IFRS 16: Leases

Presented by:
MD. NAZRUL ISLAM, ACA
Manager
Taxation & Corporate Affairs
 Why IFRS-16: Leases?
 IFRS 16-Leases was issued in January 2016 which replaced the IAS 17-Leases.

 The IFRS 16-Leases applies to the annual reporting periods beginning on or

after January 1, 2019.

 IAS 17-Leases allowed the Lessee to distinguish the leases into finance leases
or operating leases depending on certain characteristics of the leases.

 The lease classification set out in IAS 17 was subjective and there was a clear
incentive for the preparers of lessee’s financial statements to ‘argue’ that leases
should be classified as operating rather than finance leases. As a result, leased
assets and liabilities were left out of the financial statements and
misrepresented the financial position of the reporting entity.

 To avoid such situation, IFRS 16-Leases has been introduced.

 Objectives
 This Standard 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.

 An entity shall consider the terms and conditions of contracts and all relevant
facts and circumstances when applying this Standard. An entity shall apply
this Standard consistently to contracts with similar characteristics and in similar
circumstances
 Scope
 The IFRS 16-Leases applies to all the Leases, including subleases, with few
exception. The IFRS 16-Leases doesn’t apply to leases to explore for or
use minerals, oil, natural gas and similar non-regenerative resources, leases of
biological assets, service concession arrangements, licences of intellectual
property granted by a lessor and rights held by a lessee under licensing
agreements for items such as video and plays.
 Recognition Exemptions
A lessee may elect to account for lease payments as an expense on a straight-line
basis over the lease term or another systematic basis for the following two types of
leases:

 Leases with a lease term of 12 months or less and containing no purchase

options.

 Leases where the underlying asset has a low value when new.
Important Definitions Related to IFRS-16
 Commencement date -The date on which a lessor makes an underlying
asset available for use by a lessee.

 Inception date -The earlier of the date of a lease agreement and the date of
commitment by the parties to the principal terms and conditions of the lease.

 Lease term -The non-cancellable period for which a lessee has the right to
use an underlying asset, together with both:

I. periods covered by an option to extend the lease if the lessee is reasonably

certain to exercise that option; and

II. periods covered by an option to terminate the lease if the lessee is

reasonably certain not to exercise that option.
Important Definitions Related to IFRS-16(Continued)

 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.
 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.
 Residual value guarantee- A guarantee made to a lessor by a party unrelated
to the lessor that the value (or part of the value) of an underlying asset at the
end of a lease will be at least a specified amount.
 Unguaranteed residual value- That portion of the residual value of the
underlying asset, the
realization of which by a lessor is not assured or is guaranteed solely by a party
related to the lessor.
Important Definitions Related to IFRS-16(Continued)

 Lessee’s incremental borrowing rate- 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.

 Interest rate implicit in the lease - The rate of interest 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.

 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.
 Identification of a Lease
 At inception of a contract, an entity shall assess whether the contract is,
or contains, a lease.

 The IFRS 16-Leases defines leases 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:

 Obtain substantially all of the economic benefits from the use of the asset.
And

 Direct the use of the asset.

Assessment
of whether
a contract
is, or
contains, a
lease
 The biggest change: lessee’s accounting
for leases
 Lessees (those who take an asset under lease) do not need to classify the
lease at its inception and determine whether it’s finance or operating.
 Lessee’s accounting for leases
 Lessee has to start with the following 3 (three) questions:

 Is it a lease under IFRS 16?

 Is there some element other than lease element? Does it need to

separate?

 How to recognize these elements? At the commencement and

Subsequently!!
 Lessee’s accounting for leases
 At the commencement date, a lessee shall recognize a right-of-use
asset and a lease liability

 IFRS 16-Leases requires that the ‘right of use asset’ initially be measured at cost
and the lease liability should initially be measured at the present value of the
minimum lease payments that are not paid at the commencement date.

 The discount rate used to determine present value should be the rate of interest
implicit in the lease, if the rate can be readily determined. If that rate cannot
be readily determined, the lessee shall use the lessee’s incremental
borrowing rate.
 Lessee’s accounting for leases
 The cost of the right-of-use asset shall include

 The amount of the initial measurement of the lease liability;

 Any lease payments made at or before the commencement date, less any
lease incentives received;

 Any initial direct costs incurred by the lessee;

 An estimate of costs to be incurred by the lessee in dismantling and removing

the underlying asset, restoring the site on which it is located or restoring the
underlying asset to the condition required by the terms and conditions of the
lease.
 Lessee’s accounting for leases
 The lease payments included in the measurement of the lease liability comprise the
following payments for the right to use the underlying asset during the lease term that
are not paid at the commencement date:

 Fixed payments less any less incentives receivable;

 Variable lease payments;

