Sea Audit IFRS 16 Guide
Sea Audit IFRS 16 Guide
Sea Audit IFRS 16 Guide
A guide to IFRS 16
June 2016
This guide contains general information only, and none of Deloitte Touche
Tohmatsu Limited, its member firms, or their related entities (collectively, the
“Deloitte Network”) is, by means of this guide, rendering professional advice or
services. Before making any decision or taking any action that might affect your
finances or your business, you should consult a qualified professional adviser. No
entity in the Deloitte Network shall be responsible for any loss whatsoever sustained
by any person who relies on
this guide.
Foreword
Within the detailed guide, paragraphs that represent the authors’ interpretations,
material drawn from the IASB’s Basis of Conclusions on IFRS 16, and examples other
than those cited in IFRSs are highlighted by green shading.
1
Leases | A guide to IFRS 16
Contents
Executive summary 3
Dealing with transition 5
Detailed guide 9
Appendices
Appendix 1 Illustrative examples – identification of a lease 97
Appendix 2 Presentation and disclosure checklist – lessees 102
Appendix 3 Disclosure checklist – lessors 107
Appendix 4 Comparison with US GAAP
109
2
Leases | A guide to IFRS 16
Executive summary
IFRS 16 Leases was issued by the IASB in For lessees, the picture is fundamentally • a shift in lease expense classification from
January 2016. It wil replace IAS 17 Leases different and IFRS 16 can be expected to operating expenses to financing costs and
for reporting periods beginning on or after have a significant impact, particularly for amortisation (i.e. moving below metrics
1 January 2019. It can be applied before entities that have previously kept a large such as operating profit, EBITDA or EBIT).
that date by entities that also apply IFRS 15 proportion of their financing ‘off-balance There are some exceptions: any variable
Revenue from Contracts with Customers. sheet’ in the form of operating leases. This lease payments not included in the initial
operating lease-style accounting treatment is measurement of the lease liability are
IFRS 16 sets out a comprehensive model no longer available, except for short-term classified as operating expenses, as are
for the identification of lease arrangements leases (lease term 12 months or less) and the expenses associated with short-term
and their treatment in the financial leases of low-value assets (‘low value’ is and low-value asset leases for which
statements of both lessees and lessors. IFRS not specifically defined but the IASB has recognition exemptions are applied; and
16 applies a control model for the indicated that it has in mind assets with a
• for entities that present cash flows
identification of leases, distinguishing between value, when new, in the order of magnitude
related to interest on leases as financing
leases and service contracts on the basis of of US$5,000 or less).
flows, a shift of the payments previously
whether there is an identified asset
associated with operating leases to the
controlled by the customer. While, for the All other leases within the scope of IFRS 16
financing category (unless they change
majority of contracts, the classification under are required to be brought on-balance
their policy regarding presentation
the new Standard as either a lease or a sheet by lessees – recognising a ‘right-of-
of interest cash flows). Cash from
service contract may not be different to the use’ asset and the related lease liability
operations and financing activity outflows wil
classification under the IAS 17 ‘risks and at commencement of the lease, with
both increase for these entities.
rewards’ model, divergence may emerge, for subsequent accounting generally similar to
example, when the pricing of the contract the finance lease model under IAS 17. A number of aspects of the application
was a significant consideration under IAS 17. of IFRS 16 wil require the exercise of
Importantly, both lessors How these new requirements affect a judgement – particularly in respect of the
and lessees are entitled to ‘grandfather’ lessee’s financial statements wil obviously definition of a lease and the assessment of
assessments regarding whether a contract depend on the mix of lease agreements in the lease term. Entities wil also need to
existing at the date of initial application of place, and also on which of the Standard’s take time to consider whether to avail of
IFRS 16 contains a lease so that entities are exceptions and practical expedients are practical expedients and recognition
not required to incur the costs of detailed applied. However, the expectation for exemptions (including, in particular, reliefs
reassessments. lessees wil be: available on transition, as discussed in detail
in the next section of this guide).
One of the most notable aspects of • an increase in recognised assets and
IFRS 16 is that the lessee and lessor liabilities (right-of-use assets and liabilities In addition, there are important business
accounting models are asymmetrical. recognised other than for short-term considerations – including whether changes
While the IASB has retained IAS 17’s leases and leases of low-value assets); are needed to systems and processes
finance lease/operating lease distinction for (e.g. to track leases individually or at a
• more lease expenses recognised in
lessors (and carried into IFRS 16 the related portfolio level, or to accumulate the
the early periods of a lease, and less in
requirements virtually intact), the distinction information needed for disclosures); any
the later periods (‘front-loaded’ finance
is no longer relevant for lessees. potential tax impacts (if the treatment of a
charge on lease liability versus straight-
lease for tax purposes is based on
line expense under IAS 17’s operating
For lessors, the changes introduced by IFRS its treatment in the financial statements);
lease approach);
16 are not significant and, except in respect and the impact of changes in the amounts
of subleases, a lessor is not required to reported on key metrics, debt covenants
make any adjustments on transition for and management compensation.
leases in which it is a lessor. Additional
requirements have been introduced for
subleases and lease modifications, and
lessor disclosure requirements have been
expanded.
3
Leases | A guide to IFRS 16
IFRS 16
Key judgements, policy choices and exempti ons Detailed guide reference
Policy choice: Lessee may, but is not required to, apply Scope
IFRS 16 to leases of intangible assets (section 2)
4
Leases | A guide to IFRS 16
Although IFRS 16 is not mandatorily Readiness as se ssment Data gathering and s y s t em s readiness
effective until periods commencing on or A readiness assessment is a good way Compiling all of the data necessary for
after 1 January 2019, for many entities to gauge the scale of the challenge reporting under IFRS 16, and ensuring that
the scale of the challenge ahead means ahead and to identify which aspects of it is robust, may take considerable time and
that they wil be starting to think about implementation are likely to prove trickiest, effort, particularly in global organisations
implementation sooner rather than requiring the most time and effort. To begin where lease information is spread around
later. For some, there wil be technical this process, here are 10 questions for various jurisdictions, sometimes in electronic
accounting questions that require careful management to ask themselves. format and sometimes not.
consideration but, for many, the primary Real estate teams may be in possession
challenge wil be gathering the necessary of property leases, operations personnel
data, ensuring that it is reliable and that 10 Key questions for management in possession of equipment leases and
systems are ready. This section of our finance teams in possession of others.
guide highlights some of the primary 1. Do you know which of the entity’s
considerations entities should have in mind contracts are, or contain, leases? Some entities wil have stronger starting
as they begin to prepare for transition to points than others in terms of their existing
2. Are your systems and processes
IFRS 16. records, but even when data points such
capturing all of the required
as future rentals and lease terms have
information?
