IFRS 16 Leases – Summary
In January 2016, the new standard about lease accounting IFRS 16 was issued and it introduced a few major changes. The most significant are:
- New definition of the lease can cause that some contracts previously treated as “service contracts” can now be treated as “lease contracts”,
- Accounting for leases in the lessee’s financial statements changed and lessees do not classify the lease anymore. Instead, they should account for all the leases in the same way.
I wrote an article highlighting these changes and illustrating them on examples some time ago, but you might want to check that out here.
In this article, I’d like to sum up the main requirements of the new IFRS 16 and you’ll find a video in the end.
Why IFRS 16 Leases?
The objective of the standard IFRS 16 Leases is to specify the rules for recognition, measurement, presentation and disclosure of leases.
But, why is there a new lease standard when we had an older IAS 17 Leases?
The main reason is that under IAS 17, lessees were still able to hide certain liabilities resulting from leases and simply not present them on the face of the financial statements.
I’m talking about operating leases, especially those with non-cancellable terms.
Under the new standard, lessees will need to show all the leases right in their statement of financial position instead of hiding them in the notes to the financial statements.
What is a lease under IFRS 16?
A contract is or contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration (IFRS16, par.9).
This definition of lease is much broader than under the old IAS 17 and you must assess all your contracts for potential lease elements.
You should carefully look at:
- Can the asset be identified? E.g. is it physically distinct?
- Can the customer decide about the asset’s use?
- Can the customer get the economic benefit from the use of that asset?
- Can the supplier substitute the asset during the period of use?
If the answer to these questions is YES, then it’s probable that your contract contains a lease.
As I wrote in my article about comparison of IFRS 16 and IAS 17, the impact of this new broader definition can be quite big, because some service contracts (with payments recognized directly in profit or loss) can now be considered as lease contracts (with necessity to recognize right-of-use asset and lease liability).
Under IFRS 16, you need to separate lease and non-lease components in the contract.
For example, if you rent a warehouse and rental payments include the fees for cleaning services, then you should separate these payments between the lease payments and service payments and account for these elements separately.
However, lessee can optionally choose not to separate these elements, but account for the whole contract as a lease (this applies for the whole class of assets).
Accounting for leases by lessees
Warning: Lessees do NOT classify the leases as finance or operating anymore!
No classification!
Instead, lessees account for all the leases in the same way.
Initial recognition
At lease commencement, a lessee accounts for two elements:
- Right-of-use assetInitially, a right-of-use asset is measured in the amount of the lease liability and initial direct costs.Then it is adjusted by the lease payments made before or on commencement date, lease incentives received, and any estimate of dismantling and restoration costs (remember IAS 37).
- Lease liabilityThe lease liability is in fact all payments not paid at the commencement date discounted to present value using the interest rate implicit in the lease (or incremental borrowing rate if the previous one cannot be set).These payments may include fixed payments, variable payments, payments under residual value guarantees, purchase price if purchase option will be exercised, etc.
Let me outline the journal entries for you:
- Lessee takes an asset under the lease:
-
Debit Right-of-use asset
-
Credit Lease liability (in the amount of the lease liability)
-
- Lessee pays the legal fees for negotiating the contract:
-
Debit Right-of-use asset
-
Credit Suppliers (Bank account, Cash, whatever is applicable)
-
- The estimated cost of removal, discounted to present value (lessee will need to remove an asset and restore the site after the end of the lease term):
-
Debit Right-of-use asset
-
Credit Provision for asset removal (under IAS 37)
-
Subsequent measurement
After commencement date, lessee needs to take care about both elements recognized initially:
- Right-of-use asset
Normally, a lessee needs to measure the right-of-use asset using a cost model under IAS 16 Property, Plant and Equipment.It basically means to depreciate the asset over the lease term:-
Debit Profit or loss – Depreciation charge
-
Credit Accumulated depreciation of right-of-use asset
However, the lessee can apply also IAS 40 Investment Property (if the right-of –use asset is an investment property and fair value model is applied), or using revaluation model under IAS 16 (if right-of-use asset relates to the class of PPE accounted for by revaluation model).
-
- Lease liability
A lessee needs to recognize an interest on the lease liability:-
Debit Profit or loss – Interest expense
-
Credit Lease liability
Also, the lease payments are recognized as a reduction of the lease liability:
-
Debit Lease liability
-
Credit Bank account (cash)
If there is a change in the lease term, lease payments, discount rate or anything else, then the lease liability must be re-measured to reflect all the changes.
-
Is this too complicated? Exemptions exist!
If you got this far in reading this article, maybe you find it overcomplicated, especially for “small” operating leases.
Here’s the good news:
You do NOT need to account for all leases like described above.
IFRS 16 permits two exemptions (IFRS 16, par. 5 and following):
- Leases with the lease term of 12 months or less with no purchase option (applied to the whole class of assets)
- Leases where underlying asset has a low value when new (applied on one-by-one basis)
So, if you enter into the contract for the lease of PC, or you rent a car for 4 months, then you don’t need to bother with accounting for the right-of-use asset and the lease liability.
You can simply account for all payments made directly in profit or loss on a straight-line (or other systematic) basis.
Accounting for leases by lessors
Nothing much changed in accounting for leases by lessors, so I guess you already are familiar with what follows.
Classification of leases
Unlike lessees, lessors need to classify the lease first, before they start accounting.
There are 2 types of leases defined in IFRS 16:
- A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset.
- An operating lease is a lease other than a finance lease.
IFRS 16 (IFRS 16, par. 63) outlines examples of situations that would normally lead to a lease being classified as a finance lease (and they are almost carbon copy from older IAS 17):
- The lease transfers ownership of the asset to the lessee by the end of the lease term.
