of payments to be lease payments; or
(c) there is more than one realistic set of payments that a lessee could make, but it
must make at least one of those sets of payments. In this case, an entity considers
the set of payments that aggregates to the lowest amount (on a discounted basis) to
be lease payments. [IFRS 16.B42].
4.5.2 Lease
incentives
Lease incentives are defined as ‘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’.
[IFRS 16 Appendix A].
A lease agreement with a lessor might include incentives for the lessee to sign the lease,
such as an up-front cash payment to the lessee, payment of costs for the lessee (such as
moving expenses) or the assumption by the lessor of the lessee’s pre-existing lease with
a third party.
For lessees, lease incentives that are received by the lessee at or before the lease
commencement date reduce the initial measurement of a lessee’s right-of-use asset.
[IFRS 16.24(b)]. Lease incentives that are receivable by the lessee at lease commencement
date, reduce a lessee’s lease liability (and therefore the right-of-use asset as well).
[IFRS 16.27(a)].
For lessors, lease incentives that are paid or payable to the lessee are also deducted from
lease payments and affect the lease classification test. For finance leases, lease
incentives that are payable to the lessee reduce the expected lease receivables at the
commencement date and thereby the initial measurement of the lessor’s net investment
in the lease. [IFRS 16.70(a)]. For operating leases, lessors should defer the cost of any lease
incentives paid or payable to the lessee and recognise that cost as a reduction to lease
income over the lease term.
Example 13 of the Illustrative Examples to IFRS 16 indicates that the reimbursement of
leasehold improvements from the lessor are accounted for by applying other standards
and are not a lease incentive. However, we believe that lessor reimbursements of
leasehold improvements are lease incentives and therefore should be accounted for as
such under IFRS 16. The IASB, at its May 2018 meeting, concluded that the example
may cause confusion about the accounting for lease incentives under IFRS 16.
Therefore, the IASB tentatively decided to propose amending Illustrative Example 13 as
part of its next annual improvements to IFRS Standards. The proposed amendment will
remove from the example the illustration of the reimbursement of leasehold
improvements by the lessor.
1722 Chapter 24
4.5.3
Variable lease payments that depend on an index or rate
Variable lease payments that depend on an index or a rate include, for example,
payments linked to a consumer price index, payments linked to a benchmark interest
rate (such as LIBOR) or payments that vary to reflect changes in market rental rates.
[IFRS 16.28]. The payments are included in the lease payments and are measured using
the prevailing index or rate at the measurement date (e.g. lease commencement date
for initial measurement). The IASB indicated in the Basis for Conclusions that, despite
the measurement uncertainty associated with changes to index- or rate-based
payments, the payments meet the definition of an asset (lessor) and a liability (lessee)
because they are unavoidable and do not depend on any future activity of the lessee.
[IFRS 16.BC165]. Lessees subsequently remeasure the lease liability if there is a change in
the cash flows (i.e. when the adjustment to the lease payments takes effect) for future
payments resulting from a change in index or rate used to determine lease payments.
[IFRS 16.42(b)].
Example 24.13: Variable lease payment that depends on an index or rate
Assume that Entity A enters into a 10-year lease of property. The lease payment for the first year is CU1,000.
The lease payments are linked to the consumer price index (CPI), i.e. not a floating interest rate. The CPI at
the beginning of the first year is 100. Lease payments are updated at the end of every second year. At the end
of year one, the CPI is 105. At the end of year two, the CPI is 108.
Analysis: At the lease commencement date, the lease payments are CU1,000 per year for 10 years. Entity A
does not take into consideration the potential future changes in the index. At the end of year one the payments
have not changed, so the liability is not updated. At the end of year two, when the lease payments change,
Entity A updates the remaining eight lease payments to CU1,080 per year (CU1,000 / 100 × 108) and does
not change its discount rate to remeasure the lease liability (and right-of-use asset).
4.5.4
The exercise price of a purchase option
If the lessee is reasonably certain to exercise a purchase option, the exercise price is
included as a lease payment. That is, entities consider the exercise price of asset
purchase options included in lease contracts consistently with the evaluation of lease
renewal and termination options. See 4.4 above.
4.5.5
Payments for penalties for terminating a lease
If it is reasonably certain that the lessee will not terminate a lease, the lease term is
determined assuming that the termination option would not be exercised, and any
termination penalty is excluded from the lease payments. Otherwise, the lease
termination penalty is included as a lease payment. The determination of whether to
include lease termination penalties as lease payments is similar to the evaluation of lease
renewal options.