Who to involve? previously been gathered, items such as
Good project governance wil be essential in 3. Are systems and processes discount rates are unlikely to have been
preparing for the implementation of IFRS capable of monitoring leases and previously determined for those leases
16 and, when appropriate, representatives keeping track of the required classified as operating leases under
from the following departments should be ongoing assessments? IAS 17. Estimating appropriate discount
involved in discussions and planning: 4. Have you considered the potential rates may prove time consuming and
use of IFRS 16’s recognition require specialist input, whether it be for the
• accounting/finance;
exemptions and practical purpose of determining residual values (and,
• real estate/property; expedients? in turn, the interest rate implicit
in a lease), or ascertaining the rate an
• operations; 5. Do you know which transition entity would have to pay on incremental
• procurement; reliefs are available, and whether borrowings (which potentially bear little
you wil apply any of them? resemblance to debt instruments already
• information technology;
6. Do you know what discount rates in issue).
• tax; you wil be using for your different
leases? For smaller entities with relatively few
• treasury; and
leases, the data gathering may be
7. Have you considered the impact undertaken by a project team, whereas
• investor relations.
of the changes on financial results those with larger portfolios may look to
Once the various stakeholders have and position? ascertain whether technology can offer
been identified, conversations can begin
8. How wil you communicate the assistance. For example, contract-reader
regarding timelines and responsibilities.
impact to affected stakeholders? technology has developed considerably in
Support from external providers may also
recent years, often handling multiple
be desirable at some stages during the 9. Have you planned when you wil languages and extracting information in a
transition project. consider the tax impacts? fraction of the time it would take humans.
10. Have you considered whether your
leasing strategy requires revision?
5
Leases | A guide to IFRS 16
Gathering the data for transition is not Entities would be well advised to consider Commercially, the new accounting may
the end of the story; systems need to the potential knock-on effects in the prompt entities to reconsider their lease-
be able to store this information and following areas: buy strategy and/or whether to move to
update it on an ongoing basis. Accounting shorter leases or leases involving more
software providers are developing various • key performance indicators; variable rentals so as to minimise the
offerings to deal with the ongoing assets and liabilities to be added to the
• bonus targets and executive
accounting for leases under IFRS 16. The balance sheet. Of course, commercial
remuneration schemes;
more comprehensive lease management decisions on whether to lease an asset
tools may offer this functionality alongside • contingent consideration in business and how long to lease it for are driven
features designed to enable entities to combinations; by a whole range of factors, not just the
manage their leasing portfolios, prompt accounting. For example, some lessees and
• tax;
monthly payments, highlight extension some lessors may not appreciate the lack
options due to be exercised, schedule • debt covenants (if not based on ‘frozen’ of security offered by entering into shorter
restoration works and much more besides. GAAP); leases. From a cash perspective, leasing wil
Unsurprisingly, the more powerful the unsurprisingly stil remain an attractive
• ability to pay dividends; and
system the more it tends to cost, meaning proposition for many.
that different solutions are likely to be • regulatory capital requirements.
appropriate for different entities. Transiti on reliefs
To avoid unforeseen and potentially
As set out in section 11 of our detailed
undesirable consequences, contractual
Whichever technology strategy is guide, there are numerous reliefs available
arrangements may need to be renegotiated
adopted, adequate testing wil need to be on transition, particularly for lessees (given
and, for arrangements under negotiation
undertaken and ‘dry runs’ performed to that it is their accounting that has changed
between now and transition to IFRS 16,
avoid last minute problems. most significantly).
the effects of the new accounting carefully
considered and pre-empted.
Considering the effects and Both lessees and lessors are able to
co mmunicati ng impac t s ‘grandfather’ previous conclusions reached
Investors wil not welcome surprises when
The knock-on effects of IFRS 16 are under IFRIC 4 and IAS 17 as to whether
amounts and adjustments reported on
potentially significant for many entities. For contracts existing at transition are, or
transition are considerably different to
lessees, balance sheets wil be expanded contain, leases, although this exemption
those that had been anticipated, and
by the recognition of new liabilities and must be applied either for all contracts or
the sooner the potential impacts are
assets, although these wil not always be none (no ‘cherry-picking’ permitted). It is also
communicated the better. IAS 8 sets out
equal and opposite. In the income worth noting that this exemption does not
specific disclosure requirements regarding
statement, the lease expense profile wil mean that items previously identified as
the potential impact of Standards in
be front-loaded, at least for any individual operating leases can remain off-balance
issue but not yet effective and regulators
lease, and presented as sheet for lessees (unless they qualify for a
are likely to be scrutinising information on
depreciation and interest rather than as an recognition exemption); it merely saves the
IFRS 16 in this regard. If an incentive were
operating expense (with the exception of entity the costs and effort of reassessing
needed, then entities would do well to
variable rentals which wil be expensed as those contracts existing at the date of
examine their existing disclosures
incurred). This means that numerous key transition against IFRS 16’s new definition of
regarding operating lease commitments
performance indicators may be affected a lease. New contracts entered into after
to ensure that they are doubly confident
– EBITDA being a prime example. The transition wil, unsurprisingly, need to be
in the information presented therein,
statement of cash flows is affected too, with assessed against IFRS 16’s definition rather
given that it might be expected to bear
payments needing to be split between than relying on historical conclusions for
some resemblance to amounts arising on
repayment of principal and interest. similar contracts.
transition.
6
Leases | A guide to IFRS 16
For lessees, the main choices regarding Comparison of transiti on opti ons
how to transition to IFRS 16 and bring On the next page, we have set out an
assets and liabilities on-balance sheet are example illustrating the application of the
summarised in the decision tree below. The options described above. This example
reliefs are described in more detail reveals the potential for differing impacts
in section 11 of this guide. on the statement of financial position at
transition and the subsequent expense
Options for lessees transitioning to recognised in the income statement.
IFRS 16
Option 2A – Option 2B –
Measure asset Measure asset
as if IFRS 16 had at amount
been applied equal to liability
from lease (adjusted for
commencement accruals and
(but using prepayments)
incremental
borrowing rate at
date of transition)
7
Leases | A guide to IFRS 16
8
Leases | A guide to IFRS 16
Contents
Section 1 General principles 10
Section 2 Scope 13
Section 3 Identifying a lease 15
Section 4 Separating components of a contract 26
Section 5 Lease term 31
Section 6 Lease payments 36
Section 7 Accounting by lessees 43
Section 8 Classification of leases by lessors 67
Section 9 Accounting by lessors 78
9
Leases | A guide to IFRS 16
A contract is defined as “an agreement between two or more parties that creates enforceable rights and obligations”.
