unrelated to the lessor that the value
guarantee
(or part of the value) of an underlying asset at the end of a lease will be at least
a specified amount.
Leases (IFRS 16) 1695
Right-of-use asset
An asset that represents a lessee’s right to use an underlying asset for the lease term.
Short-term lease
A lease that, at the commencement date, has a lease term of 12 months or less.
A lease that contains a purchase option is not a short-term lease.
Sublease
A transaction for which an underlying asset is re-leased by a lessee
(‘intermediate lessor’) to a third party, and the lease (‘head lease’) between the
head lessor and the lessee remains in effect.
Underlying asset
An asset that is the subject of a lease, for which the right to use that asset has
been provided by a lessor to a lessee.
Unearned finance
The difference between:
income
(a) The gross investment in the lease; and
(b) The net investment in the lease.
Unguaranteed residual
That portion of the residual value of the underlying asset, the realisation of which
value
by a lessor is not assured or is guaranteed solely by a party related to the lessor.
Variable lease
The portion of payments made by a lessee to a lessor for the right to use an
payments
underlying asset during the lease term that varies because of changes in facts
or circumstances occurring after the commencement date, other than the
passage of time.
The following terms are defined in other standards and are used in IFRS 16 with the
same meaning.
Contract
An agreement between two or more parties that creates enforceable rights
and obligations.
Useful life
The period over which an asset is expected to be available for use by an entity;
or the number of production or similar units expected to be obtained from an
asset by an entity.
3
WHAT IS A LEASE?
IFRS 16 defines a lease as ‘a contract, or part of a contract, that conveys the right to use
an asset (the underlying asset) for a period of time in exchange for consideration’.
[IFRS 16 Appendix A]. The determination of whether an arrangement contains a lease is
performed at the inception of the contract. [IFRS 16.9].
The assessment of whether a contract is or contains a lease will be straightforward in
most arrangements. However, judgement may be required in applying the definition of
a lease to certain arrangements. For example, in contracts that
include significant
services, we believe that determining whether the contracts conveys the right to direct
the use of an identified asset may be challenging. We discuss this further at 3.1 below.
3.1
Determining whether an arrangement contains a lease
At inception of a contract, an entity assesses whether the contract is, or contains, a lease.
A contract is, or contains, a lease if the contract conveys the right to control the use of
an identified asset for a period of time in exchange for consideration. [IFRS 16.9]. See 3.1.2
below for additional discussion on identified assets.
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A period of time may be described in terms of the amount of use of an identified asset
(for example, the number of production units that an item of equipment will be used to
produce). [IFRS 16.10].
To assess whether a contract conveys the right to control the use of an identified asset
for a period of time, an entity assesses whether, throughout the period of use, the
customer has both of the following:
(a) the right to obtain substantially all of the economic benefits from use of the
identified asset (see 3.1.4 below); and
(b) the right to direct the use of the identified asset (see 3.1.5 below). [IFRS 16.B9].
If the customer has the right to control the use of an identified asset for only a portion of the
term of the contract, the contract contains a lease for that portion of the term. [IFRS 16.B10].
An entity assesses whether a contract contains a lease for each potential separate lease
component. [IFRS 16.B12]. See 3.2 below.
3.1.1 Joint
arrangements
Entities often enter into joint arrangements (JOAs) with other entities for certain
activities. For example, the exploration of oil and gas fields, or the development of
pharmaceutical products.
A contract for the use of an asset by a joint arrangement might be entered into in a
number of different ways, including:
• directly by the joint arrangement, if the joint arrangement has its own legal identity;
• by each of the parties to the joint arrangement (i.e. the lead operator and the
other parties, commonly referred to as the non-operators) individually signing
the same arrangement;
• by one or more of the parties to the joint arrangement on behalf of the joint
arrangement. Generally, this would be evidenced in the contract and the parties to