- The lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date of the option exercisability. It is reasonably certain, at the inception of the lease, that the option will be exercised.
- The lease term is for the major part of the economic life of the asset even if the title is not transferred.
- At the inception of the lease the present value of the lease payments amounts to at least substantially all of the fair value of the leased asset.
- The leased assets are of such a specialized nature that only the lessee can use them without major modifications.
Accounting for finance lease by lessors
Initial Recognition
At the commencement of the lease term, lessor should recognize lease receivable in his statement of financial position. The amount of the receivable should be equal to the net investment in the lease.
Net investment in the lease equals to the payments not paid at the commencement date discounted to present value (exactly the same as described in lessee’s accounting) plus the initial direct costs.
The journal entry is as follows:
-
Debit Lease receivable
-
Credit PPE (underlying asset)
Subsequent Measurement
The lessor should recognize:
- A finance income on the lease receivable:
-
Debit Lease receivable
-
Credit Profit or loss – Finance income
-
- A reduction of the lease receivable by the cash received:
-
Debit Bank account (Cash)
-
Credit Lease receivable
-
Finance income shall be recognized based on a pattern reflecting constant periodic rate of return on the lessor’s net investment in the lease.
IFRS 16 then also specifies accounting for manufacturer or dealer lessors.
Accounting for operating lease by lessors
Lessor keeps recognizing the leased asset in his statement of financial position.
Lease income from operating leases shall be recognized as an income on a straight-line basis over the lease term, unless another systematic basis is more appropriate.
Here you can see that the accounting for operating leases is asymmetrical: both lessees and lessors recognize an asset in their financial statements (it’s a bit controversial and there were huge debates around).
Sale and Leaseback transactions
A sale and leaseback transaction involves the sale of an asset and the leasing the same asset back.
In this situation, a seller becomes a lessee and a buyer becomes a lessor. This is illustrated in the following scheme:
Accounting treatment of sale and leaseback transactions depends on the whether the transfer of an asset is a sale under IFRS 15 Revenue from contracts with customers.
- If a transfer is a sale:
- The seller (lessee) accounts for the right-of-use asset at the proportion of the previous carrying amount related to the right-of-use retained. Gain or loss is recognized only to the extend related to the rights transferred. (IFRS 16, par.100)
- The buyer (lessor) accounts for a purchase of an asset under applicable standards and for the lease under IFRS 16.
- If a transfer is NOT a sale:
- The seller (lessee) keeps recognizing transferred asset and accounts for the cash received as for a financial liability under IFRS 9 Financial Instruments.
- The buyer recognizes a financial asset under IFRS 9 amounting to the cash paid.
The final word
IFRS 16 prescribes a number of disclosures in the notes to the financial statements.
I’d also like to point out that you have to apply IFRS 16 for the periods starting on or after 1 January 2019 (careful about the comparatives).
You can apply IFRS 16 earlier than that, but only if you apply IFRS 15 Revenue from Contracts with Customers, too (the reason is that these 2 standards are closely related).
Please check out IFRS 16 Leases in the following video:
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157 Comments
Leave a Reply
Thank you for all
Dear all
I need assistance with regards to Leaseshold improvements, do we capitalize leasehold improvements under IFRS16
Yes, you can, but not under IFRS 16 🙂 They are a separate asset under IAS 16. Just be careful about their useful life (if they are attached to the leased asset, then the useful life should not exceed the lease term).
Can you please provide a reference or is there any provision in IFRS 16 regarding this issue?
what are the reason that leasehold property is not classified Under IFRS 16,
Here lease rent is also paid, lower Purchase option also provided to convert freehold property
have also right to use , right to provide direction .
Ok if this cover under IAS 16 then it is amortized over the lease period because lessee have right only ( as intangible ) , but in our book we have shown as PPE not a Intangible assets —Why
Hi I wanted to know how to adopt IFRS 16 by following retrospective modified approach for the following items”-
1) Lease equalisation reserve
2) Advance rent paid
3) Prepaid expenses
4) Rent already paid
thanks for the insight
Thank you soo much
Thank you for all
Hi, Thank you for all the updates…!
Thank you soo much.
Thanks for sharing the article!
Thanks for sharing the video. You have made the complex IFRS 16 look easy !The moot question of double accounting of asset by both lessor and lessee remains.
Yes, Atul, you are right. It might seem a bit odd that currently, an asset is shown in both lessors’ and lessees’ accounts. S.
In fact it is not the same asset that lessor and lessee show in case of operating lease. Lessor presents PPE while Lessee has to account for his “Right to use that PPE” and that too only to the extent of what he has to pay for a rented period (not the fair value of the asset (or the carrying value of the asset in Lessor’s books) on the date of the lease). So, technically they are different.
Kamran, I never ever said that these 2 assets are the same. All I said is that yes, both lessor and lessee have an asset in their books.
Thanks
I have questions related to (IAS 17) old standard.
Our company is doing the convergence to IFRS, as required by regulator from 1-1-2017.We didn’t apply IFRS 15 and therefore for lease we will adopt the old standard. We signed agreement with government (50) years to rent a land @ annual rent of $(803.000). The purpose of the agreement is to build & operate a hotel, which will cost our company about $(87) million
The questions are:
1- Do we need to classify the cost of the hotel as PPE or lease?
2- What about the annual rent of the land is it operating lease or finance lease?
I’m confused as our CFO claiming to capitalized the land rent which paid during the construction period to hotel cost, after the hotels open then the rent of land is to be treat as operating lease.