[IFRS 16:Appendix A]
Note that the application of IFRS 16 is not restricted to contracts, or portions of contracts, that are specifically described or labelled as
leases (see section 3).
Falling within the scope of this practical expedient are circumstances when an entity enters into a single contract to lease a number of
identical assets. Take, for example, a contract to lease 20 printers (assumed for the purposes of this example to be high-volume
commercial printers that do not qualify as low-value assets (see 7.2.3)).
As discussed at 4.1, if the printers can be operated on a stand-alone basis, the right to use each printer is required to be accounted for
as a separate lease component. The practical expedient helps to reduce that complexity by permitting the entity to account for the
leases as one portfolio, rather than recognising and accounting for 20 leases separately.
The following example, which is reproduced from the illustrative examples accompanying IFRS 16, illustrates how an entity might identify
portfolios of leases for the purpose of applying this practical expedient. It also illustrates the accounting for leases of low-value assets (see 7.2
for explanation and detailed requirements).
10
Leases | A guide to IFRS 16
Example 1.3
Portfolio applicati on
[IFRS 16: Illustrative example 11]
A lessee in the pharmaceutical manufacturing and distribution industry (Lessee) has the following leases:
c) leases of company cars, both for sales personnel and senior management and of varying quality, specification and value.
d) leases of trucks and vans used for delivery purposes, of varying size and value.
e) leases of IT equipment for use by individual employees (such as laptop computers, desktop computers, hand held computer devices,
desktop printers and mobile phones).
f) leases of servers, including many individual modules that increase the storage capacity of those servers. The modules have been
added to the mainframe servers over time as Lessee has needed to increase the storage capacity of the servers.
Lessee elects to apply the requirements in [IFRS 16:6] in accounting for all of those leases.
Although each module within the servers, if considered individually, might be an asset of low value, the leases of modules within the
servers do not qualify as leases of low-value assets. This is because each module is highly interrelated with other parts of the servers.
Lessee would not lease the modules without also leasing the servers [(see 7.2.3.5 for further discussion)].
11
Leases | A guide to IFRS 16
Lessee’s company cars are leased under a series of master lease agreements. Lessee uses eight different types of company car, which
vary by price and are assigned to staff on the basis of seniority and territory. Lessee has a master lease agreement for each different type
of company car. The individual leases within each master lease agreement are all similar (including similar start and end dates), but the terms
and conditions generally vary from one master lease agreement to another. Because the individual leases within each master lease
agreement are similar to each other, Lessee reasonably expects that applying the requirements of IFRS 16 to each master lease
agreement would not result in a materially different effect than applying the requirements of IFRS 16 to each individual lease within the
master lease agreement. Consequently, Lessee concludes that it can apply the requirements of IFRS 16 to each master lease agreement
as a portfolio. In addition, Lessee concludes that two of the eight master lease agreements are similar and cover substantially similar types
of company cars in similar territories. Lessee reasonably expects that the effect of applying IFRS 16 to the combined portfolio of leases within
the two master lease agreements would not differ materially from applying IFRS 16 to each lease within that combined portfolio. Lessee,
therefore, concludes that it can further combine those two master lease agreements into a single lease portfolio.
Lessee’s trucks and vans are leased under individual lease agreements. There are 6,500 leases in total. All of the truck leases have similar
terms, as do all of the van leases. The truck leases are generally for four years and involve similar models of truck. The van leases are
generally for five years and involve similar models of van. Lessee reasonably expects that applying the requirements of IFRS 16 to portfolios
of truck leases and van leases, grouped by type of underlying asset, territory and the quarter of the year within which the lease was
entered into, would not result in a materially different effect from applying those requirements to each individual truck or van lease.
Consequently, Lessee applies the requirements of IFRS 16 to different portfolios of truck and van leases, rather than to 6,500 individual
leases.
[IFRS 16:B2]
• the contracts are entered into at or near the same time; and
• the contracts are with the same counterparty (or related parties of the counterparty); and
The requirements of IFRS 16:B2 are intended to capture circumstances in which an entity enters into a number of contracts in
contemplation of one another such that the transactions, in substance, form a single arrangement that achieves an overall commercial
objective that cannot be understood without considering the contracts together.
For example, assume that a lessee enters into a one-year lease of an asset with particular characteristics. The lessee also enters into a
one-year lease for an asset with those same characteristics starting in one year’s time and a similar forward contract starting in two years’
time and in three years’ time. The terms and conditions of all four contracts are negotiated in contemplation of each other such that the
overall economic effect cannot be understood without reference to the series of transactions as a whole. In effect, the lessee has
entered into a four-year lease. In such situations, accounting for the contracts independently of each other might not result in a faithful
representation of the combined transaction. [IFRS 16:BC130]
12
Leases | A guide to IFRS 16
Section 2 Scope
[IFRS 16:3]
a) leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
IFRS 6 Exploration for and Evaluation of Mineral Resources specifies the accounting for rights to explore for and evaluate mineral resources.
b) leases of biological assets within the scope of IAS 41 Agriculture held by a lessee;
Biological assets that are bearer plants are within the scope of IAS 16 Property, Plant and Equipment rather than IAS 41 and, consequently,
are within the scope of IFRS 16. Therefore, for example, leases of bearer plants such as orchards and vineyards held by a lessee are within
the scope of IFRS 16. [IFRS 16:BC68(b)]
c) service concession arrangements within the scope of IFRIC 12 Service Concession Arrangements;
d) licences of intellectual property granted by a lessor within the scope of IFRS 15 Revenue from Contracts with Customers; and
e) rights held by a lessee under licensing agreements within the scope of IAS 38 Intangible Assets for such items as motion picture films,
video recordings, plays, manuscripts, patents and copyrights.
A lessee is permitted, but not required, to apply IFRS 16 to leases of intangible assets other than those described in IFRS 16:3(e). [IFRS 16:4]
Leases of ‘other’ intangible assets in the context of IFRS 16:4 might include, for example, exclusive licences for brands or trademarks held by
a lessee. Such leases were previously considered to fall within the scope of IAS 17. The IASB decided to permit, but not require, entities to
account for these leases in accordance with IFRS 16. Although there is no conceptual basis for excluding them from the scope of IFRS 16,
the Board considered that a more comprehensive review of the accounting for intangible assets is required before requiring leases of
intangible assets to be accounted for under the new Standard. [IFRS 16:BC71]
The IASB considered, but decided against, a scope exclusion for long-term leases of land (see IFRS 16:BC78). Therefore, such leases
should be accounted for in accordance with IFRS 16.
