IFRS 16 Leases vs. IAS 17 Leases: How the lease accounting changed
In January 2016, IASB issued another important and long-discussed standard: IFRS 16 Leases that will replace IAS 17.
Ever since then I receive lots of e-mails asking me to sum up what’s new.
OK, so here you go.
In this article, you’ll learn about the main changes that IFRS 16 introduces to the accounting for leases, illustrated on a very simple example.
Warning: this is NOT exhaustive description of the standard, and I simplify the things a lot for illustration purposes.
I will come back to it at the later stage, because I truly think that there will be lots of questions, discussions and additional guidance on how to tackle several areas of the lease accounting.
The effective date of the new IFRS 16 is 1 January 2019.
Why the new lease standard?
Short answer: To eliminate off-balance sheet financing.
Under IAS 17, lessees needed to classify the lease as either finance or operating.
If the lease was classified as operating, then the lessees did not show neither asset nor liability in their balance sheets – just the lease payments as an expense in profit or loss.
But, some operating leases were non-cancellable, and therefore, they represented a liability (and an asset) for the lessees.
This liability was hidden from the readers of the financial statements, as it was not presented anywhere.
Oh yes, some disclosures in the notes to the financial statements were mandatory, but frankly – who, except for auditors, ever reads the notes to the financial statements?
New IFRS 16 removes this discrepancy and puts most leases on balance sheet.
I’ll show you how in the next paragraphs.
Let’s see what has changed
Is it a lease?
The new IFRS 16 introduces a new definition of a lease. However, it is very similar to the old definition in older IAS 17 (differences do exist).
It means that when you actually accounted for some contracts as for lease contracts under IAS 17 Leases, you will continue to do so also under the new standard (careful, methodology may change).
BUT!!!
You have to be extremely careful when it comes to some service contracts.
Why?
Because, the new standard IFRS 16 provides a detailed guidance to determine whether your contract is a lease contract or a service contract (non-lease contract).
Under old IAS 17, it did not matter so much whether you have an operating lease contract or a service contract, for a very simple reason: you probably accounted for both types of contracts in the same way (that is, as a simple expense in profit or loss).
However, as the accounting for some types of previously-called operating lease contracts dramatically changes, we need to distinguish whether we have a lease under IFRS 16 or some other service contract under different standard.
As a simple illustration, let me come up with a small example:
- 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.
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.
Under new IFRS 16, you need to assess whether these contracts contain lease as defined in IFRS 16.
The first thing you would look at is whether an underlying asset can be identified.
Long story short:
- 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.
This was a very simplified illustration to make you aware of this and it’s by no means exhaustive – but you get a point.
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 older IAS 17, you did not need to think about it too much, because you put all lease payments as some rental expense to your profit or loss.
BUT!!!
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.
From our example above: let’s say you took the option 2 and you pay CU 10 000 per year. This payment includes the payment for rental of the unit n. 13 and its cleaning once per week.
Therefore, 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).
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.
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.
The biggest change: lessee’s accounting for leases
Here’s the biggest change: 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.
You might say: OH YES!!!
But not so fast.
The reason is that IFRS 16 prescribes a single model of accounting for every lease for the lessees. Very shortly:
- Lessee needs to recognize a right-of-use asset and corresponding liability in its statement of financial position.
- An asset shall be depreciated and a liability amortized over the lease term.
This model is very similar to the accounting for finance leases under IAS 17.
And yes, you need to account for operating leases in the same way.
There are 2 exceptions from this rule:
- Lease of assets for less than 12 months (short-term leases), and
- Lease of assets of a low value (such as computers, furniture etc.).
Example IAS 17 vs. IFRS 16
Let me illustrate the new accounting model and put it in the contract with the treatment under IAS 17.
I will continue in the above example of a warehouse. To make it quick, I will just make up some data:
- Annual rental payments are CU 10 000, including the cleaning services, all payable in arrears (at the end of year)
- Appropriate discount rate is 5%
- The lease term is 3 years.
How would you account for this contract under IAS 17 and IFRS 16?
Accounting under IAS 17 Leases
Under IAS 17, you need to classify the lease first.
Let’s say that based on warehouse’s economic life, lease payments, etc. you assess that this lease is operating.
Therefore, accounting is very simple:
- At the commencement, you do nothing;
- At the end of each year, you simply book the rental expense of CU 10 000 in profit or loss.
Accounting under IFRS 16
Here, no classification is necessary as one accounting model applies to all leases.
You need to follow 3 steps:
- Is it a lease under IFRS 16?
Yes, here it probably is. Please see the explanation above.
- Is there some element other than lease element? Do we need to separate?
Yes, we need to separate the cleaning element from the lease element. We did it above:
- CU 8 571 relates to the lease element;
- CU 1 429 relates to the cleaning element.
- How to we recognize these elements?
- At the commencement:
- You need to recognize right to use a warehouse in the amount equal to the lease liability plus some other items like initial direct costs.
- The lease liability is calculated at present value of lease payments over the lease term. In this case you need to calculate the present value of 3 payments of CU 8 571 (only lease element) at 5%, which is CU 23 341.
- Accounting entry is then
-
Debit Right-of-use asset: EUR 23 341
-
Credit Lease Liability: EUR 23 341
-
- Subsequently, when you make a payment and/or at the end of reporting period, you need to:
- Recognize depreciation of the right-of-use asset over the lease term, in this case CU 7 780 (CU 23 341/3) per year (I took straight-line depreciation);
- Recognize remeasurement of the lease liability to include interest, exclude amounts paid and take any lease modifications into account.
- At the commencement:
This simple table illustrates our example:
| Year | Lease liability b/f | Add interest at 5% | Less amounts paid | Lease liability c/f |
| 1 | 23 341 | 1 167 | – 8 571 | 15 937 |
| 2 | 15 937 | 797 | – 8 571 | 8 163 |
| 3 | 8 163 | 408 | – 8 571 | 0 |
| Total | n/a | 2 372 | – 25 713 | n/a |
Note: “b/f” means “brought forward (at the beginning of the year)”, “c/f” means “carried forward (at the end of the year)”.
Summary of accounting entries under IFRS 16:
| When | What | How much | Debit | Credit |
| At the commencement | Right-of-use asset + lease liability | 23 341 | Right-of-use asset | Lease liability |
| At the end of the year 1 | Interest | 1 167 | P/L: Interest expense | Lease liability |
| Rental payment | 10 000 | Cash (bank account) | ||
| 8 571 | Lease liability | |||
| 1 429 | P/L: Expenses for cleaning services | |||
| Depreciation | 7 780 | P/L: Depreciation | Right-of-use asset | |
Now, let’s compare.
Under IAS 17, the impact on profit or loss in the year 1 was CU 10 000, as we recognized the full rental payment in profit or loss.
Under IFRS 16, the impact on profit or loss in the year 1 was:
- Interest of CU 1 167, plus
- Depreciation of CU 7 780, plus
- Expense for cleaning services of CU 1 429.
- TOTAL of CU 10 376.
Hmmm, that’s actually more expenses in the first year under IFRS 16 than under IAS 17, isn’t it?
The reason is that thanks to the new model, the pattern of expenses has changed: we have loads of interest in the beginning of the lease, but smaller expenses at the end of the lease when the lease liability is amortized.
In total, both models have the same profit or loss impact over total lease term:
| Type of expense | IAS 17 | IFRS 16 | Note |
| Rental expense | 30 000 | – | 3*10 000 |
| Interest expense | – | 2 372 | Table above |
| Depreciation | – | 23 341 | 3*7 780 |
| Cleaning expenses | – | 4 287 | 3*1 429 |
| Total | 30 000 | 30 000 | |
Note: I am showing the cleaning expenses, too in order to show total impact of the whole contract, although technically they are not part of the lease accounting.
Also, under IFRS 16, we show more assets on the balance sheet, but also more debt or liabilities.
Please note that the cash flow does not change. You pay still the same amounts whether you apply IAS 17 or IFRS 16.
What about Lessors and accounting for leases under IFRS 16?
Good news, folks!
Accounting for leases by lessors almost does not change, so they can continue in the same way.
That’s all I need to say about it.
Final warning
The new lease standard will have significant impact on the companies heavily working with operating leases, no questions about it.
The financial indicators of these companies can substantially change, because new assets and liabilities are coming to the balance sheet.
