IFRS 16 Leases: key points
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Applicable from 1 January 2019, IFRS 16 Leases is particularly important to lessees, as it equalises the treatment of operating leases and finance leases, meaning that practically all leases will need to appear on the balance sheet. Like other IFRSs, this one will be mandatory for all Latvian entities that prepare their financial statements according to IFRS or whose parent requires their financial information prepared according to IFRS for group reporting purposes. This article explores what we see as key IFRS 16 requirements affecting the lessee.
What is a lease?
A lease exists where there is an identifiable asset and the buyer is entitled to substantially all economic benefits from using the asset during the period of its use. To facilitate accounting, the standard allows entities to not treat as a lease one that does not fit the definition or is for a short term (up to 12 months) or of low value (the leased item was worth up to USD 5,000 when new). The distinction between an operating and a finance lease no longer applies to lessees, and so their approach to accounting for all leases is the same.
A lease is recognised on the date the lease transaction begins. The lease period is measured by considering the non-cancellable period and the option to renew or cancel the lease as well as evaluating the likelihood and intention of taking the option.
The make-up of aspects to consider when measuring a lease liability
A lease liability is measured as the present value of all expected lease payments. It is a part of financial liabilities and is governed by all the requirements laid down for financial liabilities. Upon initial recognition, the lease liability comprises –
fixed lease payments;
any variable lease payments that are pegged to a rate or an index (such as inflation);
a purchase option if it is foreseeable;
penalties if they are foreseeable;
any other residual value guarantees the lessee has given the lessor.
The lease liability is measured as the present value of lease payments, discounted either at the interest rate specified by the lease agreement, or a similar borrowing rate if the agreement does not specify an interest rate.
After the initial recognition, interest charges are recognised for the lease liability at the effective interest rate. Any payments made for the lease reduce the lease liability and no longer appear directly in the income statement.
Accounting for right-of-use assets
The right-of-use asset is a non-current item on the balance sheet, similar to an intangible asset, a fixed asset or an investment property, and shows an amount that represents the lessee’s right to use the leased asset for some time.
The right-of-use asset consists of a lease liability, lease prepayments, restoration costs, and initial direct costs associated with entering into the lease agreement. Restoration costs (e.g. redecorating premises before moving in the future if the agreement provides for such costs) are accrued under liabilities on the balance sheet.
After the initial recognition, the right-of-use asset is depreciated and subject to impairment testing just like any other non-current asset owned by the entity.
Dealing with changes to the agreement or to assumptions made upon initial recognition
If changes are made to the lease agreement or to the initial assumptions underlying the lease liability or the right-of-use asset, a recalculation should be made to adjust the lease liability and the right-of-use asset accordingly.
Implementing the new standard
IFRS 16 should be initially implemented –
retrospectively, i.e. by completely changing all the comparables; or
aking the easy approach, i.e. reporting changes in shareholders’ equity on the date of initial application of IFRS 16.
It is important to note that the standard makes it mandatory to revise leases entered into before 2019.
The new lease standard is not complicated in terms of theory, yet it requires lessees to make significant preparations by revising and putting together all lease agreements, as well as measuring the lease liability and the right-of-use asset.
If you would like more information about the IFRS 16 requirements, you are welcome to attend a PwC seminar held on 4 December 2018 (apply here