IFRS 16 Standard

Accounting for Leases

TABLE OF CONTENTS
Introduction...........................................3
1. Identifying a lease.............................4
2. Classification Criteria for Lease –
Lessor and Lessee................................5
3. The Modifications Regarding The
Leases..................................................9
4. IFRS 16 vs IAS 17...........................11
5. Leases form Actual Life...................12
6. Summary.........................................13
7. References………..………………14

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INTRODUCTION

IFRS 16 is a new International Financial Reporting Standard for lease

accounting which came into force on 1 January 2019. It replaced the existing
IAS 17 accounting standard and was introduced by the International
Accounting Standards Board (IASB).

IFRS 16 introduces a single lessee accounting model and requires a lessee to

recognize assets and liabilities for all leases with a term of more than 12
months, unless the underlying asset is of low value. A lessee is required to
recognize a right-of-use asset representing its right to use the underlying
leased asset and a lease liability representing its obligation to make lease
payments.

IFRS 16 replaces IAS 17 accounting standard.

The objective of the change is to make sure that companies all return information
for leased items in the same way, making their existence more transparent
financially.

The objective of IFRS 16 is to report information that:

Faithfully represents lease transactions.

Provides a basis for users of financial statements to assess the amount, timing
and uncertainty of cash flows arising from leases. To meet that objective, a
lessee should recognize assets and liabilities arising from a lease.

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1. IDENTIFYING A LEASE

At inception of a contract, an entity shall assess whether the contract is, or

contains, a lease. A contract is, or contains, a lease if the contract conveys the
right to control the use of an identified asset for a period of time in exchange for
consideration.
A period of time may be described in terms of the amount of use of an identified
asset (for example, the number of production units that an item of equipment will
be used to produce).
An entity shall reassess whether a contract is, or contains, a lease only if the
terms and conditions of the contract are changed.
A lease is a contractual agreement between a lessor and a lessee, that gives the
lessee the right to use specific property, owned by the lessor, for a specified
period of time.

Capitalize a lease that transfers substantially all of the benefits and risks of
property ownership, provided the lease is no cancelable.

Leases that do not transfer substantially all the benefits and risks of ownership
are operating leases.

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 2. CLASSIFICATION CRITERIA FOR LEASE
– LESSOR AND LESSEE

CRITERION PROCESS TO CLASSIFY A LEASE

At the commencement of a lease, an entity must consider five criteria for
classifying the lease. These criteria help to identify whether a lease allows the
lessee to have effective control over the underlying asset. A lessor is deemed to
have transferred control of the underlying asset to the lessee if the lease meets
any of the following five criteria.

A lease meeting any of the above criteria would be classified as finance lease by
the lessee, and as a sales-type lease by the lessor. And, if the lease meets none
of the criteria specified, the lease would then be termed as an operating lease by
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the lessee, and as either a direct financing lease or operating lease by the lessor
subject to further analysis.

 ACCOUNTING TREATMENT BY LESSEES

FINANCE LEASE:
 The lessee would record a right-of-use asset and a lease liability in the
balance sheet.
 Interest and Amortization expenses are generally recorded separately in
the income statement.
 Interest expense is determined using the effective interest method and
amortization is usually recorded on a straight-line basis on the right-of-use
asset.
 In the statement of cash flows, repayments of the principal amount should
be classified as a financing activity, and variable lease payments should be
classified as part of operating activities.
 The interest of lease liability will follow classification as based in ASC 230.

OPERATING LEASE:
 The lessee would record a right-of-use asset and a lease liability in the
balance sheet.
 Lease expense is presented as a single line item as operating expense in
the income statement.
 Lease expense is to be recorded on a straight line basis over the lease
term by adding the interest expense to the amortization of the right-of-use
asset.
 Interest expense is determined using the effective interest method and
amortization on a right-of-use asset is determined by calculating the
difference between the straight line expense and interest expense on lease
liability.

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  The right-of-use asset is tested for impairment in accordance with ASC
360.
 Operating lease payments are to be classified as part of operating
activities.
 Lease payments that are capitalized as the cost of bringing an asset to its
intended use are to be classified as an investing activity.

 ACCOUNTING TREATMENT BY LESSORS

SALES TYPE LEASE:

 In a sales-type lease, the underlying asset is derecognized and the net
investment in the lease is accounted for in the balance sheet.
 The net investment in the lease is calculated on the basis of the sum of the
present value of all future lease payments, and unguaranteed residual
value.
 Interest income is added, and payments collected are decreased from the
net investment.
 Selling profit or loss is recorded at the commencement of lease in the
income statement.
 Interest income is determined using the effective rate of interest method.
 Cash receipts from all leases are accounted for as part of operating
activities in the statement of cash flows.

DIRECT FINANCING LEASE:

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  In a direct financing lease, the underlying asset is derecognized and the net
investment in the lease is accounted for in the balance sheet.
 The net investment in the lease is calculated on the basis of the sum of the
present value of all future lease payments, and unguaranteed residual
value.
 Interest income is added, and payments collected are decreased from the
net investment.
 Selling profit is deferred, and loss if any is recorded at the commencement
of the lease.
 Interest income is determined using the effective rate of interest method.
 Cash receipts from all leases are •accounted for as part of operating
activities in the statement of cash flows.

OPERATING LEASE:
 The underlying is recorded on the balance sheet and is depreciated over its
useful life.
 Such useful life could extend beyond the lease term.
 Lease revenue and depreciation are accounted for on a gross basis in the
income statement.
 Cash receipts from all leases are accounted for as part of operating
activities in the statement of cash flows.