Also, many lessees will have a hard time to set up a system of gathering and analyzing enough information to satisfy new requirements.
I will stop here, as this post is longer than I expected, but if you have some ideas or remarks on whether and how the new standard can affect your company, please let us know below in the comments. Thank you!
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251 Comments
Leave a Reply
Dear Silvia
Your explanation with example is really easy to understand.
“Property Lease” seems meet the definition under IFRS16, if so, after the lease commencement, should we measure the right-of-use asset by using the cost model or revaluation model?
Dear AC,
IFRS 16 says that you should measure right-of-use asset under cost model, but the fair value model as well as revaluation model are acceptable if they fit more to the specific conditions. For the simplicity, I illustrated it on the cost model. S.
Am I missing something why is the Right of assets minus depreciation not equal to the lease liability balance of 15,937 at the end of the first year. The 376 difference, where does that go in the Balance sheet?
paid amount less depreciation less interest expense. (it is kept within the lease liability).
Because in liability you reduce principal value of 7,404 (Rent 8,571 – Interest 1,167). However in assets, you reduce only depreciation, which is 7,780. So this difference between principal amount and depreciation creates difference, which will be there. No worries.
where does that amount go in the Balance sheet?
Dear Silvia
I have come with a situation whereby the company hired five cars for an agreement of five years. Insurance and maintenance is the responsibility of lessor. Lessee is responsible for providing driver and fuel only.
The client insist this is an operating lease due to maintenance service element.
Please advice
Dear Vincent,
I guess your clients follows IAS 17 rather than IFRS 16 as it’s completely new. So in this case, you need to assess 5 criteria to classify the lease properly. Let me mention that if just one of them is met, then the lease is finance in most cases.
In your situation, you need to compare the useful life of cars with their economic life (it seems your client rents these cars for most of their useful lives as it’s 5 years), you also need to compare present value of the minimum lease payments with the fair value of the cars, etc.
Let me stress that the mere fact that the lessor is responsible for maintenance DOES NOT automatically classifies the lease as operating.
Please read more here: IAS 17 Leases.
S.
Hi Silvia ,is mantainance non-leaese elemslentI?,I suppose insurance is not since it the lossor who benefits.
The IASB along with all the other accounting boards are a bunch of morons. They need to justify the money they get paid by changing the accounting standards frequently. It is a joke, a game, and is very sad the accounting standard boards continue to do this. In the future the new standards will be changed back to the old standards. Accounting is very simple until the morons step in and screw things up b/c they want to justify their existence. A lot of these standard changes started in the late 60’s and 70’s. Thank you Silvia for your good examples and illustrations.
🙂 Thank you, John 🙂
See, I also think that they make some things complicated sometimes and I’m guessing whether lots of estimates and judgements in the accounting is actually good for the clarity of the reporting. For me, that’s the main problem. S.
mate, calm down, you need to ease up on the IASB and all the Governing bodies; AICPA and CPA Australia, ACCA and ICAANZ.
We need them more than they need us, we want them to show the society (social contract) that they can (should) trust us and our numbers. We try to ensure credibility.
These regulatory bodies are just helping you and me to restore the credibility that we have lost.
Look at Creative accounting, not illegal but misleading!
Look at the scandals, such as Enron and Worldcom (they failed even the going-concern test for God’s sake), HH Insurance and Global Financial Crises.
Look at the lack of independence due to the auditor consulting businesses to their clients.
It used to be called regulatory bodies, now it is co-regulatory bodies because the government stepped in because they don’t trust the accounting profession.
This is my view
Dear Arie,
thank you for your view, it’s very valuable and I appreciate you posted it here.
Well, in my humble opinion, all what you wrote is very true and fine. But, remember, road to hell is paved with good intentions and the question is whether too many estimates and judgements won’t exactly lead to creative accounting that we want to prevent.
Take care!
S.
Hi Silvia
How does one deal with existing operating leases in place when one adopts IAS 16?
Further when first time adoption of the standard occurs is there an adjustment required for to the comparatives of the prior financial year?
Is there any guidance regarding discount rates for operating leases under IAS16?
Hi Riaan,
at the date of initial application of IFRS 16, you need to restate your operating leases under the new rules and IFRS 16 permits 2 options:
– either you do full retrospective approach (with comparatives)
– or you do one-off adjustment.
In relation to discount rates- it should be the interest rate implicit in the lease, and if this is impractical to determine, then it should be incremental borrowing rate. S.
Dear Riaan/Silvia,
I have really been so enlightened reading you interpretations to IFRS. Thank you so much for all the efforts.
Please I am very interested in the response to Riaan’s question.
Hello Silvia,
what about hire purchase? is it out or in the scope of IFRS 16?
Hi Nadiah,
well, hire purchase is very similar to the finance lease, isn’t it? It basically depends on the conditions of the contract, but sometimes, hire purchase qualifies for lease accounting. S.
As you have mentioned that there are two exceptions, in the second exception how can we decide whether the asset has a low value since it is based on judgement..
Hi Lakshitha,
yes, you do need to apply some judgement here, but the guidance says that the examples of items with low value are computers or items of furniture – so you get the point. S.
IASB seems to define ‘low-value’ lease as those have a value of 5000 dollars or less, saw it on IFRS 16, I am not sure about this.
Thank you dear Salivia M.
I am here again to thank you for your well simplified explanations. However, I have only one question, as i am finance office at Premier Bank Somalia, if we already recorded the lease as an expense; is IFRS allowed to change our records?
Regards
If IFRS are mandated by the governing laws of your bank for general purpose financial statements, then you’ll have to change your policy.
“…but frankly – who, except for auditors, ever reads the notes to the financial statements?”
I hope analysts do
Thumbs up! 🙂
Silvia, first of all, I highly appreciate your efforts. And I am 100% with you, as analysts seldom have enough time to read the notes in depth, as you might expect them to do.
I also have to contribute to the policital discussion here and I have to agree with John 100%. It is a game, played by politicians, state regulators and the accounting boards, with the aim to prevent catastrophes such as 1. the great depression 2. Dot-com 3. Enron 4. Housing bubble etc. No doubt, most of the players have the “right intentions” but guess what, although regulation grew exponantially since the 30’s, the “scandals” got more severe and greater in numbers.
There is a reason why Swiss Bluechip companies increasingly refrain from reporting under IFRS and switch to a Swiss true and fair view standard (Swiss GAAP FER, approximately 200 pages Din A5, Arial 10) the biggest one being Swatch group.
Long story short, I believe the only regulation which effectively eliminates bad players is the market, not government or any accounting standard.
Dear Bernhard,
thank you, this is a very interesting comment. I also believe in market, but frankly speaking, it’s more difficult to rely on the market these days than ever before. The reason is that “market” or business become concentrated into the hands of few multinational groups who play under their own rules. Therefore, market becomes less and less efficient. On the other hand I agree that this type of regulations will hardly help – at least, these groups will have to report everything and maybe also the things they would prefer to hide.
S.
I do!
Apart from being an accountant I like investing in my spare time and I definitely read notes to financial statements of a company I do a research on..
sometimes you can understand so much of the background of many financial decisions recorded in FS.
As usual, you make a complicated topic very simple. Thank you for an extremely lucid explanation on the new standard.
Dear Silvia M.,
The rental expense of $30,000 would be deductible for income tax purpose if it is accounted for as operating leases under previous accounting standard on leases, IAS 17. Would the both depreciation of $23,341 and interest of $2,372 (which are part of $30,000) deductible for tax as well under UK tax jurisdictions?
Would the present value calculated by discounting future lease payments (i.e.the highly certain cash outflows) at appropriate market interest/ discount rate more superior valuation method than the one under fair value model? If there exist a fair value for a leases accounted for as a finance lease, then what if the Present Value calculated result in difference much more than the fair value?
Thanks.
Yen Khang
Hi Yen,
1) Tax deductibility depends on the tax rules in the particular country and unfortunately, I don’t know how it would be in UK. Anyway, if there’s a difference between tax rules and accounting rules, you should recognize a deferred tax.
2) IFRS 16 explicitely says that you shoud measure right-to-use asset at cost – and that includes the initial measurement of a liability. So you are really using discounting technique here and not the fair value.
S.
Hello silvia,thx for ur vivid explanation.i want to know if right to use asset is a tangible or an intangible asset as compared with other rights that generates cashinflows
Obi,
it’s not really a tangible or intangible asset as such. It should be presented separately from other assets and if not, then it is included in the line where the corresponding asset would go; e.g. if you lease a car under “operating” lease, then the right-to-use asset is presented within PPE. S.
