IFRS 16: Leases

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Transcript of IFRS 16: Leases

Page 1: IFRS 16: Leases

IFRS: An Opportunity Discussing

IFRS 16: LEASES

I have made an attempt to highlight few updates on

the topic.

From a finance perspective, these 3 decisions

(Financing, Investing & Dividends) have always

been critical to a company so as to maximize firm’s

value. One of the important components of

Financing Decision is “Leasing” and let me assure

you, this time I will not be discussing it from a

finance perspective.

WHY IFRS 16

On my first paragraph I would like to answer the

most sought question “Why IFRS 16? - What’s the

problem with existing Standards!”

Answer: There is A GAP in GAAPs. US GAAP runs

around 30000 pages while IFRS runs for around

1000 pages.

Leases being an important and flexible source of

financing to the companies, over 85% of these lease

commitments do not appear on balance sheet today.

Because, the previous (old) model required lessees

and lessors to classify their leases as either finance

or operating leases and to account for those two types of leases differently. For operating leases

there was no need to recognize Lease Assets & Lease

Liabilities. The problem is transactions that were

economically similar is being accounted very

differently.

As a result the existing standards (AS-19/IAS-17)

are highly criticized as these model fails to make

faithful representation of leasing transactions which

makes investors and stakeholders difficult to get a

clear picture of company’s lease assets and

liabilities. Furthermore it’s difficult to compare the

financial position of the companies that lease assets

with those that buy assets. It’s a reality because

operating lease is an off balance sheet item

currently. Thus under IFRS 16 operating leases will

be a balance sheet item.

IFRS 16 ?

The IFRS 16: Leases was issued in 13th January 2016

and applies to annual reporting periods beginning

on or after 1st January 2019. Oh! Then is it too early

to study. It’s better to study than not to study. Early

application of IFRS 16 is permitted provided your

entity applies for IFRS 15: Revenue from Contracts

with Customers. So, if your company is highly

affected by IFRS 15, then early application is desirable.

When looked over the financial statements of two

entities-one having financial lease and another

having operating lease, it could hide the true gearing

of the company of the company, as a result it also

hampers comparability, and thus, IFRS comes into

play.

MAJOR CHANGES

Remember! Major changes have been made from

lessee's perspective, so I will be discussing the

highlights only.

Accounting for lease 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.

IFRS 16 requires a lessee to recognize the assets and

liabilities for the rights and obligation created by

leases. Hence, Operating Lease is no longer an off

balance sheet item under IFRS 16.

The lessees were able to hide certain liabilities

resulting from leases and simply not present them on

the face of the financial statements. Under the new

standard, lessees will need to show all the leases in the

statement of financial position instead of hiding them

in notes to financial statements.

Are there any exemptions??

Of course, a lessee is not required to account for

lease assets and lease liabilities for all leases with a

lease term up to or less than 12 months and for

those leases where the underlying asset is of low

value.

Page 2: IFRS 16: Leases

ACCOUNTING BY LESSEE

A lease is defined as a contract or part of contract

that conveys the right to use an asset (underlying

asset) for a period of time in exchange for

consideration.

Again I repeat- There is no more classification of lease

into Finance Lease and Operating Lease by the lessee

A lessee measures Right OF Use Assets

(ROU- Assets) similarly to other non financial

assets like (Property, plant and equipment) and

lease liabilities to other financial liabilities.

As a result:

a) he claims for depreciation

b) books interest on lease liability

c) classifies lease payments into principal portion

and interest portion and presents in statement of

cash flows.

MEASUREMENT

The right of use asset is measured initially in the

amount of the lease liability and initial direct costs

It is then adjusted by lease payments made before or

on commencement date, lease incentives received

and any estimate of dismantling and restoration

costs.

All payments not paid at the commencement date

discounted to present value using the interest rate

implicit in the lease (or incremental borrowing rate)

LOGIC-ROU -ASSET

Logic behind recognizing lessee’s right to use an

underlying asset: AS AN ASSET

IFRS defines an asset as “a present economic

resource controlled by the entity as result of past

events"

Economic resource is a right that has the potential

to produce economic benefits.

Lessee's Right to use an underlying asset meets the

definition of asset based on IASB's views, so such right

is treated as an asset.

Similarly, lessee's obligation to make lease payments

meet the definition of liability as defined in IFRS.

R LEASES & SERVICE CONTRACTS SAME?

The answer is big NO. Because in service contracts,

the customer receives the service only at the time

when the service is rendered and thus the customer

has to make the payment for the service availed.

Service provider may require the use of some asset

to provide a contracted service, but such contract

does not allow making those assets available for use

by customer.

Note: The new definition of the lease can cause that

some contracts previously treated as “service

contracts” can now be treated as “lease contracts”.

EXEMPTIONS DETAILED

Short term leases:

a) Lease term of maximum of 12 months or less

b) Lessee can recognize the lease payments

associated with short term leases as an expense over the lease term typically on straight line basis.

c) Choice to be made on the basis of CLASS (group)

of underlying assets

d) If you rent a vehicle for 7 months, you can simply

account for all payments made directly in SPL no

need to create ROU Asset and lease liability

Low value assets

a) Choice to be made on Lease by Lease basis

(asset wise)

b) Low value is to be checked assuming as if the

asset is new in all cases. (Lease of old car will not

be a low value item, because when it was new it

was not of low value)

c) You can consider asset amounting $ 5000 as low

value asset

d) Lease with purchase option does not classify to

be of low value asset

e) Lease of IT equipment used by the individual

employees, lease of office furniture.

QUESTION 4 U

Under IFRS (say for operating lease)

Lessor keeps the Asset in BS &

Lessee also keeps same asset in BS at different value.

Both lessee and lessor recognize the asset in their

statement of financial position.

Is this correct?

Thank you for reading!!!

Niraj Thapa ([email protected])