Your feedback will be highly appreciated
Hi Ahmed,
1. The cost of the hotel will definitely be the PPE (it is not subject of the lease, but you construct it).
2. The rent of the land is an operating lease, because the land has an indifinite useful life. Now, whether the rent during the construction period can be capitalized or not, it’s a huge question and I tried to clarify it here. S.
Thanks a lot for the valuable inputs, really appreciated
Hi Silvia
the rent of land for 50 years appear to satisfy the fight-of-use asset – land for a period for the lessee. why is it treated as operating lease? I note that your article about states that there is no classification of operating lease and finance lease for lessee.
Thank you for the insight. Keep the good work. GBU
Kindly upload some illustratives on sale and lease back transaction when the transaction is a sale as per IFRS 15. Thanks!
Thank you soo much .
this was really helpfull .
but i really dont understand why we should use straight line method in recognize revnues or expenses in case of operatin lease i think this will ignore the inflation impact and will show no gross in the company profit if the payments varies from year to another , and in same time iam as alessor cannot ask the lesee to pay more than what was agreed in the contract as payment term .
thanks
Hi Silvia
Company A invests in power plant to produce and supply electricity under a PPA (Power Purchase Agreement) to the national grid (govt owned organisation). Assume PPA agreement is for 10 years with possibility of extending for another 10 years. would you consider this as a lease scenario?
Thanks
Hans
Hans, under older IAS 17 yes, that would be a lease because the criterion was that the customer has the right to substantially all of the asset’s output.
Under new IFRS 16 you need to assess whether the customer has the right to direct how the identified asset (power plant) will be used. You must analyse the decision-making rights over the power plant – e.g. dispatch rights (who determines the optimal output of the plant?), curtailment rights, etc. – who has these rights? If it’s a customer (national grid), then well, you have a lease there. It’s not so straightforward and you need to analyze the contract carefully. S.
thanks Silvia. Customer has no decision making rights on the P Plant. However, in the event when output is below the PPA Kwh, Company has to compensate customer on the shortfall.
Hi Sylvia,
Good afternoon! (PH time)
I have a question. Is IFRS 16 applicable to contract of easement of right of way?
Thank you and God bless,
Rose
What about subleasing? How do we account for it?
If the sublessor will recognize in its books the right-to-use asset as a lessee, will it also recognize in its books a lease receivable as a lessor?
For the sublessee, will it recognize in its books the right-to-use asset as a lessee?
Hi, if the sublease is finance, then the intermediate lessor debits the net investment in the lease and credits right-of-use asset, the difference is recognized in profit or loss.
Hi Silvia,
How about if you are an intermediate lessor in a building where you lease office space and you sublet a portion of the space.
In this case, it is determined that the sub-lease is an operating lease.
Are you able to net the sublease income earned against the related lease expense (the depreciation)?
Furthermore – can you argue that the depreciation of the Right of Use Asset can be classified under G&A (and not with other depreciation?).
Under the current standards, I believe you are able to net the sublease income against the leasing expense.
Thank you in advance.
Ray
Following. I have the same question regarding subleasing the office.
Hello Silvia M,I request you to upload a page consisting of Manufacturer dealer lessor Journal entries format and treatment of IDC (Initial Direct Cost).
Thank you Silvia, I appreciate
thank you dear ma’am
dear ma’am, i have a question, in case of low value or less than 12 months, is exemptions applies only in operating lease, and for lessee. does it applies for lessor or for finance lease???
thanks
Thank u so much for your explanation on z new IFRS 16
Thanks madam Sylvia. Is IFRS effective starting on 1 January 2018 or 1 January 2019. Thanks
It’s written above in the article – 2019.
Hi does IFRS 16 apply to land taken on lease ?
If yes how do we depreciate the right of use asset since land is generally not depreciated.
Hi Dhaval, you are not depreciating the land, you are depreciating only the right to use the land over the lease term.
In this case the lease term is your asset’s useful life.
Hi Silvia, I have Question Please ( If I have rent contract for 5 Years Contains Base rent of 10,000,000 Per Year and 200,000 As service Charges Yearly 5% annual increment As per IAS 17 Total Base rent of the five years Amortized equally on monthly basis. shall we do the same for Service charges ?
Dear Silvia :
Are the amounts paid at the beginning of the lease as costs added to the rent payments, such as:
Amounts paid for the first time against the rental of a building
Commissions
Thank you
Hi Silvia, thank you for your article.
Will you please answer the question about lessor accounting – finance lease.
IFRS 16, 70: “…the lease payments included in the measurement of the net investment in the lease comprise the payments …that are not received at the commencement date”. What if lessee pays some amount before the commencement date (after the inception date)?
I think it should be accounted for as follows:
a) Debit Lease receivable Credit PPE
b) Debit Cash Credit Deferred income
and it will be recognised in income evenly throuthout the lease term.
Am I right?
Hi, Thanks for the valuable information. I need to ask about the journal entries in the book of Lessee . Suppose i have take a building on rent for the period of 10 years. I am lessee and building is identified asset and i have right to use. i am paying 100000 per month. Now what is journal entry for this payment. Whether i have to show the building in my books as right to use asset and Lease liability and depreciate the amount of lease liability over the Lease period. Please clearify the journal entries in the book of Lessee
Hi Meen, I think you should check out this article – it comes with example.
And also please clearify how to seperate Lease from service contract?
Hi Sylwia,
Thank for your articles.
Can you please share your approach in term of Abstract:
I have more details in the Abstract:
Current Monthly Rent include:
Base Rent
Operating Expenses
Parking
VAT Base Rent
VAT Operating Expenses
VAT Parking
What is the Right-of-use asset ?
How it should be settled?
thank you in advance,
Krystyna
Krystyna, if you can claim VAT back, then don’t include it to ROU. If you opt not to separate as a lessee, then you can include everything else.