4.5.6
Amounts expected to be payable under residual value guarantees –
lessees only
IFRS 16 requires lessees to include amounts expected to be payable to the lessor under
residual value guarantees as lease payments.
A lessee may provide a guarantee to the lessor that the value of the underlying asset it
returns to the lessor at the end of the lease will be at least a specified amount. Such
guarantees are unconditional obligations that the lessee has assumed by entering into
Leases (IFRS 16) 1723
the lease. Uncertainty related to a lessee’s guarantee of a lessor’s residual value affects
the measurement of the obligation rather than the existence of an obligation.
[IFRS 16.BC170].
A lessee is required to remeasure the lease liability if there is a change in the amounts
expected to be payable under a residual value guarantee. [IFRS 16.42(a)].
Example 24.14: Residual value guarantee included in lease payments
Entity R (lessee) enters into a lease and guarantees that the lessor will realise CU15,000 from selling the asset to
another party at the end of the lease. At lease commencement, based on Entity R’s estimate of the residual value
of the underlying asset, Entity R determines that it expects that it will owe CU6,000 at the end of the lease.
Analysis: Because it is expected that it will owe the lessor CU6,000 under the residual value guarantee,
Entity R includes that amount as a lease payment.
IFRS 16 does not state how frequently reassessment should occur for expected changes
under residual value guarantees. However, we would expect entities to apply judgement
to determine the frequency of reassessment base
d on the relevant facts and circumstances.
4.5.7
Amounts payable under residual value guarantees – lessors only
IFRS 16 requires lessors to include in the lease payments, 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. [IFRS 16.70(c)]. This amount included in lease
payments is different to that for a lessee which only includes the amount expected
to be payable. See 4.5.6 above.
4.5.8
Amounts not included in lease payments – lessees only
Variable lease payments that do not depend on an index or rate and are not in-substance
fixed (see 4.5.1 above), such as those based on performance (e.g. a percentage of sales)
or usage of the underlying asset (e.g. the number of hours flown, the number of units
produced), are not included as lease payments. Instead they are recognised in profit or
loss (unless they are included in the carrying amount of another asset in accordance
with other IFRS) in the period in which the event that triggers the payment occurs.
[IFRS 16.38(b)].
In some cases, the variability may be resolved during the lease term, so that payments
become fixed for the remainder of the lease term. The new fixed payments are then
used to remeasure the lease liability (with an offset to the right-of-use asset). In some
cases, the contract requires that when the contingency is resolved, the lessee is required
to make an immediate catch up payment. The catch up payment relates specifically to
the lessee’s prior use of the asset. In this case, we believe, when the contingency is
resolved, the catch up obligation is recognised as part of the lease liability and is
expensed immediately (rather than adjusting the right-of-use asset).
Lease payments do not include payments allocated to the non-lease components of a
contract. However, lease payments include amounts that would otherwise be allocable
to the non-lease components of a contract when the lessee makes an accounting policy
election to account for the lease and non-lease components as a single lease component.
See 3.2 above.
1724 Chapter 24
Example 24.15: Variable lease payments which do not depend on an index or rate
Entity A is a medical equipment manufacturer and a supplier of the related consumables. Customer B operates
a medical centre. Under the agreement entered into by both parties, Entity A grants Customer B the right to
use a medical laboratory machine at no cost and Customer B purchases consumables for use in the equipment
from Entity A at CU100 each. The consumables can only be used for that equipment and Customer B cannot
use other consumables as substitutes. There is no minimum purchase amount required in the contract.
Based on its historical experience, Customer B estimates that it is highly likely to purchase at least 8,000 units of
consumables annually. Customer B has appropriately assessed that the arrangement contains a lease of medical
equipment. There are no residual value guarantees or other forms of consideration included in the contract.
Analysis: There are two components in the arrangement, a lease of equipment and the purchase of consumables.
Even though Customer B may believe that it is highly unlikely to purchase fewer than 8,000 units of
consumables every year, in this example, there are no lease payments for purposes of initial measurement
(Entity A and Customer B) and lease classification (Entity A).
Entity A and Customer B would allocate the payments associated with the future payments to the lease and
consumables component of the contract.
When a lessee enters into a lease contract the lessor may be required to charge the
lessee VAT in accordance with the local tax regulations. In many jurisdictions, the lessor
charges VAT on behalf of the tax authority and payment is remitted to the tax authority.