13
Leases | A guide to IFRS 16
Unlike IAS 17, IFRS 16 contains no scope exclusions in relation to investment property. Therefore, all aspects of leases of investment
property are accounted for under IFRS 16.
Consequential amendments arising from IFRS 16 have amended the definition of investment property in IAS 40 Investment Property to
include both owned investment property and investment property held by a lessee as a right-of-use asset. Under IFRS 16:34 (see
7.5.1.5), if a lessee applies IAS 40’s fair value model to its owned investment property, it is also required to apply that fair value model to
right-of-use assets that meet the definition of investment property.
2.4 Subleases
Leases of right-of-use assets in a sublease are within the scope of IFRS 16, subject to the exclusions set out at 2.1. [IFRS 16:3]
Subleases are required to be accounted for in the same way as other leases (see 8.6) and, accordingly, are within the scope of IFRS 16.
[IFRS 16:BC73]
IFRS 16 does not specifically exclude leases of inventories from its scope. However, the IASB believes that few such transactions would
meet the definition of a lease under IFRS 16 because a lessee is unlikely to be able to hold an asset that it leases (and that is owned
by another party) for sale in the ordinary course of business, or for consumption in the process of production for sale in the ordinary
course of business. [IFRS 16:BC74]
The IASB decided to require an entity to separate from a lease any derivatives embedded in the lease (as defined in IFRS 9 Financial
Instruments), and account for the derivatives applying IFRS 9. Nonetheless, IFRS 16 includes specific requirements for features of a lease
such as options and residual value guarantees that may meet the definition of a derivative. The IASB noted that the lease accounting
model in IFRS 16 was not developed with derivatives in mind and, consequently, IFRS 16 would not provide an appropriate basis on which
to account for derivatives. Accordingly, if derivatives embedded in leases were not accounted for separately, unrelated derivative contracts
could be bundled with leases to avoid measuring the derivatives at fair value. [IFRS16:BC81]
Thinking it through
Care wil be needed to distinguish between variable lease payments, for which the accounting is specified in IFRS 16, and
derivatives embedded in a lease, which cause the payments to be variable but based on a factor that has economic risks and
characteristics that are not closely related to those of the right-of-use asset.
IFRS 16 applies to all leases except those specifically excluded under IFRS 16:3 (see 2.1). However, the Standard includes recognition
exemptions available to lessees for short-term leases and leases of low-value items and specifies alternative requirements (see 7.2).
14
Leases | A guide to IFRS 16
IFRS 16 supersedes IFRIC 4 Determining whether an Arrangement contains a Lease and SIC-27 Evaluating the Substance of Transactions
Involving the Legal Form of a Lease. Although the detailed requirements regarding the identification of a lease are amended by IFRS 16,
the key principles of IFRIC 4 and SIC-27 are carried forward, i.e. that:
• some arrangements that do not take the legal form of a lease nevertheless meet the definition of a lease under the Standard; and
• not all transactions that involve the legal form of a lease wil fall within the definition of a lease under the Standard.
An entity is required to assess whether a contract contains a lease at inception of the contract, rather than at commencement of the
lease term (see 5.3 for an explanation of these terms). This is necessary because a lessor is required to classify a lease as either a finance
lease or an operating lease at the inception date (see 8.1). In addition, a lessee is required to disclose information about leases not yet
commenced to which the lessee is committed if that information is relevant to users of financial statements. [IFRS 16:BC110]
Examples 1 to 10 of the illustrative examples accompanying IFRS 16 (summarised in Appendix 1) illustrate how an entity determines
whether a contract is or contains a lease. Although the IASB believes that, in most cases, the assessment as to whether a contract is or
contains a lease should be straightforward, it acknowledges that significant judgement wil be required to make this assessment in some
cases. [IFRS 16:BC109]
See 3.5 for a flowchart, reproduced from IFRS 16, which summarises the steps involved in the assessment as to whether a contract is, or
contains, a lease. These steps are discussed in detail in 3.3 and 3.4.
15
Leases | A guide to IFRS 16
When assessing the nature of a contract, an entity should consider whether the contract transfers control of the underlying asset itself
(as opposed to conveying the right to control the use of the underlying asset for a period of time). If so, the transaction is a sale or
purchase within the scope of other Standards (e.g. IFRS 15 Revenue from Contracts with Customers or IAS 16 Property, Plant and Equipment).
[IFRS 16:BC140]
IFRS 16 aims to distinguish a lease from a service contract on the basis of whether a customer is able to control the use of the asset being
leased. If the customer controls the use of an identified asset (see 3.3) for a period of time, then the contract contains a lease. This wil be
the case if the customer can make the important decisions about the use of the asset in a similar way to that in which it makes decisions
about owned assets that it uses (see 3.4). In contrast, in a service contract, the supplier controls the use of any assets used to deliver
the service. [IFRS 16:BC105]
3.2.4 Cus tomer ha s control for only a porti on of the term of a contrac t
If the customer has the right to control the use of an identified asset for only a portion of the term of a contract, the contract contains a
lease for that portion of the lease term. [IFRS 16:B10]
3.2.6 A ssessing whether a contrac t cont ains a lease when the custo mer is a joint arrangement
When a contract to receive goods or services is entered into by, or on behalf of, a joint arrangement (as defined in IFRS 11 Joint
Arrangements), the joint arrangement is considered to be the customer in the contract. Accordingly, when assessing whether such a
contract contains a lease, an entity should assess whether the joint arrangement has the right to control the use of an identified asset
throughout the period of use. [IFRS 16:B11]
IFRS 16:B11 clarifies that when a contract is entered into by, or on behalf of, a joint arrangement, it is the joint arrangement (rather than
the parties to the joint arrangement) that should be considered to be the customer when assessing whether the contract contains a
lease, irrespective of which entity signed the contract. Accordingly, if the parties to the joint arrangement collectively have the right to
control the use of an identified asset throughout the period of use through their joint control of the arrangement, the contract contains a
lease. It is not appropriate to conclude that a contract does not contain a lease on the grounds that each of the parties to the joint
arrangement either obtains only a portion of the economic benefits from use of the underlying asset or does not unilaterally direct the use
of the underlying asset. [IFRS 16:BC126]
This guidance is particularly relevant for joint operations where each of the parties has direct rights and obligations for the lease and for
which, in the absence of this guidance, it might not have been clear whether control should be viewed from the perspective of the joint
operation.