Hi Sylvia,
First of all, thank you for your amazing contribution to the understanding of IFRS. The article is great, but I would like to point out that when the answer is “yes” to the following question, then you probably DO not have a lease contract:
“Can the supplier substitute the asset during the period of use?
If the answer to these questions is YES, then it’s probable that your contract contains a lease.”
Thank you for the insight. Keep the good work.
Hi Silvia, if we purchased a software, naturally we can apply IAS 38. But if there are any licensing fees to use that software, can we treat the licensing fee under IFRS 16?
Hi.. Assuming that the underlying asset is an investment property (land) in the lessee’s books, what happens to the right of use asset at the end of the lease term in the lessee’s books under an operating lease?
The right of use asset has been measured at FV at the end of each year and the relevant FV adjustments have also been made,
Please recommend the relevant accounting entry as well.
Hello,Silvia! Thanks for this article! Have a question about exemption:
1. Leases with the lease term of 12 months or less with no purchase option – What about lease contracts with the lease term of less than 12 months BUT with the right for prolongation or if contract has wording as following,for example: “the term is min 8 months/ max 13 months” or min till February 11,2019 (and this is the term of 10 months) and max till May 11,2019 “. How these leases should be recognised by lessee?
Hi Olga, as for the lease term, please look here. It solves very similar cases and I have nothing to add 🙂
Hi Silvia,
Thanks for your article.
With respect to applying the short term 12 month exemption:
If we have a building lease terminating on 30.06.2019 however exit terms (for ex an exit fee etc) have all been agreed formally and in writing by 31.12.2018, then would we still be able to apply the short term exemption and continue accounting for the lease as a normal operating lease until termination?
Thanks
Steven
How does the accounting entry goes for sale and lease back on the sellers side innboth the condition?
I have a question on subcontractors e.g XYZ has over 3,000 small captive (regular) subcontractors providing their owned vehicles to the company for freight services under the following terms:
• XYZ controls and direct the use of the vehicle to customer location.
• The small contractor has only one to two trucks and works predominantly for XYZ.
• A yearly renewable contract, but majority serviced XYZ for over 3 years and some does not have a signed contract.
• Compulsory attendance at health and safety training held by XYZ sales and delivery procedures training.
• Wear XYZ uniforms and interact with the customers and customer sign acceptance of delivery on XYZ equipment
• On XYZ payment system ( e.g records number of deliveries to calculate monthly subcontractor payment)
• Subcontractor takes the vehicle home daily after working hours
• Any refund for loss of customer parcels are paid by XYZ and amount deducted from subcontractor payments, if the latter is found at fault.
Appreciate your view on whether we should account for 3,000 under Portfolio lease with following:
• Lease term 3 years
• Discount rate is the XYZ’s incremental borrowing rate
• Lease payment is estimated by reference to market vehicle rental rate ( monthly rate)
Or whether we keep those as sub-contractors expense.
Many thanks
Rama
Hi Sylvia,
We have some leases 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 would you determine the lease period which will be used for the calculation of the RoU and Lease liability?
Many thanks and regards,
Stefanos
Hi Stefanos, I think this can help. S.
Hi Sylvia ! thank you for your insightful articles, really finding it easy to follow and understand.
I have a question on IFRS 16 please – what happens on consolidation? what would be the accounting entry to reverse the right of use of the asset, liability and the income statement charge ( interest + depreciation) please? Do you have any examples you could share with us please?
Hi Daniela, are you asking on consolidation when the lease is intragroup? Well, you need to reverse all entries as if they had never happened, since the inception of the lease. Everything booked to profit/loss in previous years is reversed via equity (retained earnings). S.
I want to get a detailed notes of IFRS and IAS. How can i contact you for this
Hi Silvia! I have two questions.
1. Does this mean that we will create a new account, i.e., Right-of-use account (ROU), in our chart of accounts? Or the ROU was used for discussion purposes only.
2. We are renting an office space in a condominium hotel. Lease term is 5 years subject to annual escalation clause. Is this covered by IFRS 16?
Thank you.
Dante
Hi Dante,
1. Yes, you may.
2. Yes, it is. S.
Thank you so much for your quick reply, Silvia.
Hi, What happens when lease incentive is higher than the ROU asset and ROU asset is negative?
There could be many scenarios such as either party terminated early or a mutual agreement to provide higher lease incentive.
Using common sense, this should not be allowed otherwise companies can actually make profits when leasing but i came across situation when it is the case. Appreciate your thoughts and thank you in advance.
Hi Silvia
What if the lease agreement, other than rent, also included the fixed charge of monthly building management fee with effect from the commencement of the lease but subject to adjustment during the lease period.
Thanks!
Hi Silvia
I need some additional clarification in terms of the below point from IFRS 16, B35
IFRS 16, B35: “If only a lessor has the right to terminate a lease, the non-cancellable period of the lease includes the period covered by the option to terminate the lease.
Question: Practicable description of “the covered period” is not clear. Could you, please, bring an example in terms of Telecommunication, rent for rent of land of stations.
Hi Silvia, thanks for this. I may be misunderstanding but does this mean instead of recognising a rental expense (for a lease on a building) the P&L charge is only shown through depreciation and interest therefore improving our EBITDA position?
Yes, something like that 🙂
Hi, Silvia, What will be the treatment of previously recognized finance lease when my year end is at 31 march 2019? should i account for from 2019 or should i wait to end the year 2019?
Well, I don’t quite understand the issue here. When your year-end is 31 March 2019, then you are making a transition to IFRS 16 from 1 April 2019… S.