Helllo Silvia,
In case of a business combination done in earlier years we have created certain intangible assets (which represents right to use certain property rights for generating revenue for our business). Beside this, we were showing operating lease commitments for these property rights in our financial statements.
Now with the IFRS 16, do we need to capitalise these operating lease commitments irrespective of the fact that we have already accounted them as intangible assets at the time of business combination or is there any relief available in IFRS 16.
Thanks
Sachin,
I’m afraid you need to apply IFRS 16 retrospectively, also to existing operating leases. S.
Hello Silvia,
What do you think about the influence of the IFRS16
to the users and financial statements compare with the IAS17?
Hi Michael,
the main impact will relate to the leases previously classified as operating. There will be much more assets and liabilities in the balance sheets as before, and as a result, financial rations can change. S.
Dear Silvia,
Does the IAS 17 have any limitation, so we need to change to IFRS16?
Does the conceptual or theoretical factors for these
changes proposed in the new standard?
Hello,
hmm, not quite sure I understand the questions. IAS 17 does not have any limitation (except for almost the same scope limitations as in IFRS 16) apart from the fact that it will be superseded in 2019, so you will have to apply IFRS 16. S.
Hello,
Sorry that my question may be quite confusing. Anyway thank you very much! The “limitation” that I mentioned is actually the reason why there needs a change from IAS 17 to IFRS16. Apart from disclosing more assets and liabilities could help investors know more information about the company, I would like to know whether there is other reasons for the change.
Jessica
Hi Silvia,
This is the first time I heard about IFRS 16 leases, thank you very much for your presentation.
I’m have a dough, In one place you mentioned “But, some operating leases were non-cancellable, and therefore, they represented a liability (and an asset) for the lessees” and in the example 2 “You will occupy the unit n. 13 of XY cubic meters in the sector A of that warehouse”
In above two places I hope you mentioned about “Honorius Contract”. Where we need to book liability (IAS 37). So what is the difference between IAS 37 and ITFS 16 in above senario??
Thanks and regards.
Is there any requirement that we only record asset in operating lease when contract is for fixed time? Or we record right of use of asset irrespective of time
Under IFRS 16 yes, if you meet the definition of lease, you need to record some asset (right-to-use). There are just 2 exceptions when you don’t record asset – please look above to the article. S.
Unmatched analytical skills
Hi Silvia
The purpose of the new standard is to eliminate off balance sheet financing but it seems that in the case of operating lease we will record the assets twice. Once on the lessor book and then on the lessee book as right of use asset.
My point is that if you add the value of asset recorded on the lessor balance sheet + the right of use asset on the lessee book , it is not equal to the actual value of the asset.
Seems that this is in contradiction to the fair value accounting principle.
🙂 Yes, agreed, it sounds strange when the same asset is shown in 2 balance sheets. However, the right-to-use asset is not exactly the same as an underlying asset. S.
Dear Silvia
Thank you for you graet explanation. Under IFRS 16 , this is a problem that an asset reported in two balance sheet. Is there any reason for it?
THanks
How would we link this new standard to the conceptual framework principles
Would it be a fair presentation of operating leases to the users of statements
Don’t know yet.
It’s worth adding it. I would like to thank you for the Kit, I gain a lot of knowledge and experience from the Kit. Great and wonderful efforts.
Thank you, Mahmoud!
You’re right, it’s absolutely worth adding it. I’ll be working on that later this year, as I’m still a full-time mom of a little baby.
S.
Congratulations, God bless you both
Dear Silvia
As the purpose of IFRS 16 is to elimanate the use of “off balance sheet leases”, if a company traet an asset which is leases for every year as “one year contract”, it is recorded as operating laese because it is a contract foa 12 months (excption 1). As an auditor , how should we treat with this situation?
Thanks
hello
does this changes will affect the accounting treatment of the lease?
Hi silvia,
Thank you so much, you have made this article. It’s very very very easy to understand.
Keep writing silvia.
Oh ya, I have invite your linkedin account. i wish you can accept it. hehehhe thanks
Hi silvia, thakks for your helped
I have one question, hehehe.
In IFRS 16 stated, if the company adopt IFRS 16, they also need to adopt IFRS 15 earlier or at the same time.
Based on that statement above, My question is:
What is relationship between IFRS 15 adn IFRS 16?
Dear Deaa,
it is because IFRS 16 often refers to IFRS 15 provisions – for example, in sales and leaseback transactions. It would be non-sense to apply IFRS 16 earlier than IFRS 15. S.
Thanks for your explanation, really appreciate it
Hi Silvia,
I want to apply IFRS 16 on real financial statement and income statement of company which already have applied IFRS 17 just to know the effect of this change in the represent the financial statement, so can you tell me how can I start
Hi slay,
you need to look at your current transactions to which you apply IAS 17, and compare whether IFRS 16 rules change with respect to these specific transactions. Look after operating leases especially as the rules changed there. Then you need to:
– determine how these transactions are presented according to the current rules (IAS 17)
– how they would have been presented under IFRS 16,
– calculate differences and recognize them as at the beginning of the reporting period to equity. You also need to adjust comparatives. S.
Hi Silvia
I came cross that one of my friend’s company leased a land from government for 99 years lease term, but they not recognized it to balance sheet (Right to use land and lease obligation under liabilities)instead charging lease payment to profit or loss. I want to know is this treatment is right?
Thank you
Dear Nimasha,
IAS 17 states that the lease of land is almost always operating, because the land has indefinite useful life. So yes, I guess it’s the right treatment to recognize lease expenses in profit or loss. S.
Would your answer change now? after IAS 16 was implemented?
Well, the question was asked in 2016 when IAS 17 has been in place and I assumed no one had implemented IFRS 16 yet. Sure, if you follow IFRS 16, then of course you need to recognize right-of-use asset and lease liability for any lease (except for short-term and low-value), so yes, the company with 99-year land lease needed to make an adjustment during transition to IFRS 16.
Hi Silvia,
I have a question on sale and leaseback-Transition part.
Para C18 of the IFRS 16 states:
If a sale and leaseback transaction was accounted for as a sale and operating lease applying MFRS 117, the seller-lessee shall:
(a) account for the leaseback in the same way as it accounts for
any other operating lease that exists at the date of initial
application; and
(b) adjust the leaseback right-of-use asset for any deferred gains or losses that relate to off-market terms recognised in the
statement of financial position immediately before the date of
initial application
I do not understand what does b) means. I mean, I tried to find examples but failed to find a simple explanation.
Thank you in advance Silvia!=)
I have an ACCA P2 exam and after some weeks reading and trying to compare, your examples have broke it down and made it easy to understand. Here is hoping it comes up in the exam!
Thank you 🙂
All the best, good luck! You’ll kill it! 🙂
Hi silvia,
Thanks for your simple yet informative post.
But would like to ask, in practice/real life, where do we get the discount rate to calculate the lease?
Do different type of lease uses different discount rates? (office lease, equipment lease, vehicle lease, etc)
Thanks.
Dear Petter, in practice, you would calculate the discount rate as the rate implicit in the lease. Yes, it works in most cases. If not, then you should look to incremental borrowing rates (e.g. rates for similar loans at the market). To your last question – yes, there can be different discount rates for leases, but it’s not a leased asset that makes a difference. It’s rather term of lease, credibility of lessee (its credit rating), etc. S.
Hi1 Sylvia,
The effective date is 1 January 2019, so company at present moment can choose to apply between the old IAS 17 is IFRS 16
is it?
Yes 🙂
Hi Sylvia
I am doing a presentation on ifrs 16 and i have been asked to address the provisions of ifrs 16, what exactly are these provisions?
Thank you
Dear Silvia,
I end up @ IFRSbox whenever in doubt and have to say, no one else does a better job than you in clearing out the hazy parts in the IFRS.
So simple once read through!
Quick question though, If i made all my operating lease contracts to be under one year, I wouldn’t have to bother much about IFRS 16 right?!
And a very big congrats on your bundle of joy..God bless!
Thanks Ashvin 🙂
And yes, you are right. Leases below 1 year are the exception. S.
For an operating lease under IFRS16, does the lessor record the lesaed asset as an Asset and depreciate it?