16
Leases | A guide to IFRS 16
[IFRS 16:B13]
• the asset is explicitly specified in the contract (e.g. a specific serial number); or
• the asset is implicitly specified at the time that it is made available for use by the customer (e.g. when there is only one asset that is
capable of being used to meet the contract terms).
3.3.2.1 Right to use a n identified asset is undermined by substantive substi tuti on right
Even if an asset is specified as discussed in 3.3.1, a customer is not considered to have the right to use an identified asset (and, therefore,
the contract is not a lease) if the supplier has a substantive right to substitute the asset throughout the period of use. [IFRS 16:B14]
The ‘period of use’ is “the total period of time that an asset is used to fulfil a contract with a customer (including any non-consecutive
periods of time)". [IFRS 16:Appendix A]
If a supplier has a substantive right to substitute the asset throughout the period of use, there is no identified asset and the contract
does not contain a lease. This is because the supplier, and not the customer, controls the use of the asset in such circumstances. [IFRS
16:BC112]
If a substitution clause is not substantive because it does not change the substance of the contract (i.e. the conditions set out in 3.3.2.2
are not met), that substitution clause does not affect an entity’s assessment as to whether a contract contains a lease. [IFRS 16:BC113]
The illustrative examples accompanying IFRS 16 (as summarised in Appendix 1) include a number of scenarios in which substitution
rights are considered.
[IFRS 16:B14]
• the supplier has the practical ability to substitute alternative assets throughout the period of use (e.g. the customer cannot prevent the
supplier from substituting the asset and alternative assets are readily available to the supplier or could be sourced by the supplier within a
reasonable period of time); and
• the supplier would benefit economically from exercising its right to substitute the asset (i.e. the economic benefits associated with
substituting the asset are expected to exceed the costs associated with substituting the asset).
Substitution rights are not substantive if it is not likely, or practically or economically feasible, for the supplier to exercise those rights. The
IASB believes that, in many cases, it wil be clear that the supplier would not benefit from the exercise of a substitution right because of the
costs associated with substituting the asset. [IFRS 16:BC113]
17
Leases | A guide to IFRS 16
3.3.2.3 Substi tuti on on or af ter a specified future date or dependent on the occurrence of a specified event
If the supplier has a right or an obligation to substitute the asset only on or after either a particular date or the occurrence of a specified
event, the supplier’s substitution right is not substantive because the supplier does not have the practical ability to substitute alternative
assets throughout the period of use. [IFRS 16:B15]
3.3.2.4 Evaluati on to be based on circu m s t anc e s a t incepti on and to exclude considerati on of future events not considered
likely to o ccur
An entity’s evaluation of whether a supplier’s substitution right is substantive should be based on facts and circumstances at inception of
the contract. [IFRS 16:B16]
Future events that, at inception of the contract, are not considered likely to occur should be excluded from the evaluation. Examples of
such future events include:
[IFRS 16:B16]
• an agreement by a future customer to pay an above market rate for use of the asset;
• the introduction of new technology that is not substantially developed at inception of the contract;
• a substantial difference between the customer’s use of the asset, or the performance of the asset, and the use or performance
considered likely at inception of the contract; and
• a substantial difference between the market price of the asset during the period of use, and the market price considered likely at
inception of the contract.
If a supplier would benefit from substitution only in circumstances that are not likely to occur, such as those listed in IFRS 16:B16, those
substitution rights are not substantive, regardless of whether the circumstances are specified in the contract. [IFRS 16:BC114]
3.3.2.5 Substi tuti on costs generally higher when the asset is located a t the customer ’s premises or elsewhere
If the asset is located at the customer’s premises or elsewhere, the costs associated with substitution are generally higher than when
located at the supplier’s premises and, therefore, are more likely to exceed the benefits associated with substituting the asset.
[IFRS 16:B17]
3.3.2.7 Cus tomer cann ot readily determine whether the supplier h a s subst antive substi tuti on rights
If the customer cannot readily determine whether the supplier has a substantive substitution right, the customer should presume that any
substitution right is not substantive. [IFRS 16:B19]
The IASB believes that it should generally be relatively clear from the facts and circumstances whether substitution rights are substantive,
and the Board intends that customers should assess whether substitution rights are substantive if they are reasonably able to do so.
However, the requirement in IFRS 16:B19 is intended to clarify that a customer is not expected to exert undue effort in order to provide
evidence that a substitution right is not substantive. [IFRS 16:BC115]
18
Leases | A guide to IFRS 16
A capacity or other portion of an asset that is not physically distinct (e.g. a capacity portion of a fibre optic cable or a pipeline) is not an
identified asset, unless it represents substantially all of the capacity of the asset and thereby provides the customer with the right to
obtain substantially all of the economic benefits from use of the asset. [IFRS 16:B20]
The IASB concluded that a customer is unlikely to have the right to control the use of a capacity portion of a larger asset if that portion is
not physically distinct because decisions about the use of the asset are typically made at the larger asset level. [IFRS 16:BC116]
Thinking it through
The determination as to whether an asset is physically distinct may not be dificult for items such as buildings, where it is clearly
accepted and acknowledged in IFRS 16 that a floor of a building can be distinct, even though the ability to use it depends on having
access through common areas used or controlled by others. However, it may be more dificult to conceptualise for assets such as
technology assets (e.g. a satellite), whether there is a distinct portion that can be controlled, when the ability to use that portion
may require access or power, say, from a portion that is not controlled.
• the right to obtain substantially all of the economic benefits from use of the identified asset (see 3.4.2); and
• the right to direct the use of the identified asset (see 3.4.3).
The ‘period of use’ is “[t]he total period of time that an asset is used to fulfil a contract with a customer (including any non-consecutive
periods of time)”. [IFRS 16:Appendix A]
As discussed in the following sections, the IASB decided that to control the use of an asset, a customer is required to have not only the right
to obtain substantially all of the economic benefits from use of an asset throughout the period of use (a ‘benefits’ element) but also the ability
to direct the use of that asset (a ‘power’ element). The shift in focus from ‘risks and rewards’ to ‘control’ is consistent with other recent
Standards (e.g. IFRS 10 Consolidated Financial Statements and IFRS 15 Revenue from Contracts with Customers) and with the IASB’s
proposals regarding control in the Conceptual Framework exposure draft.