Hi Silvia, previously, a Company, which used to obtain vehicles on say vehicle lease finance for a period of 5 years and the asset used to be jointly registered until the lease was padi. In such cases the asset was debited in the books of lessee and the vehicle lease finance was shown as lease liability. Under IFRSs 16, will the vehicle in PPE schedule be replaced by RIght of use asset?? Or is it ok to show as vehicles as was shown by lessee when IAS 17 was in place
IFRS 16 C.17 mention:
If a lessee elects to apply this Standard in accordance with paragraph C5 (b), for leases that were classified as finance leases applying IAS 17, the carrying amount of the right-of-use asset and the lease liability at the date of initial application shall be the carrying amount of the lease asset and lease liability immediately before that date measured applying IAS 17. For those leases, a lessee shall account for the right-of-use asset and the lease liability applying this Standard from the date of initial application.
Hi Silvia,
Thanks for your wonderful articles. I always find them extremely helpful for understanding the concept.
Here, I have one question related to Accounting for finance lease by lessors. As per the articles lease receivable should be equal to the net investment in the lease that is equals to the payments not paid at the commencement date discounted to the present value plus direct costs. Shouldn’t we take the fair value of leased assets at the commencement date plus direct costs?
Hello, Pramod, thank you! The answer is no. S.
Hi silvia,
i have a query regarding sale and lease back transactions. i have provided here an example please help me out:
Sale value at the date of sale: USD 25m
FV at the date of sale USD 23m
Gain on sale: USD 5 m
sale qualifies ifrs 15
present value of new lease liability USD 15m.
what would be the accounting treatment for this?
Really helpful, thanks. One question:
Initial recognition journal 3 is Debit Right-of-use asset, Credit Provision for asset removal for the discounted value of cost of removal. Say that estimated cost is £100k and the discounted value at start is £70k – what are the entries to increase that provision up to £100k by the time it needs to be settled? Where does the additional £30k get debited, and when?
Hi Silvia,
I hope this massage find you well
I have enquiries regarding the IFRS 16, Our company signed land lease agreement with government for (50) years extendable but without buying option the annual rent is $(1.3 million).
The questions are:
1- Does the IFRS 16 apply on land lease? if Yes
2- Considering there are no land depreciation as per IFRS, how we will account for it under the IFRS16?
Your feedback will be highly appreciated
Regards,
Dear Silvia,
Great as usual, thanks.
I have one question. Assume Company XYZ rent a building for it’s office. The contract agreement is for 6 months. XYZ have been using this building for the past 3 years and was renewing the contract every 6 month. Is this lease exempted from IFRS 16 for < 12 months criteria? I'm thinking "Substance over form".
If it is exempted, don't you think IFRS 16 is prone to manipulation of "off balance sheet financing"?
Thanks
Finally I was able to read this article. Great and clear explanation. Thank you so much Silvia for all your efforts. Your materials/articles are very impressive. At least I got some idea/knowledge about this new standard on lease.
Hi Silvia,
Thank you very much.
Thank you so much for the detail explanation. Please explain the treatment with the revaluation and double entries related to revaluation of ROU (Operating lease).
Hi Rizny, thank you – it is all explained in the IFRS Kit – this is too elaborate to explain it in the comment.
Hi Silvia,
I just completed the IFRS 16 Course of the IFRS Kit. And I have some follow-up questions:
Incremental Borrowing Rate:
How often should we recalculate the IBR(lessee’s incremental borrowing rate) of a lease?
Should it be recalculated monthly, quarterly, yearly, or should we use the same IBR over the full lifetime of the lease?
If we implemented IFRS 16 on 01.01.2019 should we recalculate the IBR on 31.12.2019?
Sublease:
How should the ‘Finance Lease Receivable’ from a sublease be presented in the ‘Statement of Financial Position’? Under ‘Right-of-use Asset’ or ‘Other receivables’?
And should it be split between long-term and short-term?
Hi Alexander,
IBR – if there’s no change in a lease contract, then you keep it as it is.
Finance Lease Receivable in the lessor’s statement is not the same as right-of-use asset. Yes, split to current and non-current portion.
Hi Silvia, if a company as a lesse lease a car, and the least contract specifies that the lessee will pay salary for the driver on a periodical basis, which is provided by lessor; does the RoU should include the driver expense? Or it should not? Thank Youu
I don’t think so since the salary is paid rather for the driver’s service than for the right-of-use asset. This would be a service component of a contract and here you have 2 options as a lessee: either account for it separately, or account for the whole contract as for the lease.
Hi Silvia,
We have leased agreement for office and warehouse since past few year and we will use in future as well , but the lease agreement is renewed every year (12 month) with not right to purchase , In this case will IFRS16 applicable ? if yes then there is no definite future period mentioned in the agreement .
Please advice.
Hi Silvia.
Company A has a lease that increases 1st January each year based on a price index.
Should the Company remeasure the lease liability:
(A) on 31.12 the previous year, or
(B) on 1st January, the day the lease payments increased?
Should the 2019 Annual Report of the Company include the updated price change that happend on 01.01.2020?
Thank you for such an effective presentation on summary of IFRS 16, which make it so easier to understand. Well done.
Hi Silvia,
Please guide on accounting treatment and disclosure for the property taken on lease for 30 years and lease payment made in one go on lease commencement.
Hi Palak,
well, you don’t have any lease liability here, only right-of-use asset and you will depreciate it over 30 years. S.
Hi Silvia, thank you for your very helpful detailed and as always insightful explanations.
I have a query regarding how we would adjust for rent accruals and prepayments existing at ye 31 dec 2018 under modified retrospective approach whereby we set the lease liability = right of use asset. I am getting confused would the journal entries on 1 jan 2019 be as simple as
Dr accrual
Cr right of use asset
Dr right of use asset
Cr prepayment
Hello.