Irshad, the lessor’s accounting has not changed. It means that under IFRS 16, lessor keeps an asset it its financial statements when it comes to an operating lease. S.
Thanks for the clarification, Silvia.
Thank you for the clarification, Sylvia. Does that mean the asset will appear in both balance sheets: the lessor’s and the lessee’s?
Dear Irshad,
yes, but it’s not the same asset. A lessor will show a PPE and a lessee will show a right to use a PPE. Also, the amounts will be different. S.
Thanks for the added clarification, Silvia. This is very useful. If I understand correctly, the asset will be under PPE in the Lessor’s books and will be depreciated. Will it also be included under PPE in the Lessee’s books? at what value? does the Lessee depreciate it? at what rate?
What explains / makes up the difference between the Lessor’s and the Lessee’s valuation of the asset?
Hi Silvia,
How do I calculate retroactively? We have Bldg rental payments since 2012 on our (Lessee)books? Can you explain with example?
Thanks
Hi
Sincere apologies for the inconvenience.
Please could you upload an illustration of an example of an IFRS 16 note in the annual financial statements.
I am curious to know how it would be presented and disclosed in a set of annual financial statements.
The standard is vague with regards to this.
How should the note look like?
(for lessees as well as for lessors)
How do IFRS-16 apply to sale and leaseback transaction. Is gain still required to be accounted for in the same way like in IAS-17?
Thank God I found ifrsbox,I’m gaining momentum for my P2 exam. Your articles are blessing me.
Thanks, Bob and all the best!!! Remember – keep it simple, revise a lot and re-do past ACCA’s exam questions as much as you can. During the exam, read the question and underline major information while reading. STATE THE OBVIOUS – you can earn easy marks. All the best! S.
Hi Silvia,
Thank you very much for your very informative post, especially that you made it very simple to understand.
I just have a question, How will we classify the “right-of-use asset” in the balance sheet? Will it be part of property plant and equipment, or intangible assets? Thanks
Hi Jay,
you can either present it separately from other assets in the statement of financial position, or you can include it within the same line as within you would include the underlying asset and disclose it in the notes to the financial statements only. S.
Hi Silva,
Your posts are very informative and easy to understand. IFRS box always proved the best platform to provide quick, accurate and best explanation of IFRS standards whether its new standard or existing standards. Your illustrations are very simple and thorough.
I have a question related to IFRS 16
How do IFRS-16 apply to sale and leaseback transaction specially for lessee?
Dear Muhammad,
thank you for your kind words 🙂 In relation to your question – I will send out the newest article the next week, it’s going to be about leases in IFRS 16 and the sale and leaseback is covered there, so please wait a bit 🙂 S.
Dear Silvia, here the questions. How can I solve this case?
You discovered that a company, Axia Automobile is not listed in the subsidiary ledger. You
have asked your account assistant, who is controlling the transaction of vehicle from Axia
Automobile. The account assistant told that she did not record the automobile because the
company was only leasing it. The lease agreement was created on 1 January 2016. You
decided to review the lease agreement to ensure that the lease should be afforded operating
lease treatment, and you discovered the following lease terms:
1. Non-cancellable term of 4 years.
2. Rental of RM38,000 per year at the end of each year. (The fair value of the automobile is
RM135,000).
3. The estimated economic life of the automobile is 5 years.
4. The implicit rate and Honey’s incremental borrowing rate is 8% per year.
thank you.
Dear Kakciksmine,
this looks like your homework and if you know me, I try to give you a hint, but you should solve it yourself. Therefore, assuming that you apply older IAS 17:
– you need to classify the lease first (it says that it’s operating, but looking to the conditions- is it really?)
– then you need to learn how to account for finance and operating leases by the lessee, and then
– draft the journal entries. S.
DEAR SALVIA
I request you to please upload a video solving a comprehensive worked example.that will surely help us to get benefit from your supreme perfection on IFRS.
Best Regards.
Hello,
Considering that the lessor accounting remains unchanged, it will result in a single asset recorded by two separate entities in its books, which seems bizarre. Could you please confirm?
Suppose an entity owning and operating a power plant where all the electric output is sold to the Government off taker (customer) via a power purchase agreement for 20 years. The lessor recognizes the asset in its balance sheet, which is depreciated over its useful life. The lessee records the expense of monthly payments, however with the implementation of IFRS 16, the lessee will also recognize the asset and liability in its books. As the lessor will continue to account for the asset in its books under IFRS 16, this results in the same asset being recorded by two separate entities. Your thoughts?
What do I do with the balance of my deferred liability for previously expensed straight-line rent for leases formerly classified as operating leases?
Todd,
We have the same question with respect to IFRS 16. I have not been able to find an answer as of yet.
I have the same question as well. Our auditor currently also raise this issue but haven’t been able to arrive an conclusion yet.
OK OK guys, sorry for not responding! If you are adopting IFRS 16 from IAS 17, you have to state the balances as if IFRS 16 has always been adopted. It means that you need to reverse all entries under IAS 17 and book entries under IFRS 16. It relates to previous periods, too. And, when doing this, you will book the cummulative adjustment in opening retained earnings (depending on which approach you take, whether modified or full). If you can tell me how you accounted for operating leases previously and how the deferred liability arose, I will show you the entries. Meanwhile, here’s the article about transition to IFRS 16. – you will see how I did the adjustments (reversal of “old” numbers and booking of “new” numbers). S.
Hi Silvia,
How do you account for it if the modified retrospective approach, ROU=LL is adopted?
IFRS 16 C8(b)(ii)
Hi Martin, I described various options here. S.
Your article is really so helpful.
Especially with example it is like a cakewalk
Thanks for such an elaborate explanation of each and every detail
What are changes in Finance lease of Lessor.
Is there any change regarding journal entries.
as previously we record as
Dr. Gross investment in Lease
Cr. Asset (net investment in lease)
Cr. unearned Finance Income
Subsequently
Dr. Bank
Cr. Gross Investment in Lease
&
Dr. UEFI
Cr. Finance income
i am confused as i have seen different entries now.
I believe that there is a serious difference in sale and lease back transactions as well. I appreciate the effort you have made and for clarifying a lot of misconceptions of mine. And now I need to know about how IFRS 16 deals with the sale and lease back sceneries. Can you help here as well?
Hi SK,
this article was written to give a word of warning in order to prepare – it’s by no means exhaustive. And yes, I will write some other articles about IFRS 16 later on. S.
Hi Silvia,
Thankyou so much for the wonderful article:)
Hi Silvia,
Thank you for this wonderful article. Just a quick question regarding the example calculation. why did you include the interest and add it to the carried forward liability? In your other example of finance lease, the interest portion is always just in the p/l and never part of the liability. Can you please explain why this is?
Thank you.
Hi James,
the interest portion IS recognized in P/L – please note the debit side of the entry. The credit side is a liability and when it’s paid, then it’s a cash. S.
Dear Sylvia,
Thank you for your immense contributions. When in doubt, i read your posts for guidance.
Per your post above, i have some questions which I have been trying to rationalize. Perhaps your input would help demystify them.
First, IAS 17 prescribes assets acquired under finance lease to be depreciated at the shorter of the lease term and its economic useful life. what then happens to the carrying amount of the leased asset at the end of its lease period if the lease period is shorter than its economic useful life because at this point, the asset would have been fully depreciated but then it continues to generate economic benefits for the company.
Secondly, why is IASB compounding issues for Accountants? As you have rightly noted, too much estimates and judgments in accounting for these transactions might in fact defeat the objective of fair reporting. Arriving at a suitable discount rate, determining the cost of the non lease element to be separated from the lease payment would all contribute to creating headache for accountants. Why creating a fuss over nothing?? The new standard would even help bloat total assets and total liabilities if the lessee defaults in annual lease payments. Although no impact on net asset.
Thank you.
Dear Christian,
1. If the lessee intends to use the option to purchase the asset at the end of the lease term, then you need to depreciate over its economic life.
2. I’m not the right person to respond to this question, sorry 🙂 I just take the rules as they are and try to play with the cards I have. S.
Hi Silvia,
How would I account for leases of land with a life of 99 years? Debit Right of use of asset discounted at 99 years? This would be impractical and surely the rental value will likely change at every 5-10 year period. Appreciate your view. Thanks.