3.4.2.1 Cus tomer m u s t have the right to obtain subst anti ally all of the economic benefits from use of the asset
To control the use of an identified asset, a customer must have the right to obtain substantially all of the economic benefits from use of
the asset throughout the period of use (e.g. by having exclusive use of the asset throughout that period). [IFRS 16:B21]
Therefore, in circumstances when an asset might be considered to be implicitly identified (e.g. the supplier has only one machine capable of
delivering the customer’s requirements), if the supplier can regularly use the machine for other purposes during the course of the contract
(e.g. to supply other customers), the customer does not have the right to obtain substantially all of the economic benefits from the use of
that asset and there is no lease.
19
Leases | A guide to IFRS 16
The assessment as to whether a contract contains a lease should not consider economic benefits relating to ownership of an asset (e.g.
tax benefits as a result of owning an asset). This is because a lease does not convey ownership of the underlying asset. [IFRS 16:BC118]
[IFRS 16:B22]
• if a contract limits the use of a motor vehicle to only one particular territory during the period of use, only the economic benefits from
use of the motor vehicle within that territory should be considered; and
• if a contract specifies that a customer can drive a motor vehicle only up to a particular number of miles during the period of use, only the
economic benefits from use of the motor vehicle for the permitted mileage should be considered.
Therefore, potential additional economic benefits outside the scope of the customer’s rights (e.g. in the second bullet point above,
beyond the specified mileage for the motor vehicle) are not relevant to the determination as to whether the customer has the right to
obtain substantially all of the economic benefits from use of the asset throughout the period of use.
Thinking it through
Sometimes it may be dificult to make the assessment of the economic benefits within the defined scope of the right-of-use asset,
in which case it may be helpful to consider the arrangement not just from the customer’s perspective but also from the
perspective of whether another party can use the asset for its own benefit during the period of the contract. In the examples
above it can be seen that another party could not, during the contract, use the motor vehicle to drive in other territories, or
drive additional mileage.
3.4.2.4 Cus to mer required to pay a porti on of the c a s h flows derived from use of the asset a s considerati on
If a contract requires a customer to pay the supplier or another party a portion of the cash flows derived from use of an asset as
consideration, those cash flows paid as consideration should be considered to be part of the economic benefits that the customer obtains
from use of the asset. [IFRS 16:B23]
For example, if the customer is required to pay the supplier a percentage of sales from use of retail space as consideration for that
use, that requirement does not prevent the customer from having the right to obtain substantially all of the economic benefits from use of
the retail space. This is because the total cash flows arising from those sales are considered to be economic benefits that the customer
obtains from use of the retail space, a portion of which it then pays to the supplier as consideration for the right to use that space. [IFRS
16:B23]
20
Leases | A guide to IFRS 16
3.4.3.1 C ir cu m s t anc e s when the cus tomer h a s the right to direct the use of a n identified asset
A customer has the right to direct the use of an identified asset throughout the period of use only if either:
[IFRS 16:B24]
a) the customer has the right to direct how and for what purpose the asset is used throughout the period of use (see 3.4.3.2); or
b) the relevant decisions about how and for what purpose the asset is used are predetermined and specified conditions are met
(see 3.4.3.3).
If neither of the conditions in IFRS 16:B24 is met, the supplier directs how and for what purpose the asset is used and, consequently, the
contract does not contain a lease.
Note that, as explained in IFRS 16:BC120, ‘how and for what purpose’ an asset is used is a single concept (i.e. ‘how’ an asset is used is not
assessed separately from ‘for what purpose’ an asset is used).
A customer has the right to direct how and for what purpose the asset is used if it can change how and for what purpose the asset is used
throughout the period of use. In making this assessment, the focus is on whether the customer has decision-making rights that affect the
economic benefits to be derived from use of the asset. [IFRS 16:B25]
The decision-making rights that are most relevant for this purpose are likely to be different for different contracts, depending on the nature
of the asset and the terms and conditions of the contract. Depending on the circumstances, these could include rights to change:
• the type of output that is produced by the asset (e.g. to decide whether to use a shipping container to transport goods or for storage, or
to decide upon the mix of products sold from retail space);
• when the output is produced (e.g. to decide when an item of machinery or a power plant wil be used);
• where the output is produced (e.g. to decide upon the destination of a truck or a ship, or to decide where an item of equipment is used);
and
• whether the output is produced, and the quantity of that output (e.g. to decide whether to produce energy from a power plant and how
much energy to produce from that power plant).
Rights that are limited to operating or maintaining the asset are examples of rights that do not grant the right to change how and for what
purpose the asset is used. Although such rights are often essential to the eficient use of an asset, they are not rights to direct how and for
what purpose the asset is used and are often dependent on the decisions about how and for what purpose the asset is used.
[IFRS 16:B27]
21
Leases | A guide to IFRS 16
Therefore, for example, if a contract covers the use of a fleet of trucks for an agreed period and the customer has the right to decide
how and when the trucks are used, the fact that the supplier continues to operate and maintain the trucks does not undermine the
customer’s ability to direct the use of the trucks.
In the IASB’s view, the decisions about how and for what purpose an asset is used are more important in determining control of the use of
an asset than other decisions to be made about use, including decisions about operating and maintaining the asset. This is because
decisions about how and for what purpose an asset is used determine how, and what, economic benefits are derived from use.
[IFRS 16:BC120]
However, rights to operate an asset may grant the customer the right to direct the use of the asset if the relevant decisions about how
and for what purpose the asset is used are predetermined as contemplated in IFRS 16:B24(b)(i) (see 3.4.3.3).
When decisions about how and for what purpose an asset is used are predetermined, they cannot be changed by either the customer
or the supplier during the period of use. The IASB noted that it would expect these circumstances to arise in relatively few cases.
[IFRS 16:BC121]
When the relevant decisions about how and for what purpose the asset is used are predetermined, a customer has the right to direct the
use of an identified asset throughout the period of use only if either:
[IFRS 16:B24(b)]
i) the customer has the right to operate the asset (or to direct others to operate the asset in a manner that it determines) throughout the
period of use, without the supplier having the right to change those operating instructions; or
ii) the customer designed the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset wil
be used throughout the period of use.
22
Leases | A guide to IFRS 16
The approach to determining whether a customer has the right to direct the use of an identified asset changes if the decisions about how
and for what purpose an asset is used are predetermined. IFRS 16 clarifies that, in such circumstances, a customer can stil direct the use of
an asset if it has the right to operate the asset, or if it designed the asset in a way that predetermines how and for what purpose the
asset wil be used. In either of these cases, the customer controls rights of use that extend beyond the rights of a customer in a typical
supply or service contract (i.e. the customer has rights that extend beyond solely ordering and receiving output from the asset). In these
cases, the customer has the right to make (or, in the case of design, has already made) decisions that affect the economic benefits to be
derived from use of the asset throughout the period of use. [IFRS 16:BC122]
For example, consider a contract for the use of a fleet of trucks for an agreed period where the contract specifies how and for what
purpose the trucks are to be used (e.g. to carry rock from a specified quarry site to crushing facilities); these matters have been agreed
between the parties prior to the commencement date and they cannot be changed. In such circumstances, if the customer has the
right to operate the trucks throughout the period of use, under IFRS 16:B24(b)(i) it has the right to direct the use of the trucks,
notwithstanding its inability to change how and for what purpose the trucks are used. In contrast, if the supplier is the operator, then the
customer does not have the right to direct the use of the trucks, and there is no lease.