Could you please share your opinon on the acounting treatment of refundable purchase taxes (e.g. VAT) at initial measurement of right of use asset-ROA. I think that there is a small “consistency hole” in IFRS 16.
The “story blocks” are …
1. basic concept in accounting leases from lessee’s perspective is … ROA = Lease liability
2. the primary element of ROA is the amount of the initial measurement of the lease liability
3. as lease liability is present value of the lease payments that are not paid at the lease commencement date we get from 1. and 2. … ROA (= initial measurement of the lease liability) = Lease liability (=initial measurement of the lease liability) i
But! (the point):
> if lease payments include purchase taxes which the lesee can not refund it is “logical” that non refundable taxes are a cost part of ROA;
> if lease payments include purchase taxes which the lesee can! refund, then it is not “logical” that these refundable taxes should be a cost part of ROA – reminder: the IFRS 16 rule is “ROA (= initial measurement of the lease liability) = Lease liability (=initial measurement of the lease liability)«.
Althought under IAS 16 (art. 16) non refundable purchase taxes are a part of cost of PPE, IAS 16 does not apply to initial measurment of leases as leases have to accounted for in accordance with IFRS 16 (IFRS 16 is “special law”), The problem with IFRS 16 is that it does not contain provisions about the impact/treatment of refundable purchase taxes on the initial measurement of ROA.
As it is not logical that two leased assets – one with refundable purchase taxes, one with non refundable pruchase taxes – that have the same lease payment schedule should have the same ROA-cost amount I think (my opinion) that IFRS 16 art. 24 a) should (must) be interpreted in the following way:
»The cost of the right-of-use asset shall comprise:
(a) the amount of the initial measurement of the lease liability, as described in paragraph 26 LESS REFUNDABLE PURCHASE TAXES;«
Thank you,
Matt
It’s simple, include the non refundable purchase taxes and exclude the refundable purchase taxes when computing the cost of right of use asset. IAS 16 makes it clear. Thanks
Hi, I have a question.
X Company has a Business site under a finance lease. However Y Company entered in a contract with X for sharing their site. Contract term shows that they can end the contract anytime on 30 days’ notice period. What will be treatment in books of Y Company? Is this a finance or operating lease for Y Company?
Hi Silvia,
Thank you for such a detailed explanation.
Regarding initial direct costs (IDC) for the lessee, should legal costs realted to a lease agreement be considered an IDC? or are there instances where legal costs incurred may be expensed rather than capitalized.
They should be capitalised as long as directly attributable rob the lease and are incured by the lessee. Thanks
Hi, I have a question.
What if the contracts doesn’t state any useful life/term and the contract is renewable and cancellable.
Thank you
Hi Silvia,
i need your support to make journal entry for lessee (leaseback)
Asset: Land with book value 700,000
market value 1,000,000
interest rate 20% with zero DP 5 years monthly installments
thanks in advance and waiting for your cooperation
Amr
Hello Sylivie. Thanks for this awesome article about IFRS 16. My question is what could be the conditions for an asset to qualify to be a low value asset. Thanks
Hi Kaplan,
well, IFRS do not define what “low-value when new” asset is, but IFRS 16 gives the examples, such as small furniture, computers, etc.
Hi Silvia – Great Article. Question on Restoration costs. How and when do they get added to the ROU Asset. Example at lease commencement I did work on the asset and knew I would incur 10K to undo or reinstate the asset to original condition at the end of the lease say 5 years. Do I include that at the end of year 5 with my last year payment and then discount that to get the liability which will form the basis for the ROU starting asset or does it get added to the ROU asset in another manner.
Thank you
Hi Paul, well, your own costs can be capitalized as a separate asset under IAS 16 PPE (“leasehold improvements”). They do not affect lease liability (unless there is such a term in the lease contract).S.
thank you Silvia. If the contract states i have to resinstate the asset to its original condition do i book that liability (the cost to reinstate the asset to original condition) as and IFRS 16 liability or do i provide for that separately under IAS 37?
Hi Silvia,
How do we adjust straight lining figure that was held in the trial balance earlier
Hi,
Under the limited retrospective approach to applying IFRS 16 by lessees, does a lessee need to to determine a new discount rate on the date of initial application (Jan 1st, 2019) to subsequently remeasure the lease liability carried forward from 2018 for a lease previously accounted for a finance lease?
Hi Silvia,
Thank you for your clarifications about IFRS 16. I have a question about restoration cost. If a restoration cost is incurred in the middle of the contract period say for example a cost incurred after 2 years of the commencement date for a 5 year lease contract should I adjust the ROUA on the month the cost is incurred?
Thank You
Hi Hanna, you should have provided for restoration cost at the contract commencement (I mean the cost for restoring the site). So, the acquisition cost of your ROU asset should have included the provision for the restoration cost. Once the cost is incurred, then it is recognized as Debit Provision/Credit Cash (bank, suppliers…). If you haven’t done that at the contract commencement, then this is the error and you need to correct it in line with IAS 8 (depending on its materiality – if immaterial, then yes, adjust ROU asset, if material – restate).
Thank You Silvia
what about the cost is for innovation (eg. building partitions) in the rented office for a better use?
Those are the leasehold improvements and are NOT a part of ROU asset. You can capitalize them as a separate item of PPE and depreciate over their useful life (which is max. rental period).
Hi. On first applying the IFRS 16 to create ROU & finance lease liability we were not made aware of an addendum to the lease period. That is we computed the lease over 60 years but it should have been over 70 years. This year we made the new calculation to reflect the 70 years but we do not know how to show these adjustment on the statement of income. For example the amortisation has decreased since in previous calculation we over amortise. Where should we show this on the statement of income? Should it be reflected in the normal line for amortisation or is there some other way to show it?