Dear John,
yes, exactly as you write. Debit ROU asset Credit Lease liability, where ROU asset = all lease payments in 99 years discounted to present value. And if there’s a change in payments, then you would need to account for the lease remeasurement. I covered all of this in my IFRS Kit with very detailed explanations. S.
Dear Silvia,
Thank you for your detail explanation in an understandable way. I am bit confused by your point that is, IFRS16 does not affect Lessors books, however i need to clarify following points:
a. Whether separation of elements is applicable for both lessor and lessee?
b. How to ensure the element cost is fairly measured comparing to market prices?
c. Should I consider a one year contract with non-cancellable period of two months with option to continue/terminate as lease contract?
d. All the leases will be in one line item in SFP?
Please reply
Thank you
Hi Silvia,
Thank you so much for the awesome job on these new IFRSs.
I have a question on the calculation of the PV. How did you get CU23,341? when PV (8571×3, 3 yrs @ 5% I am getting CU22,211.86.
Thanks
Hmhmhm, how are you getting CU 22 211,86? 🙂
PV = 8571*1/1,05+8571*1/(1,05*1,05)+8571*1/(1,05*1,05*1,05)
Dear Silvia, Thank you for the brilliant easily understandable article on IFRS 16. I have a question on Lessor Accounting. While the lessor continues to classify leases as under IAS 17 (Operating of Finance) the lessee is required by IFRS 16 to recognize an asset (provided that all conditions are met). There is a little confusion, if the lesser identifies an asset as a finance lease (and therefore the asset remains in its accounts) and the lessee has identified the same asset as a right-to-use asset, will there not be the case where the same asset is recognized twice (once in the lessee’s accounts and also in the lessors’ accounts)?
Really a nice article and very informative, keep up the good work.
You are truly helping the students.
Hi Silvia:
I must commend your simple writing style devoid of all confusing technical jargons!
I was sondering if you have any plans to write on the IFRS16 disclosure requirements – or if you can explains the same briefly here.
Thanks in advance for your response!
Hi Silvia,
I would like to seek your view on revenue recognition – operating lease rental on investment properties.
I have a tenancy agreement with a lessee at monthly rent of $10,000, payable in advance on the 1st day of each month, for 24 months from 1 January 2016 to 31 December 2018. The tenant has been paying rent promptly from January to September 2016. However, the tenant did not pay the rental from 1 October to December 2016 but continue to occupy the premises. The tenant has moved out in January 2017.
My question is it appropriate to recognise the rental income from October to December 2016 ($30,000) and then make full allowance for the rental receivable?.
Thank you.
Kelvin
Hi Silvia,
Your explanation and illustration is very simple and easy to understand. Appreciate your efforts in making it simple for users. I take it that under IFRS16, both lease and asset will be classified as long term assets since it will over 12 months anyways. Thanks again.
Hai Silvia,
I have this issue on Operating lease on the book entries for lease premium paid in advance.
1. Do we amortize the lease premium over the period of the lease agreement?
2. Or do we expense the total lease premium to P&L?
Many thanks,
Andrew
Hi, you should amortize it, because it’s a prepayment. S.
Hai Silvia, many thanks. Cheers. Andrew
As per IAS 17, We have recognized advance payment lease as an non current asset and lease rent equivocations (deferred lease rent. What are the effects under IFRS 16 for above two balances?
Thank you. Well explained.
Hi Silvia,
One small detail, I was wondering if the right of use asset could go under current assets, for example the amount of lease liability that is due in the next 12 months. Can I account this amount as a current asset? I am asking because of performance ratios, such as current assets/current liabilities, that may be impacted for the worse.
No, that’s under non-current assets if the lease term is longer than 1 year. S.
Great explanation and much appreciated. I have a question though:
If the lease payments (on a lessees CF statement) appear under financing activities, doesn’t that impact Free-cashflows to the Firm and hence impact NPV, project IRR…etc?
If I’m not mistaken, the definition of Free-cashflows will have to be revised to include the lease payments as an operating outflow.
Thanks for the great article! I have a question about lease of land. Lease of land will still be reported as operating, aren’t I right? It should not be reported in balance sheet as long as it is not appreciable. So reporting of land will stay according to IAS 17?
Thank you
I meant depreciated of course instead of appreciable :))
No, Alex. Under IFRS 16, if you are a lessee, you do NOT classify the lease anymore and every single lease is reported in the same way. However, let me remind you that you will NOT show the land itself in your balance sheet. Instead, you will show the right to use that land. S.
How did you reach to the result of 23,341 as a lease liability b/f in the first year? Can someone explain as to how this was calculated.
Dear Bander,
this is clearly written above in the article: “The lease liability is calculated at present value of lease payments over the lease term. In this case you need to calculate the present value of 3 payments of CU 8 571 (only lease element) at 5%, which is CU 23 341”. S.
Thank you. I am sorry, the present value of three payment is 8571*3=25871*5%=1285.65 I know it is wrong but could you please guide me on how can I reach to 23,341
Yes, Bander, that’s wrong – I have no idea what you have calculated. The present value is calculated as 8571*1/(1,05^3)+8571*1/(1,05^2)+8571*1/1,05 – these 1/(1,05^3) etc. are discount factors for 3 years and 5%… etc. S.
Wowda! Good article da! I like it da!
Hi Silvia
Your article is very helpful.
I was just wondering what will happen to corporation tax position. Will we be adding the asset to capital allowances and claiming AIA?
Dear Raja,
in fact, this is good question and I don’t have the same answer for everyone, because it really depends on the tax rules of your own country. In our country, the tax legislation does not know the term “right-of-use asset” and operating lease expenses are fully deductible – which gives rise to the deferred tax. S.
Hi Silvia,
Thank you for great article.
In IAS17 definition of interest rate implicit in the lease clearly states that it should be determined at the lease lease inception (based on the fair value of asset on inception date and discounted to present value to inception date). But in IFRS16 definition of interest rate implicit in the lease does not clarify this, it seems IASB guys remove this intentionally.
Please share your opinion – should we calculate implicit rate at lease inception or commencement?
Thank you
Hi Silvia,
Thanks for your explanation in simple terms. I have a query in terms of both IAS 17 and IFRS 16.
Example- A bank has opened a branch at a building, by signing a rental agreement with the landlord of the building on which branch is situated. The cost of the structural works in that building for setting up bank is 100,000, which will be borne by the bank. The terms of the agreement are as follows: The initial agreement will be for 10 years amounting 10000 per month and price will increase by 10% every 2 years. Either party can terminate the agreement at any time by giving two month’s notice. The tenure of the agreement can be extended at both parties consent.The bank has no intention to discontinue the branch operations in near future. However, loss making branches may be subject to relocation or closure in the future.
In this case, is the lease agreement non-cancellable in nature as per IAS 17,IFRS 16? And how should the accounting and disclosure be done as per IAS 17 and IFRS 16?
Hi Shiva,
no. In this case, the lease is non-cancellable only for 2 months, especially when each party can terminate with 2 months notice without any significant penalty. The reason is that the lease is non-cancellable as long is it is enforceable and it is not enforceable beyond 2 months. I recommend reading the paragraph IFRS16.B34 for the reference. As for accounting – you just book rentals as an expense. You can capitalize the structural works as “leasehold improvements” and depreciate them over the useful life.
Would you mind if I use this question with your first name in my podcast (as for example here)? I think more people would appreciate the answer. S.
Of course and thanks for the answer.
Thanks for the answer. Regarding accounting treatment, should the rental expenses be booked as per actual rental cost payable or should it be on a straight line basis over the term of the lease by taking into account 10% increment on rent amount every 2 years.
And for podcast, of course , yes and thanks.
Hi Silvia,
It was a simple and a good read.
I have a question, Can you help me in understanding whether Asset & liability recorded under IFRS 16 requires re-statement as per IAS 21 – “The effects of changes in Foreign Currency”” ? .
Your earliest response will be helpful.
It’s a non-monetary asset, similarly as PPE or intangible asset and no, you do not revalue it at the year-end.
Hi Silvia
Paragraph 4 mentions that “a lessee may, but is not required to, apply this Standard to leases of intangible assets…”, does this mean we can decided whether or not these contracts are included as a lease asset/liability or expensed?
Yes 🙂
Hi Silvia,
could you please clarify the different in the sale & lease back under IAS 17 and IFRS 16?