 Amounts expected to be payable by the lessee under residual value guarantees;

 the exercise price of a purchase option if the lessee is reasonably certain to

exercise that option;

 Payments of penalties for terminating the lease, if the lease term reflects the
lessee exercising an option to terminate the lease.
 Lessee’s accounting for leases
 Subsequent measurement- After the commencement date, a lessee shall measure the
right-of-use asset applying

 Cost model –a lessee shall measure the right-of-use asset at cost:

I. Less any accumulated depreciation and any accumulated impairment losses; and

II. Adjusted for any measurement of the lease liability.

 Fair value model – If a lessee applies the fair value model in IAS 40 Investment Property to
its investment property, the lessee shall also apply that fair value model to right-of-use assets that
meet the definition of investment property in IAS 40.

 Revaluation model- If right-of-use assets relate to a class of property, plant and equipment
to which the lessee applies the revaluation model in IAS 16, a lessee may elect to apply that
revaluation model to all of the right-of-use assets that relate to that class of property, plant and
equipment.
 Leases in the Financial Statements
of Lessees
 At the time of Initial Recognition: Journal Entry
Right-of-use asset……….Dr.
Lease Liability…………….Cr.

 At the Subsequent time, when lessee makes a payment and/or at the

end of reporting period: Journal Entry
 To recognize depreciation of the right-of-use asset over the lease term:
Depreciation……………….Dr.
Right-of-use asset……….Cr.
Leases in the Financial Statements
of Lessees
 To recognize remeasurement of the lease liability to include interest:
Interest Expense………….Dr.
Lease Liability…………….Cr.

 To recognize rental payment:

Lease Liability..…………..Dr.
Cash/Bank……………………Cr.
 Practical Implication of IFRS-16
 Case Study (1): Imagine you want to rent some space in the warehouse for
storing your goods. You’d like to enter into a 3-year rental contract. The owner
of that warehouse offers 2 (two) options to you:
 You will occupy a certain area of XY cubic meters, but the specific place will be
determined by the owner of the warehouse, based on actual usage of the
warehouse and free storage.
 You will occupy the unit n. 13 of XY cubic meters in the sector A of that
warehouse. This place is assigned to you and no one can change it during the
duration of the contract.

Are the both options contained lease??

 Practical Implication of IFRS-16
Solution of Case Study (1):

 Both contracts look like lease contracts, and indeed, in both cases, you would book the rental
payments an expense in profit or loss under older IAS 17.

 But the history is different under IFRS-16:

 The first contract does not contain any lease, because no asset can be identified.
The reason is that the supplier (warehouse owner) can exchange one place for another and
you lease only certain capacity. Therefore, you would account for rental payments as for
expenses in profit or loss.

 The second contract does contain a lease, because an underlying asset can be
identified– you are leasing the unit n. 13 of XY cubic meters in the sector A.
Therefore, you need to account for this contract as for the lease and it means recognizing
some asset and a liability in your balance sheet.
 Practical Implication of IFRS-16
Do we pay only for a lease, or also for some services?

 This is another change we need to watch out under IFRS 16.

 When you lease some assets under operating lease (as called by older IAS 17),
in most cases, a lessor provides certain services to you, such as maintenance,
repairs, cleaning, etc.

 Under new IFRS 16, you need to split the rental or lease payments into
lease element and non-lease element, because you need to:

 Account for a lease element as for a lease under IFRS 16 (if it meets the
criteria in IFRS 16); and

 Account for a service element as before, in most cases as an expense in

profit or loss.
 Practical Implication of IFRS-16
Case Study (2)
 Imagine you want to rent some space in the warehouse for storing your goods.
You’d like to enter into a 3-year rental contract. The owner of that
warehouse offers the following option to you:
You will occupy the unit n. 13 of XY cubic meters in the sector A of that
warehouse. This place is assigned to you and no one can change it during the
duration of the contract. Here, you have to pay CU 10,000 per year. This
payment includes the payment for rental of the unit n. 13 and its cleaning
once per week.
In the above scenario, you need to split the payment of CU 10,000 into
lease element and cleaning element based on their relative stand-
alone selling prices (i.e. for similar contracts when got separately).
Suppose, you find out that you would be able to rent out similar unit in the
warehouse next door for CU 9,000 per year without cleaning service, and you
would need to pay CU 1,500 per year for its cleaning.
 Practical Implication of IFRS-16
 Based on this, you need to:

 Allocate CU 8,571 (CU 9,000/(CU 9,000+ CU 1,500)) to the lease element

and account for that as for the lease; and

 Allocate CU 1,429 (CU 1,500/(CU 9,000+ CU 1,500)) to the service element

and in this case, probably recognize it in profit or loss as an expense for
cleaning.

Not an easy thing, especially when the stand-alone selling prices are not
readily available!!!!
Any Questions ?