Hi Juliette, was the amendment in place on the first application and you forgot to include it? If this is the case, you made an error and you should correct it retrospectively as written in this article. If the error is not material, then you don’t have to touch equity, but all entries that would be correcting equity can be done in profit or loss.
Thanks. This was very helpful
Hai. here is a query.please do respond
if there is a lease period of 50years but from this year on remaing period is 45years. how to calculate PV ,depreciation and interest? on basis of 50 or 45 years? and how to adjust the 5 yr diff?
Hi, I understood you are adopting IFRS 16 for the first time, so in this case please check out this article describing different options that you have, with examples. S.
Hi Silvia, for accounting sublease as a lessor finance lease under FRS 116, i would have derecognised the ROU against the net investment of the lease. Please advise how is the head lease rental expenses is recorded subsequently. It can’t be depreciation since the ROU is no longer there. stating as rental expense also looks weird.
Hi Silvia, we have a rental lease from a landlord for his wharehouse, it is a 4 year lease but paid monthly. Do we still need to do ROU of asset and lease libility ? The lease started in January 2018, will we need to restate 2018 financials ?
Hi, please assist
Company X Rents a handset to a customer on a contract basis with an option to renew the lease or purchase the assets at a cost of 3 months installments. What will the Journal entries be for the initial recognition on Company X books?
Hi Silvia,
Should I translate lease liability ( recognized based on IFRS16) into the functional currency at every reporting date using the closing rate? I`m not sure since it seems to be non-monetary (let`s say virtual) item.
Your assistance will be much appreciated.
Thank you in advance for your prompt answer.
Hello, yes, it is a monetary item. After all, you need to give out some cash in order to derecognize that liability (although yes, I see your point).
Hi Silvia
I have a question about a lease agreement signed by a holding company with landlord of office premises. From the agreement, the landlord allows the office premises can be used by the holding company and its three subsidiaries but each subsidiary has to sign a deed of indemnity to the landlord individually, i.e. if the holding company default in lease payment, each subsidiary will be liable to any loss to the landlord. May I know how to treat the right-of-use asset and lease liability under IFRS 16? Can the ROU be split between all four companies? Does all four companies have obligation on lease liability?
Thank you So Much , Great Work
Hello Silvia
It is always great to follow you, and thanks for the best class we are getting .
Adding to the same, I have a doubt regarding the current scenario that I am facing. I working in UAE and we are having warehouses on lease. As per the signed contract the term of the lease is only one year and we can renew for the upcoming years. Each year we need to renew the contracts. Does it come under purview of ifrs 16. Or can we treat the same as rental as usual
Your expertise in this matter is highly appreciated
Hello Silvia, assuming i have leashold land for 49 years at $2m. After 5 years, its revalued to $3M. What journal entries should be passed in the accounts?
Hello Silvia, Thanks very much for the valuable insights into the standards, If we have some rights to use the parent company’s assets – we are an advertising company we place digital signage and posters in the assets of the parent company (playground and spaces) and we are generating revenue. But we don’t pay anything to our parent company. please advice, the impact of IFRS-16 on us
Thanks in advance.
Very good presentation , Great work.
Hi Silvia, thanks so much for your article. Quite insightful. I do however want to ask, if the lease period is, say 5 years but the lease makes a prepayment. He debits the “right of use assets”, right but what will be the corresponding credit entry since he has no lease liability.
Hi Silvia
Thank you for your clarifications. Please assist me in the following case.
A 5 years lease contract has a term to pay 3 years rent in advance and the rest amount (2 years rent) at the end of the first three years. At the beginning of the contract the lease liability is the discounted amount of the unpaid 2 years rent amount.
But at the end of the first three years the actual payment is only one year rent amount and the lease liability extends up to the beginning of the fifth year to be settled by the last payment.
Should I re discount the lease liability and adjust the ROUA and lease liability at the end of the first three years in my books?
If so doesn’t it affect previous fiscal periods?
Thank You
Could you kindly elaborate more on sale and leaseback maybe with the use of an example.
How do I:
– account for the disposal or write-off of the asset and de-recognition of the leasee’s lease laibility.
– What are my journal entries?
– The lease did not run to the end of the period.
Hi Sylvia,
I hope you are well. What if we just started a tenancy agreement with our landlord for 12 months but they gave us 1 month free, so in total, 13 months for the price of 12 months. Will it still be included under IFRS 16? If yes, how will be the accounting entries? Because we are paying in two payments. first payment from the commencement (50%) and remaining (50 %) in the middle of our contract. I can’t seem to understand the interest expense as this agreement does not include any interest rates. Thank you so much for your help.
Thank you Silvia, this was great article to get the first touch to the standard.
We have faced couple of things about IFRS 16 about which our auditors don’t agree. So we have a big factory building leases with two kind of lease terms:
1) open end contracts, which we are going to renew every year. I understand that in these cases, the management of our company should evaluate those and give best possible prediction on how long they are going to rent this building. But how often should we revaluate the asset and liability values? If we evaluate that we will stay there for 3 years, do we depreciate it fully or do we revaluate it every year back to 3 years?
2) This is slightly different scenario, but about the same topic. We have 5 year lease, with 5 year extension option. What kind of process we should have, when we decide when to calculate the extension in our numbers? So if we use first 5 year lease term, and then in year 3 we are sure enough to add extension. Is there any rule or suggestion on how to handle these evaluations of the lease terms? In the bigger picture, if we have quite stable big rents, should their BSvalues go down near to 0 through depreciation, and then suddenly they go back to full value when the new contract starts?