In circumstances when the VAT is the obligation of the lessee (i.e. not the lessor’s
obligation) the VAT charged is not a lease payment from the perspective of the lessor.
From a lessee’s perspective, typically the lessee only incurs a liability for the VAT when
the lessor invoices the lease payment. In some cases VAT is not fully recoverable by the
lessee, usually because either the activities of the lessee prohibit the recovery of VAT
or recovery is prohibited due to the nature of the leased asset. Generally, we expect that
lessees will not include VAT in lease payments in these situations, but rather recognise
it in profit or loss (unless it qualifies for capitalisation under another standard) when the
liability arises. However, this is an area where practice is still developing.
4.5.9
Reassessment of the lease liability
IFRS 16 contains specific requirements about how to remeasure the lease liability to
reflect changes to the lease payments (see 5.4 below). A lessee recognises the amount
of the remeasurement of the lease liability as an adjustment to the right-of-use asset.
However, if the carrying amount of the right-of-use asset is reduced to zero and there
is a further reduction in the measurement of the lease liability, a lessee recognises any
remaining amount of the remeasurement in profit or loss. [IFRS 16.39].
4.5.10
Remeasurement by lessors
Lessors remeasure the lease payments upon a modification (i.e. a change in the scope
of a lease, or the consideration for a lease that was not part of its original terms and
conditions) that is not accounted for as a separate contract. See 6.4 below.
4.6 Discount
rates
Discount rates are used to determine the present value of the lease payments which are
used to determine lease classification (see 6.1 below) and to measure a lessor’s net
investment in the lease and a lessee’s lease liability.
Leases (IFRS 16) 1725
The discount rate for lessors is the interest rate implicit in the lease, which is defined as
the rate that causes the present value of (a) the lease payments and (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. [IFRS 16 Appendix A].
Initial direct costs, other than those incurred by manufacturer or dealer lessors, are
included in the initial measurement of the net investment in the lease and reduce the
amount of income recognised over the lease term.
For lessees, lease payments are discounted using the interest rate implicit in the lease if
that rate can be readily determined. If that rate cannot be readily determined, the lessee
uses the incremental borrowing rate. [IFRS 16.26]. The interest rate implicit in the lease is
not necessarily the rate stated in the contract and reflects, among other things, the
lessor’s initial direct costs and estimates of residual value. Therefore, lessees may find it
difficult to determine the interest rate implicit in the lease, in which case they will need
to determine the incremental borrowing rate.
The term readily determinable is not equivalent to estimable. Therefore, when the
interest rate implicit in the lease can only be determined by using estimates and/or
assumptions, then the interest rate implicit in the lease is not r
eadily determinable.
The lessee’s incremental borrowing rate is the rate of interest that a lessee would have
to pay to borrow over a similar 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. [IFRS 16 Appendix A].
In determining the incremental borrowing rate, the lessee considers borrowings with a
similar term and security to the right-of-use asset, not the underlying asset. For example,
in the case of a five year property lease, the lessee considers borrowings with a similar
term to the five year right-of-use asset, not the property itself, which may have a
significantly longer life. Observable rates, such as a property yield can be used as a
starting point to determine the incremental borrowing rate but adjustments need to be
considered for an asset with a value similar to the right-of-use asset. Other potential
sources of adjustment may include the credit profile of the lessee, the borrowing
currency, or the length of the lease term. It is likely that in some cases significant
judgement will be needed to determine the incremental borrowing rate.
As explained above, the lessee’s incremental borrowing rate reflects the rate of interest
that a lessee would have to pay, among others, in a similar economic environment. If
the contract requires lease payments to be made in a currency other than the functional
currency of the lessee, the incremental borrowing rate of the lessee should be
determined based on a borrowing of a similar amount in that foreign currency. Leases
denominated in a foreign currency are discussed further at 5.6.2 below.
4.6.1
Determination of the incremental borrowing rate by a subsidiary
with centralised treasury functions
Some groups maintain centralised treasury functions and all funding requirements for
the group are managed by the parent entity. Under IFRS 16, subsidiaries participating in
a centralised treasury function cannot default to their parent’s incremental borrowing
rate. Rather all facts and circumstances should be considered to determine the
1726 Chapter 24
subsidiary/lessee’s incremental borrowing rate. The existence of guarantees of the
subsidiary’s obligations may result in a rate that is similar to the parent’s rate as if the
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 340