Hi Silvia,
We are a wind power company, we have an agreement with an electric company to provide them with all output generated by the wind farm, the contract is for 20 years and the electric company has an option to purchase the power plant after 20 years (two other choices are available: extend the project or decommissioning), there are no fixed monthly charges (it depends on the monthly actual output multiplied by the tariff). The expected useful life for the wind turbines is 20 years. In this case, which accounting treatment shall be applied? IAS 16 or IFRS 16?
This is the best article/summary I’ve read anywhere on the internet, thank you!
Hi Silvia,
A few questions below:
1) My company leased out shop space to inter-company over a fixed lease term but on a variable component of the sales (10% of nett sales for the month). In this case, what will be the base of the rent that we should use to PV? Can we use the average of 12 months sales over 5 years?
2) Since this is an inter-company transaction, there will be no implicit interest rate that has been included in the rental agreement. In such a case, what kind of similar incremental borrowing rate should be used? There are also no borrowings for the company so I cannot use any comparative to determine the incremental borrowing rates to use. Can you please advise what rate should be used?
Appreciate your kind advice.
Thanks.
Hi Lyn,
1) No. Please see this IFRS Q&A session, it will help.
2) Yes, that’s difficult to determine, but you can start looking to the banks and the rates that they offer on similar loans to similar clients. I will make another Q&A session on this topic.
S.
Hi Ms. Sylvia!
Great article, thank you! What about security deposits? I’ve been googling a while and still can’t find the right IFRS, so I’d really appreciate your help.
1. security deposit – nonrefundable. do I recognize this like a lease incentive and offset from commencement date?
2. security deposit – refundable. so as this is a financial liability, I should amortize. however, where do I charge the amortization? one article says to charge the difference to lease liability?
so:
dr. cash 1000
cr. xxx
cr. lease liability 900
and every month
dr. xxx
cr. lease liability
Hi Silvia,
Thanks for the article!
It is a little bit mindblowing for me.
I remember attending one of the seminar in my country. The speaker was senior auditor in KPMG. He brought this topic, and in the end I ask him question, whether rent office treatment will be impacted by this IFRS 16 or not. He was a little bit hesitant but in the end confirmed that rent office should be out of scope since there is no option to purchase the office.
But I think that is false, moreover after read you article, I am pretty sure that rent office should be recorded under IFRS 16.
But some question that is still confuse me:
1. In notes to financial statement we need to disclose long term commitment. Usually lease office contract will be described in here. Stated how long until the contract expired and how much the residual contract value that need to be paid. In this case, we do not need this anymore? Since in the first place we have already record as long term lease payable.
2. also in lease contract usually do not mentioned any interest. Not like car lease contract. How do we determine the discount rate?
Hi Ridwan,
I beg to disagree with your speaker – yes, rent of offices can be affected by IFRS 16, depending on the specific conditions in the contract. For your other questions, it is too long to respond in the comment, but please check this article and also this one, they will help. S.
Hi Silvia.
your efforts to simplify IFRS is very appreciated and considered.
Please, I want to ask if we pay the rental fees at the beginning of each year not in the end,
1- I will record the assets and liabilities only or there are any other accounts.
2- The asset and the liabilities will be 0 (zero) at the end of the year.
Thanks in advance.
Hi Silvia,
I think if we separate the payment CU 8.571 equal Interest CU 1.167 + Principal (asset) CU 7.403 (end of first year), and then we make accounting treatment base on this; that will make its easier.
Ex. for that:
Debit P/L interest 1.167
Credit Cash 1.167
Debit Lease liability 7.403
Credit cash 7.403
Debit P/L Depreciation 7.780
Credit Right-to-use-asset 7.780
I work for a bank (Ghana) and as usual most of the banking premises are rented. As at now, we treat them as operating leases. Here in Ghana, the lessors will normally ask you to pay say 3 years rent advance. Repairs and maintenance cost are borne by the lessee.
When we pay the rent advance (say $36000 for 36 months), we debit Rent prepaid and credit cash. After that we amortize the total rent paid over the duration of the rent agreement. In this example, we debit p/l $1000 and credit rent prepaid $1000 every month.
Please I will like to know how will IFRS 16 affect us
Thank you
Hi Efface,
yes, IFRS 16 affects you, because instead of accounting for prepaid rent, you have a right-of-use asset here, so you need to account for Debit ROU asset/Credit Cash (or lease liability, but if the full rent is prepaid, then just cash). And then you need to depreciate ROU asset.
Hello Silvia,
In our group of companies (60 companies) all companies enter the lease cost into their legal books in the P/L. How do we treat that “technically” when consolidating on group level? I mean we can’t have both the lease cost and the depreciation/interest cost in the P/L. Do we “eliminate” the same amout as the total sum of depreciation and intrest ending up with just a reclassification of part of the costs or are we supposed to remove the lease costs in total (and which account should then be used as “counter part”) and only have the depreciation/interest elements left in P/L?
Br /Maria
Hi Maria,
exactly as you say. You should take 2 steps:
1) Eliminate everything NOT under IFRS, and
2) Recognize it under IFRS 16.
So you need to reverse whatever lease costs in P/L and recognize them under IFRS 16. I wrote 2-part article on this topic here and here, plus in my IFRS Kit there is a full lecture on how to do exactly these adjustments. S.
Dear Silvia,
Thank you for the insightful details and example. In the accounting entries proposed, how would you address the entries generated by the normal process of payment when you commit to the rental and then pay the invoices? In most of the ERP used, when your P2P process is automated, a commitment (contract rental) will generate an entry in the P&L (Cost of rental) balanced with Vendor account. In the table Summary of accounting entries under IFRS 16 we may therefore need to reverse these entries before proceeding to the booking of IFRS 16 postings in order to avoid recognizing twice the cost (once through depreciation, and once through invoice). Do you see any other way to avoid such reversal mechanism as it may be really complex of you have to go through different allocations process (from analytical accounting and costing point of view)
Dear Silvia, I would like to first thank you for demystifying IFRSs that seemed to be complicated.
Now I want to ask if there is a circumstance where Right Of Use asset will be higher than Lease liability since we have to recognize ROU asset in the amount equal to Lease liability plus some other items like initial direct cost if any.
Thank you
Yes, of course, there can be such circumstance.
Dear Silvia,
My company currently uses a warehouse under IAS 17 operating lease where the lessor provides repairs and maintenance. My company paid the lessor for water and electricity usage. Air Condition units were installed and maintained by my company. How does this changes come January 01, 2019 under IFRS 16?
Hi Lydia, well, most probably you will need to recognize a right-of-use asset because if you are a lessee then you do NOT classify the lease as either finance or operating. You book all the leases the same way, with small exceptions.
Hi Silvia,
Could you please share the article for more details about the exception.
I am dealing with the same case. Lease warehouse for 2 years with no purchase option and economic life of the warehouse is unknown. should we charge Depreciation and interest?
Dear Silvia,
Under IFRS 16 for the lessee there is no finance or operating lease its a same treatment ” right to use assets” well if the lessor is a Holding company and the lessee is a subsidiary what about elimination entry regarding a consolidation financials when we apply the operating lease ” The same assets will booked in the two entity and deprecated but in a different amounts ?
Dear Sylvia,
Under IFRS 16:36 (subsequent measurement of lease liability) as stated there, Why is it that the carrying amount of lease liability is to be increased by its interest expense? Thank you so much.
Because at initial recognition, your lease liability was discounted to present value and you need to bring that present value to the future value by unwinding the discount = increasing it by its interest expense.
is this the same with the previous amortization of the lease liability under PAS 17? Im so sorry I got confused. Thank you in advance
Yes, essentially the same as IAS 17.
How about upon depreciation of the PPE? Since under IFRS 16 Operating lease was eliminated in Accounting for lessee. All lease shall be classified as Finance lease unless it is a low value asset and the lease term is only for 12 months, then we have to account the right of use asset under PAS 16 using either Cost model, Fair value model or revaluation model. Under Cost model, we have to recognize Depreciation Expense yet as per books of the lessor if the lease was accounted as operating lease, the PPE shall continue to be recognized in its books thus recognizing depreciation expense as well, in that case the PPE will be depreciated under the books of both lessor and lessee accounting. depreciating the same asset at different amount?
Yes. I have answered the same question multiple times. The accounting for leases is NOT symmetric anymore. And, the right-to-use asset is not the same as underlying asset itself. Yes, both lessee and lessor depreciate something.