Hi Eric, well, I am aware of the fact that there is too many estimates and forecasts to use when applying IFRS, and leases is one area of them. What can I say? The standards do not really tell you how you should evaluate or assess, because each situation is specific, but in your assessment, you need to be in line with IFRS 16. And I know, it is judgemental. See, if this is really burning question, you can sign up for my Helpline service and our consultants can give you the clear advice based on assessing your situation.
Hi, may I clarify if the financial report covers 18 months period from July 2018 to December 2019, can we don’t take rental payment under IFRS 16, I know that this standard is effective beginning on or January 2019, Early adopt is allowed, can we treat this rental expense throughout this 18 months since our financial report started from 1 Jul 2018? Because our auditor insists want to pass the ROU at beginning of 2019.
Hi Dennis, according to IAS 1, you should present your financial statements at least annually. Hence I doubt that your financial report for 18 months is fully in line with IFRS – just as a technical note. So I am not able to express my opinion on this. Also, the standard IFRS 16 is mandatory for all periods starting on or after 1 January 2019. Thus, if your ANNUAL period started on 1 July 2018, you do not have to apply IFRS 16. If you are still presenting 18 months… well… if I omit the fact that you do not comply with IAS 1 regarding the frequency of reporting… presenting 6 months under IAS 17 and remaining 12 months under IFRS 16 is simply not acceptable under IAS 8 and IAS 1 (remember, consistent accounting policies throughout the period). As a result, I would apply IFRS 16 right on 1 July 2018.
Thank you Silvia, nicely explained.
I have 1 query. Suppose vendor has deferred the lease payments by more than 1 year then the same will be considered as a lease modification? (assuming Company doesnt want to exercise the recent amendment of IFRS 16 relating to COVID 19
Yes.
Hi, May I clarify something. If you sublet a building for the remainder of the lease (to be classified as a finance lease), how do you treat fixtures & fittings that you hold as an asset on your balance sheet? Do they stay on the balance sheet and depreciate or are they impaired? Thanks
Dear Silvia Mam
Can you please explain me on IFRS 16 as we are going to take equipments on rent from our mother company which worth about USD 1 million and we have to pay monthly rent USD 15000/- upto 8 years. Please tell me how this IFRS 16 effect us and what journal entries we have to pass??
Dear Silva,
You are doing a great work here, keep it up. A question for you.
For finance lease, will the lessor still recognise depreciation expense on the PPE?
Thank you! No, because under the finance lease, the lessor does not have an item of PPE, but the net investment in the lease (receivable).
Many thanks
Hello Silva,
Very helpful information.
I have a question. The low value assets exemption you mentioned at the beginning of the video, is it applicable to the lessee, lessor or both of them?
Lessee. It is irrelevant for the lessor as the lessor has a different accounting model.
Thank you Silvia
Please i need some clarity,
What is the accounting treatment to give to a vehicle that is on lease but was given out as gift 10 months into the 48months leases period. Lease payments due on vehicle is still been paid by lessee even after gifting car out.
Hi Silva, thank you for your articles on IFRS 16, very useful. Looking for some information about subleases and was hoping you might do something on this. Looking to see how you would account for a sublease of 7 years if head lease is for 10 years. Would like to sublease for the 10 remaining years but unable to, so there is 3 years remaining. During 7 year sublease (finance lease) do you fully derecognise ROU asset or part of it? Thanks
Hi Silva,
We fully run the service for another company and this includes the use of our fleet. We ultimately charge one fixed price for the entire service. Do they need to record the use of our fleet at all on their balance sheet?
Hi Silvia
Thanks for your article
would like to clarify with you a simple things
Assets obtained through customer finance facility (loan) which are paid in monthly installment later (Entity direct own the title of the asset, but at the same time pledge it for finance facility), whether under this arrangement can be considered as finance lease assets (under previous IAS) which now (reclassed) are ROU under IFRS 16 lease?
Hi Budi, I can’t really say from this short description, but it seems it would be rather financing agreement (loan pledged with assets) under IFRS 9, and your assets would be shown rather as PPE, not ROU.
Hi Silvi
thanks a lot your sharing.
Can you please share information of accounting entries at lease modification level ? what entries would be in general when we extend the period of lease as if the lease yet classified as operating lease. either the accrued rent receivables entries would be write at lease modification or simply it would be adjust in subsequent payments ?
Thanks in Advance
Hi Silvia,
If the tenancy agreement doesn’t state the lease term, and either of of the party can terminate by giving 1 month notice. is IFRS 16 still enforceable?
Hello Mam, today i am buying one asset on my customer request, customer is going to reimburse me full cost of asset + 15%. after period of 36 months customer has right to buy this asset at $1 (negligible amount) what should be accounting treatment in my books ?
Can i calculate the impact to B/S and P/L and comment immaterial to apply FRS116 even thought we did not fulfilled the exemption requirement?
What it means by lease by lease basis?
Hi Silvia,
Can we capitalise depreciation charges on right to use asset (land) during the construction period of a permanent building on the same land?
Hi Silvia your articles and website is so helpful it has helped me through many questions I have come across on IFRS 16. Huge thank you for making things so easy to understand.
I have a question I wonder if you could please Advise on… in relation to the asset restoration costs that need to be added to ROU asset, presumably this is the NBV of the asset restoration costs at 1st jan 19 that is added to ROU asset and depreciated on Straight line basis? Presumably there would be no impact to the depreciation hitting the p&l on the asset restoration piece as it is not discounted the same way with present value of future lease payments ?
Do you just disclose it as reclassification under IFRS 16 on PPE note ?
Thanks
V