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 3. THE MODIFICATIONS REGARDING THE
LEASES

In April 2001 the International Accounting Standards Board (Board) adopted IAS
17 Leases, which had originally been issued by the International Accounting
Standards Committee (IASC) in December 1997. IAS 17 Leases replaced IAS 17
Accounting for Leases that was issued in September 1982.

In April 2001 the Board adopted SIC-15 Operating Leases—Incentives, which

had originally been issued by the Standing Interpretations Committee of the IASC
in December 1998.
In December 2001 the Board issued SIC-27 Evaluating the Substance of
Transactions Involving the Legal Form of a Lease. SIC-27 had originally been
developed by the Standing Interpretations Committee of the IASC to provide
guidance on determining, amongst other things, whether an arrangement that
involves the legal form of a lease meets the definition of a lease under IAS 17.

In December 2003 the Board issued a revised IAS 17 as part of its initial agenda
of technical projects.

In December 2004 the Board issued IFRIC 4 Determining whether an

Arrangement contains a Lease. The Interpretation was developed by the
Interpretations Committee to provide guidance on determining whether
transactions that do not take the legal form of a lease but convey the right to use
an asset in return for a payment or series of payments are, or contain, leases
that should be accounted for in accordance with IAS 17.

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In January 2016 the Board issued IFRS 16 Leases. IFRS 16 replaces IAS 17,
IFRIC 4, SIC-15 and SIC-27. IFRS 16 sets out the principles for the recognition,
measurement, presentation and disclosure of leases.

In May 2020 the Board issued Covid-19-Related Rent Concessions, which

amended IFRS 16. The amendment permits lessees, as a practical expedient,
not to assess whether rent concessions that occur as a direct consequence of
the covid-19 pandemic and meet specified conditions are lease modifications.
Instead, the lessee accounts for those rent concessions as if they were not lease
modifications.

In August 2020 the Board issued Interest Rate Benchmark Reform―Phase 2

which amended requirements in IFRS 9, IAS 39, IFRS 7, IFRS 4 and IFRS 16
relating to:
changes in the basis for determining contractual cash flows of financial assets,
financial liabilities and lease liabilities;
hedge accounting; and
disclosures.
The Phase 2 amendments apply only to changes required by the interest rate
benchmark reform to financial instruments and hedging relationships.

Other Standards have made minor consequential amendments to IFRS 16,

including Amendments to References to the Conceptual Framework in IFRS
Standards (issued March 2018).

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 4. IFRS 16 VS IAS 17

The new – and hopefully improved – lease accounting standard from the
International Accounting Standard Board (IASB) changes the way leases affect
reported financial metrics as IAS 17 is replaced by IFRS 16. Operating leases
have long appealed to businesses for their ability to avoid recognizing assets and
liabilities on financial statements. Now, after a decade of deliberation, there is a
new IFRS accounting standard for leasing that brings these figures onto the
balance sheet. What exactly does that mean, though? How does IFRS 16 differ
from IAS 17?

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5. LEASES FORM ACTUAL LIFE

MENDOTA TRUCK CO.

The following is an analysis of the Mendota Truck Co. lease.
1. Transfer of title? No.
2. Bargain-purchase option? No.
3. Economic life test: The lease term is three years and is just 43 percent of the estimated
economic life of seven years. Thus, it does not meet the economic life test.
4. Recovery of investment test:
Rental payments € 5.582.62
PV of annuity due for 3 years at 12% X 2.69005
PV of rental payments €15,017.54
(Note: Adjusted for €0.01 due to rounding)
PV of guaranteed residual value = €7,000 X (PVF3,12%) = €7,000 X .71178 = €4,982.46
PV of rental payments €15,017.54
PV of guaranteed residual value 4,982.46
PV of minimum lease payments €20,000.00
The present value of the minimum lease payments is equal to the fair value; therefore, the
lease meets the recovery of investment.
Assuming that Mendota's implicit rate is the same as Morgan's incremental borrowing rate, the
following entries are made on January 1, 2015.

Morgan Bakeries Mendota Truck Co.

(Lessee) (Lessor)

Leased Equipment 20,000 Lease Receivable 20,000

Lease Liability 20,000 Cost of Goods Sold 15,000
Inventory (truck) 15,000
Sales Revenue 20,000

Morgan depreciates the leased asset over three years to its guaranteed residual value.

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6. SUMMARY

This concludes our high-level overview of IFRS 16. We got acquainted

with International Standard 16, which replaced Standard 17, which is
an international standard that specializes in preparing financial reports
for lease contracts and their types, and it was updated in the 2019, and
it was created to ensure that all companies use one method.

We have international standards for lease contracts, found to protect

the right of both the lessee and the landlord, and that there are
standards, parties and exemptions for each lease contract, and the
parties to the lease contract consist of the lessee and the lessor.

There are types of lease contracts and we explained them and the way
to deal with the contract from the point of view of the tenant and the
lessor. We introduced the key differences for lessee accounting under
IAS 17 and IFRS 16, provided an example, and discussed the required
disclosures.

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7. REFERENCES

1. Intermediate accounting ch21

2. IFRS Foundation
3. RevGurus
4. LeaseQuery

Team workers:

Layal Jamal Omar Aljabari 2133369

Malak Adnan Abu Markhia 2133993

Gana Mahmoud Mohammad Ayyash 2132231

Sara Esam Mousa Alshami 2134525

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