What if the lessor is a parent entity and the lessee is its subsidiary? Upon preparation of consolidated FS both amounts will be recognized, does it makes the FS overstated?
They won’t be recognized both, because you must eliminate intragroup transactions and thus all leasing in subsidiary will be removed on consolidation (there’s no lease from the point of external user).
Thank you so much Sylvia,
Hi
I would like to know how to calculate the lease liability and right of use asset with the following conditions:
a) Annual escalation of 8%
b) 29 months left of a 5 year lease.
The escalation clause is confusing me…
And do you measure the lease liability for 5 years, and then subtract the 271 months paid so far?
Please advise
Hi Swaleha,
it is the lease modification and in the inception, you do not take this into account (simply take initial payments for full 5 years). When the lease payments change, you recalculate your lease liability with new payments and account for the adjustment. It is very simply said. I have great excel examples exactly on these issues in my IFRS Kit. S.
Hi,
There are some lease for offices for which the initial duration of the contract has ended and since then the contract is silently renewed every year. In this cases how do we determine the lease period which will be used for the calculation of the RoU and Lease liability? Can it be applied the exception for leases with duration less than one year and expense the rent amount instead of bringing them on BS? What is the best practise?
Many thanks,
Petros
Hi Petros, please read this. S.
Hi Silvia, is IFRS16 applicable for leasing apartments (typically 2 years contract) for expats/employees to stay as part of their employment package
Yes.
Hi Silvia, when i disclose operating lease commitments on the Annual Financial statements do i include VAT or exclude it . My second question is when i enter into a new contract with the lessee and pay a deposit, do i include the deposit on the straight lining ?
Thanks
Dear Silvia,
in some parts of your presentations regarding the application of IFRS 16, you indicate that the lease period is determined only for the non-cancellable period (+possible extension of the contract).
Does this means that contracts that do not have a specified non-cancellable period are not under the jurisdiction of IFRS 16? The lease payments are recorded in profit or loss.
Did I understand it well?
Thanks.
Hi Sanela, no, not quite, but non-cancellable period is crucial for determining the lease term. You can read more about the lease term here.
Dear Silvia,
The lesson is very useful, thank you for that.
This way I would like to kindly ask you one more question. The value of the lease liability includes all payments that are not paid at the commencement date: fixed payments, variable payments, residual value guarantees, exercise price of purchase option and penalties for terminating.
What about lease contracts that do not have an agreed fixed price? The company leases equipment, and the rental price is determined based on hours of use of this equipment. So the rental price is not fixed, it depends on the use of the equipment.
Thanks.
Dear Silvia,
As per this standard can we treat cancellable leases as short term leases.
I just want to say thank you for this clarification re IAS 17 and IFRS 16 though i’m aware some real-life situations may not be this simplified.
Dear Silvia
I would like to ask about how to calculate the amount 23,341.
8571 per year x 3 = 25,713
Then there is an interest 5%.
Will that be 25,713 x 95%? =24,472 at the commencement day?
I am sorry, I really have no idea.
Please help.
Hi Silvia
I have a transaction whereby a land owner has entered into a 99 year lease agreement with an individual who will occupy the land for that period and may build a residential property on it, at the end of the term the land owner may buy back that building at 50% of its fair value.
The buyer/lessor pays the whole amount (equal to the value of the land) up front.
Can the land owner recognise this as a sale; derecognise the land and recognise a profit?
Or does the land owner have to recognise a revenue over 99 years?
Please help
Hello Hamza,
Lease of a property and sale of a property is not same. If it is under a lease then the owner should be having the actual ownership of the land and if it is a sale then ownership is now in buyer hand.
According to the scenario, if it is a 99yr lease then why the buyer has paid the total value of the land ?
also after payment if the ownership has been transferred to the buyer then lessor can show it as profit and de-recognized it as a sale . but if the ownership has not been transferred then lessor can not show it as a profit rather than it will be a term payment for the 99yeras.
Hope u got your answer & please share your feedback accordingly.
Dear Silvia,
Can you advise please, how we need to eliminate entries under IFRS 16, if lessor is a Parent company and leasee is a subsidiary?
Well, you will simply reverse everything as no lease has ever happened. Even the cash movement – since this is a full consolidation, no cash moves outside the group. S.
Hi Silvia
I want to understand the concept of novated leases. In case employer has taken on lease car for specified no. of years from a finance company and given this car to employees for their personal/ official use. Would that be covered under IFRS 16 ? Currently company is recognising the amount paid to finance company under salary cost. Could you please explain how this will be treated under IFRS 16?
Hello Anjali,
currently the employer is maintaining the books according to IAS17, and charging the cost in P&L as expenses. This can be implemented through IFRS16 and for that reason employer will be the lessor and finance company will be the Lessee.
The cost of the asset will be amortized in SLM over the life of the asset and interest will be charged on the asset on a discounting factor and this will be decreased by the lease payment as per the payment method applied.
Hope you got your answer. Let me know your feedback.
Hi Silvia
I would like to enquire if the rented equipment is subsequently sent for repair and the owner gave some rental refund for the repair period, can the amount go directly to PL instead of affecting our initial Lease Liab calculation? thanks
Under IFRS 16 it does not affect the lease liability because the variation was not caused by change of the lease term or other circumstance. This item simply does not enter into variable lease payments.
Hi Silvia
Thank you for your summarized and simple presentation in IFRS 16. i would like to know the situation when interest rate on lease amount change on semi annually. how we account for the changes in interest rate in right to use of asset because we treat interest rate as a discount factor to calculate Present Value of an asset.should we reassess asset PV semi annually when interest rate changes ?
Kind Regards,
Asif
Hi Silvia, if a tenant has financial year end other than December 2018, when should the IFRS 16 be applied? Will it be from January 2019 or depending on the tenant’s year end?
Hi Shana, from the first day of his accounting period if it starts after 1 January 2019. I.e. if his year-end is 31 March 2019, then he starts applying IFRS 16 in the period starting 1 April 2019.
Hi Silvia
In terms of IAS 17 operating lease, can the lessee capitalise the lease improvements made?
In short – yes.
Hi – thanks for this article – very useful. When reporting can the liability be off-set from the right of use asset?
Nope.
Hi Silvia,
I realized that there were lesser attention given to the distinction between acquisition and leasing of assets. If an Entity is acquiring the assets by way of finance lease, rightfully it should be accounted under IAS16 instead of IFRS 16. right?
Question 1: if I debit my Plant and Equipment (“PPE”) and credit my hire-purchase/finance lease payable, would this seem strange? since IFRS 16 has clearly remove the distinction between operating lease and finance lease. Showing a finance lease payable in the financial statements seem to indicate a departure of IFRS 16.
Question 2: For example, an entity purchase an equipment that typically last for 20 years. The acquisition is by way of financing for a period of 5 years. Under IFRS 16, i may account the Right-of-Use of assets (“ROU”) and depreciate over 20 years with i account the lease liabilities over 5 years. So what happened at the end of the 5th years? Do i do a reclassification from ROU to PPE? Or should I account them under PPE at inception?
Hi Kelvin,
the answer to the first question is no. If an entity acquires an asset under the lease, then it is accounted for under IFRS 16 as for the right-of-use asset and not a piece of PPE itself.
Hi Silva,
Thanks for the answer,
Would the following situation make a different?
the entity purchase an assets, the ownership (both legal and accounting, ie. substance over form) has been effectively transfer to the entity, the entity finance the assets by way of installment plans.
In this situation, will you account them as ROU or PPE?
Then it’s probably PPE and loan, because legal ownership passes straight away to the lessee.
Hi Silvia,
Thank for interesting article here.I have encountered a concern where a company identified a lease liability in there book of account and once i persuade agreement, the agreement parties are the parent company vs lease company.Do the subsidiary company can recognize the lease liability as per IFRS 16?
Hi Devo,
yes, if a subsidiary is a lessee and a parent is a lessor, then yes. However – upon consolidation, there is no lease as it is fully intragroup and in the consolidated financial statements it will be eliminated.
Hi Silvia
If the operating lease ( rent expense) was previously straight -lined in accordance with IAS 17 and resulted in a deferred rent liability as at 31 December 2018. What will happen during the initial recognition of the right of use of asset at the comencement on 1 January 2019 if the lease’s termination date is after 2021?
Do we reduce the ROU by the deferred rent liability amount? What happens to the lease liability?
