Leases (IFRS 16)

What IFRS 16 does

IFRS 16 Leases brings almost every lease onto the lessee's statement of financial position. Instead of an operating lease expense, the lessee shows an asset (the right to use the item) and a liability (the obligation to pay for it).

Initial recognition

At the start of the lease the lessee recognises:

• a lease liability: the present value of the lease payments not yet paid, discounted at the rate implicit in the lease (or the lessee's incremental borrowing rate);
• a right-of-use asset: the lease liability, plus payments made at or before the start, initial direct costs and estimated restoration costs, less any incentives received.

Worked example

A lessee leases a machine for five years, paying $10,000 at the end of each year. The interest rate is 8%, and the five-year annuity factor at 8% is 3.993.

• Lease liability at the start: $10,000 × 3.993 = $39,930. The right-of-use asset is also $39,930.
• Year 1 interest: 8% × $39,930 = $3,194, charged to profit or loss.
• Liability at the end of year 1: $39,930 + $3,194 − $10,000 = $33,124.
• Depreciation: $39,930 ÷ 5 = $7,986 a year.

In the exam, show the liability table and split the closing liability into current and non-current amounts.

Exemptions

A lessee may choose not to recognise leases of 12 months or less, or leases of low-value assets such as laptops. The payments are expensed on a straight-line basis.

What SBR examiners look for

SBR lease questions often test judgement: is there a lease at all (an identified asset and the right to control its use), how to treat a lease modification, or whether a sale and leaseback is a genuine sale. Explain the principle, apply it to the scenario and state the effect on the financial statements.

Common mistakes

• Discounting payments in advance as if they were in arrears.
• Recognising the full gain on a sale and leaseback.
• Forgetting the current and non-current split of the liability.