The concept of directing use through design (as contemplated in IFRS 16:B24(b)(ii)) is explored in Example 9A of the illustrative examples
accompanying IFRS 16 (see Appendix 1 for summary). In the situation described, the customer purchases all of the output of a solar farm
with predetermined activities. Although the customer makes no decisions during the life of the farm, it has the right to direct the use of the
farm as a result of having designed the asset before it was constructed.
For example, if a customer is able only to specify the output of an asset before the period of use, the customer does not have the right to
direct the use of that asset. The ability to specify the output in a contract before the period of use, without any other decision-making
rights relating to the use of the asset, gives a customer the same rights as any customer that purchases goods or services. [IFRS 16:B29]
It wil not be unusual for a customer to specify its requirements prior to the commencement of a contract and to reach an agreement with
the supplier as to how those requirements wil be met. For example, a customer requires a supply of iron over an extended period. It
agrees with the supplier prior to the commencement of supply that this requirement wil be met by utilising all of the capacity of a specifically
identified smelting plant operating for an agreed number of hours over that period. Assuming that the customer was not involved in the
design of the smelting plant, the fact that it is able to specify the output of the smelting plant before the period of use does not mean that it
has the right to direct the use of the plant. In this scenario:
• if the customer has the right to change how and for what purpose the smelting plant is used during the period of use, the customer
has the right to direct the use of the smelting plant and, subject to other conditions, there may be a lease;
• if the supplier has the right to change how and for what purpose the smelting plant is used during the period of use, the supplier has the
right to direct the use of the smelting plant and there is no lease; and
• if neither party has the right to change how and for what purpose the smelting plant is used, its activities are predetermined, and the
right to direct its use wil be determined by which entity is operating the smelting plant during the period of use (see 3.4.3.3).
23
Leases | A guide to IFRS 16
[IFRS 16:B30]
• specify the maximum amount of use of an asset or limit where or when the customer can use the asset; or
• require a customer to inform the supplier of changes in how an asset wil be used.
Rights of this nature typically define the scope of the customer’s right of use but do not, in isolation, prevent the customer from having the right
to direct the use of an asset. [IFRS 16:B30]
The illustrative examples accompanying IFRS 16 cite examples of protective rights, including the following.
• Example 1 describes a situation in which the customer generally determines when, where and how rail cars are used, but subject to
restrictions on the types of cargo (e.g. explosives) that can be carried. These restrictions are considered to be protective rights of the
supplier and to define the scope of the customer’s right to use the rail cars, but not to limit the customer’s right to direct the use of the rail
cars within that defined scope.
• Example 6B describes a situation in which the customer generally determines whether, where and when a ship sails, as well as the cargo
it wil carry, but contractual restrictions prevent the customer from sailing the ship into waters at a high risk of piracy or carrying hazardous
material as cargo. Again, these restrictions are considered to be protective rights that protect the supplier’s investment
in the ship and the supplier’s personnel. They define the scope of the customer’s right to use the ship but they do not limit the
customer’s right to direct the use of the ship within that defined scope.
24
Leases | A guide to IFRS 16
3.5 S u m m a r y flowchar t
The following flowchart, which is reproduced from IFRS 16, summarises the steps involved in the assessment as to whether a contract is, or
contains, a lease. [IFRS 16:B31]
No
Is there an identified asset?
Consider IFRS 16:B13 – B20.
Yes
Yes
No
Yes
25
Leases | A guide to IFRS 16
Section 4
Separating components of a contract
4.1 Separating components of a contrac t – requirements applicable for both lessees and lessors
Some contracts contain both lease and non-lease (service) components. For example, a contract for a car may combine a lease with
maintenance services. Other contracts contain two or more lease components. For example, a single contract may include leases of
land, buildings and equipment. [IFRS 16:BC133]
The IASB considers that the identification of separate lease components in a lease contract is similar to the identification of performance
obligations in a revenue contract – in both circumstances, an entity is trying to identify whether a customer or a lessee is contracting
for a number of separate deliverables or contracting for one deliverable that may incorporate a number of different assets. Accordingly,
rather than developing new requirements addressing how to identify separate lease components, the IASB decided to include in IFRS 16
requirements similar to those in IFRS 15 Revenue from Contracts with Customers on the identification of performance obligations.
The IASB intends that those requirements in IFRS 16 are applied in a similar way to their application within the context of a revenue
contract in IFRS 15. [IFRS 16:BC134]
Note that the effect of the practical expedient described in 4.2.3 is that lessees have a choice as to whether to separate the non-lease
components of a contract.
[IFRS 16:B32]
• the lessee can benefit from use of the underlying asset either on its own or together with other resources that are readily available to
the lessee. Readily available resources are goods or services that are sold or leased separately (by the lessor or other suppliers) or
resources that the lessee has already obtained (from the lessor or from other transactions or events); and
• the underlying asset is neither highly dependent on, nor highly interrelated with, the other underlying assets in the contract. For
example, the fact that a lessee could decide not to lease the underlying asset without significantly affecting its rights to use other
underlying assets in the contract might indicate that the underlying asset is not highly dependent on, or highly interrelated with, those
other underlying assets.
Take, for example, a contract for the hire of a pneumatic hammer and an air-compressor for breaking up concrete (assume that the
contract meets the definition of a lease). The hammer only works with an air-compressor. However, the hammer is not linked to the
specific air-compressor and could be used with a different compressor purchased or hired elsewhere. In this example, having regard to
the conditions in IFRS 16:B32, the contract is considered to have two separate lease components.
26
Leases | A guide to IFRS 16
In contrast, consider a contract for the hire of two interdependent items of equipment that have been specifically configured to work in
unison so that neither item can be readily substituted. In this case, the contract is likely to be considered to consist of only one lease.
Note that, even when separate lease components are identified, if the lease components have similar characteristics, it may be possible to
account for them as a single portfolio under IFRS 16:B1 (see 1.3).
The following example, which is reproduced from the illustrative examples accompanying IFRS 16, illustrates the application of IFRS
16:B32.