Hi Anna,
you do not reduce anything. You will simply recalculate new deferred tax liability/asset based on ROU and lease liability and book any change or difference from previous amount. This is very simply said – you need to be careful with how to recognize the difference (equity vs. profit or loss). S.
Hi Silvia-Thanks for sharing a good article. The inter-company elimination on consolidation level is getting more challenging in the case where the Parent itself leasing the assets from an outside group of an entity and sub-leasing it to its subsidiary i.e. Parent is lessee in head lease and lessor in sub-lease. The difficulty arise where sub-lease results in operating lease since ROU has not been sublet for the majority of the part. How the elimination work in such cases?
Good day Sivia,
Thank you for breaking this down. I need a clarification on lease payments where total lease rentals have been paid upfront. I presume that means there is no recognition for lease liability. I checked the standard and it does not state that clearly. Is there any other way this should be treated?
can you please send me all advantages and disadvantages with IFRS 16 compared to IAS 17. God bless
HI Silvia,
We have instances in our company where a lease is entered into then prepaid in full for all outstanding payments at inception, how does this affect the right of use calculation/lease liability calculation?
Hi Silvia,
First of all thank you so much for your help .
I miss something here , How you allocate the lease amount 8571 and the service exp. amount 1429 ? i miss the calculation
Dear Silvia
Thanks for your useful video. could you please guide me how can I find the question and answer for each Standards separately.
Best Regards
Hi Sylvia
It’s rikas. Just on my question. Currently the lease is for $200 per month paid monthly on the 1st of each month, now we need to apply IFRS 16
I cannot say based on the monthly expense – you need to look at the value of an underlying asset and assess.
Hi Sylvia
What happens if the lease is of low-value and are renewed on an annual basis. Do we leave it as an expense in the income statement or do we still have to do all the journals as per IFRS16 to get it onto the balance sheet.
If underlying assets low-value when new, then don’t worry about the lease term and put all expenses in profit or loss.
Dear Silvia
Under IAS 17 straight-lining, a asset or liability will sitting in the balance sheet. Adopting IFRS16 we now recognise a right of use asset, corresponding liability. And depreciation and interest in the balance sheet. What happens to the IAS16 smoothing balance sheet item, do we release it to the income statement.
Hi Silvia,
What we do we onerous lease provision recognised at the date of transition under modified retro. approach?
The standard says that it has to be set off against the ROUA at the transition date, what does this mean?
Do we credit ROUA and Debit Provision for onerous leases? or we amortise onerous provision over the lease term?
Hi Silvia,
It is difficult to identify from your notes in ifrsbox but what would you do if the company is paying the lease of the car (invoice issued to company) of some employees and then the lease amounts are deducted from the salary of the employees? should you use IFRS to capitalise car leasing if other IFRS 16 conditions met?
Hi billl,
there are 2 separate contracts I assume: 1) one with the lease company; 2) one with the employee regarding deductions; thus treat it as 2 separate things and yes, apply IFRS 16 to the lease.
Thanks for your quick reply .there is only one contract with the employee, the invoice is issued to the company and paid by the company but then this amount is deducted from the salary of the employee, so PnL effect should be nill. Is IFRS16 applicable to that case?
Hi Silvia,
Lets say, the arrangement is for the asset to transfer ownership at the end of the lease period. the depreciation would have done on the useful life of the asset, hence leaving a balance on the Right to use at the end of the lease term.
What is then the double entry to convert this remaining Right to use to actual asset i.e. PPE.
Hi Silvia
I wanted to know if we ever reclassify Lease receivable that was previously recognised on IAS 17
Hi Silvia,
I have encountered a case for IFRS 16.
A parent company has a contract for lease of building office with the lessor. Parent company pays this rent to the vendor. Thereafter, it cross charges its subsidiary who is using that building.
Here, there is no agreement between the subsidiary and the lessor and no agreement for cross charge between parent and subsidiary.
Shall we consider this as a sub lease ?
Hi Silvia
I would be glad if could assist with this situation:
We entered into a five year lease on Jan. 1, 2020 with annual rentals payable on Jan. 1 of each year. The rental amount is GHc100,000 per year in advance. We made an advance payment of GHc300,000 on Jan. 1, 2020. Our incremental rate of borrowing is 15% so we set the initial entries as follows:
Dr: ROU asset-385,500
CR: Liase Liability-85,500
CR:Bank-300,000
The challenge now is how to set up the amortization table. Kindly assist
Thanks! A really clear explanation. It’s just what I was looking for, Congratulations and thanks again!
Dear Silvia,
Thank you so much for providing such information, I have 2 question, could you please answer them?
First, what is the need for an updated standard on leases ?
Second, what is the impact that the standard will have on the financial statements of companies that adopt IFRS?
Hi rsh, thank you! Well, these are so broad questions that I will not reply them here in the comment and you need to do a little research on this website, as I answer these in numerous articles and comments. You can start here. S.
hi, could you please clarify, if we recognise FRS 16 impact in FY2019 (both ROU and lease liability), However, in subsequent year, (FY2020), we have early terminate the tenancy. therefore, we need to reverse the ROU and lease liability, the difference will charge to profit or loss as what item ?
Hello Sylvia,
Kindly advise how concession agreement should be accounted for by the landlord. That is the agreement has a fixed fee (guarantees) and variable fee (based on volumes). IFRIC 12 is excluded from IFRS 16 and I cannot find any other standard addressing this issue
Hello Sylvia,
Your example above made the subject very understandable, However i have a query where with mutual understanding both lessor and lessee agree to vacate the place without any more liabilities at both end. How this will be treated, i will take the same example used by you above. We are vacating the place at the end of Year 2 . Normal Account P&L total charge would have been CU 20,000 however as per IFRS 16 accounting we would have got a charge of CU 20,382 which would have been covered if we had stayed in the location for last year as well. Please advise.
Hi Silvia,
Thanks for the clarity on IFRS16. I have one question though, How do we treat the security deposits when implementing this standards?
Hello Silva,
Thanks for all your IFRS guidance. Is employee accommodation rent paid/funded by Company within the scope of IFRS 16 being employee benefit and also within 12month term with or without renewal option?
Dear Silva,
Please enlighten us in case of IFRS-16 accounting for lease contract for assets with infinite useful life.
Thanks
Dear Silva,
Please help me understand the IFRS -16 accounting in Lessee’s book for the following transaction;
1. Lease contract – Right to use the land for indefinite period with minimal fee (i.e. rental) with lease increment of 0.2 % every two years.
2. The lessee has used the leased land to construct the production facilities and office building. The lessee do not intend to terminate the contract and use for indefinitely.
Thank you
Dear Silvia,
When a company adopts IFRS 16 for the first time, can it decide to reverse or stop apppying it?
I do not think so.
Hi, Thank you so much for that educational comparison of the two.
I am struggling to identify some of the key challenges and potential benefits key stakeholders will be presented with following the implementation of IFRS 16.
While your discussion has brought clarity for me on differences IFRS 16 brings compared to IAS 17 which many other articles have not, this is an area which has been difficult to acquire useful information on.
Many thanks
Yvonne
Hi Silvia,
We are engaged in a business renting residential properties on an annual basis. We require our customers to pay ther rent 100% in advance, but they wont pay unless we issue an invoice. I know it is a bit off-topic but my question would be: are we allowed as lessors to invoice the client in advance before the lease starts and recognize accounts receivable and “advance contract billing” which is like a deferred income but uncollected? Thank you in advance!
Dear Silvia,
I’m confused as to how the lessor and lessee shall recognise an asset and a RUA respectively at the same time when a lessor enters into an operating lease and the lease qualifies as per ifrs 16 as a lease contract.
Does this happen. Can the same asset be on the Balance sheets of 2 entities.
Please elaborate.
Thanks.
Correction….lessor enters into a finance lease and the lessee recognise a RUA.
Can this happen
Yes, it can happen and happens a lot; however when lessor enters into a finance lease, he/she does not have an asset in the balance sheet, but instead he has a net investment in the lease. You perhaps meant the first question – when a lessor enters into an operating lease, he/she does not give up the asset, but recognizes received lease payments straight in profit or loss; and on the other hand, lessee recognizes right of use asset. Yes, this is asymetric accounting, meaning that both of them have an asset in their account. I must say that ROU asset (at lessee’s accounts) is not the same as an underlying asset itself though. But this normally happens and IASB is fully aware of it.