IFRS 16 Leases to take effect from 1 January 2019

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17.11.2017

On 9 November 2017 the European Commission approved IFRS 16 Leases for use across the EU from 1 January 2019. However, all lessees should already start thinking about its implementation because the changes it brings are crucial and may significantly affect the lessee’s balance sheet. The lessor’s accounting treatment of operating and finance leases will stand with slight amendments to disclosure requirements. This article explores only the changes affecting lessees.
 
Key changes
 
Like the standards on revenue and financial instruments we wrote about earlier, this standard 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.
 
IFRS 16 should initially be implemented retrospectively, i.e. by either completely changing all the comparables or taking the easy approach and reporting changes in shareholders’ equity on the date of initial application of the standard. It is important to note that the standard makes it mandatory to revise leases entered into before 2019, only allowing not to reassess their compliance with the definition of lease and not to apply the standard to any leases expiring in 2019.
 
One novelty the standard brings is a complete change of the basic definition of a lease. For the purposes of IFRS 16, 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. The standard provides detailed explanations for each of these elements and their practical meaning.
 
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 standard includes considerations for assessing the lease period, which helps prevent manipulation of lease periods: the standard provides that a lease period should be determined by taking into account any expected lease extension or termination.
 
Another key novelty the standard brings is that any asset that fits the definition of lease is subject to a single scheme of recognition by removing operating and finance leases from the lessee’s books. The new model also provides for recording all types of leases on the balance sheet.
 
A lease transaction is initially recognised on the balance sheet as follows:
  • A lease liability is first measured as the present value of all future lease payments to be made under the agreement, discounted at the interest rate implicit in the lease (or at a similar borrowing rate). The lease liability is recognised just like any other liability;
  • The right-of-use asset is then measured, which consists of the lease liability, lease prepayments, restoration costs, and initial direct costs associated with entering into the lease agreement. The right-of-use asset is recognised under fixed assets or as a separate item under long-term investments. 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 their initial recognition, lease transactions are accounted for as follows:
  • The right-of-use asset is depreciated and tested for impairment like any asset owned by the entity;
  • Interest costs arising from discounting are recognised for the lease liability;
  • Any variable lease payments that IFRS 16 does not allow to be included in the lease liability are recognised separately;
  • If necessary, the accrued lease liability and restoration costs are regularly remeasured when the underlying asset is remeasured.
If you have any questions about IFRS, please contact Tereze Labzova-Ceicane (tereze.labzova@pwc.com, phone +371 67094400).

 

 
Contacts
Terēze Labzova-Ceicāne
tereze.labzova@pwc.com
Tel: +371 67094400
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