Example 4.1.2
Identificati on of lease components
[IFRS 16:Illustrative example 12 (part)]
Lessor leases a bulldozer, a truck and a long-reach excavator to Lessee to be used in Lessee’s mining operations for four years. Lessor also
agrees to maintain each item of equipment throughout the lease term. The total consideration in the contract is CU600,000, payable in
annual instalments of CU150,000, and a variable amount that depends on the hours of work performed in maintaining the long-reach
excavator. The
variable payment is capped at 2 per cent of the replacement cost of the long-reach excavator. The consideration includes the cost of
maintenance services for each item of equipment.
Lessee accounts for the non-lease components (maintenance services) separately from each lease of equipment applying
[IFRS 16:12]. Lessee does not elect the practical expedient in [IFRS 16:15 – see 4.2.3]. Lessee considers the requirements in [IFRS 16:B32]
and concludes that the lease of the bulldozer, the lease of the truck and the lease of the long-reach excavator are each separate lease
components. This is because:
a) Lessee can benefit from use of each of the three items of equipment on its own or together with other readily available resources
(for example, Lessee could readily lease or purchase an alternative truck or excavator to use in its operations); and
b) although Lessee is leasing all three items of equipment for one purpose (ie to engage in mining operations), the machines are neither
highly dependent on, nor highly interrelated with, each other. Lessee’s ability to derive benefit from the lease of each item of equipment
is not significantly affected by its decision to lease, or not lease, the other equipment from Lessor.
Consequently, Lessee concludes that there are three lease components and three non-lease components (maintenance services) in the
contract.
4.1.3 Activiti es and costs th at do not trans fer a good or ser vice to the lessee
A contract may include an amount payable by the lessee for activities and costs that do not transfer a good or service to the lessee. For
example, a lessor may include in the total amount payable a charge for administrative tasks, or other costs it incurs associated with the lease,
that do not transfer a good or service to the lessee. Such amounts payable do not give rise to a separate component of the contract, but
are considered to be part of the total consideration that is allocated to the separately identified components of the contract.
[IFRS 16:B33]
27
Leases | A guide to IFRS 16
For example, a contract includes a lease component (hire of a machine) and a non-lease component (maintenance of the machine over
the lease term). The contract also provides for an additional charge for administrative tasks of 2 per cent of the amounts otherwise
payable under the contract. Because these administrative tasks do not transfer a good or service to the lessee, the additional charge is
not considered to be a separate component of the contract. Rather, assuming that the lessee does not elect to use the practical
expedient in IFRS 16:15 (see 4.2.3), both the lessee and the lessor account for the hire and maintenance components separately and the
administration charge is included in the total consideration to be allocated between those components.
The relative stand-alone price of lease and non-lease components should be determined on the basis of the price the lessor, or a similar
supplier, would charge an entity for that component, or a similar component, separately. If an observable stand-alone price is not readily
available, the lessee should estimate the stand-alone price, maximising the use of observable information. [IFRS 16:14]
IFRS 16:14 permits a lessee to estimate the stand-alone prices of lease components because it may not have the necessary information to
determine the lessor’s stand-alone prices. The Standard requires the lessee to maximise the use of observable information – for example,
the price charged by other suppliers or the price charged by the supplier to other customers.
In addition, having regard to the likelihood that a lessee may not have complete information on the lessor’s pricing model, the IASB has
granted relief from the requirement to separate non-lease components (see 4.2.3).
Thinking it through
In order to assist with their estimation process, lessees are likely to look first to lessors for more detailed information on the
pricing of bundled contracts. Some lessors can be expected to be relatively forthcoming with such information, but this is
unlikely to be the case across the board, meaning that lessees may need to look further afield to make an estimate of the
relative stand-alone prices.
In the case of ‘wet’ leases of aircraft or ships, entities may be able to observe prices for ‘dry’ leases to begin this estimation
process. The determination of stand-alone prices for communal spaces and services linked to a property is likely to be a more
dificult process and involve more complex judgements. If non-lease components are not expected to be a significant
proportion of the rentals, or if the judgements are dificult, a lessee may decide to use the practical expedient and not separate
the lease components, as explained in 4.2.3.
The following example, which is reproduced from the illustrative examples accompanying IFRS 16, illustrates the application of IFRS
16:13 and 14.
28
Leases | A guide to IFRS 16
Example 4.2.1
Allocati on of considerati on between lease and non-lease components
[IFRS 16:Illustrative example 12 (part 2)]
Lessee applies the guidance in [IFRS 16:3 and 14] to allocate the consideration in the contract to the three lease components and the
non-lease components.
Several suppliers provide maintenance services for a similar bulldozer and a similar truck. Accordingly, there are observable stand-alone
prices for the maintenance services for those two items of leased equipment. Lessee is able to establish observable stand-alone prices for the
maintenance of the bulldozer and the truck of CU32,000 and CU16,000, respectively, assuming similar payment terms to those in the
contract with Lessor. The long-reach excavator is highly specialised and, accordingly, other suppliers do not lease or provide maintenance
services
for similar excavators. Nonetheless, Lessor provides four-year maintenance service contracts to customers that purchase similar long-reach
excavators from Lessor. The observable consideration for those four-year maintenance service contracts is a fixed amount of CU56,000, payable
over four years, and a variable amount that depends on the hours of work performed in maintaining the long-reach excavator. That variable
payment is capped at 2 per cent of the replacement cost of the long-reach excavator. Consequently, Lessee estimates the stand-alone price of
the maintenance services for the long-reach excavator to be CU56,000 plus any variable amounts. Lessee is able to establish observable stand-
alone prices for the leases of the bulldozer, the truck and the long-reach excavator of CU170,000, CU102,000 and CU224,000, respectively.
Lessee allocates the fixed consideration in the contract (CU600,000) to the lease and non-lease components as follows:
Long-reach
CU Bulldozer Tr u ck excavator Total
Non-lease 104,000
Lessee allocates all of the variable consideration to the maintenance of the long-reach excavator, and, thus, to the non-lease
components of the contract. Lessee then accounts for each lease component applying the guidance in IFRS 16, treating the allocated
consideration as the lease payments for each lease component.
29
Leases | A guide to IFRS 16
IFRS 16 only deals with the accounting for lease components of a contract – not the accounting for services. The IASB considers that the
accounting for services (or the service components of a contract) should not be affected, regardless of whether the contract is only for
services or includes the purchase, or lease, of an asset as well as services. [IFRS 16:BC135]
Consequently, although IFRS 16 requires entities to separate non-lease components (unless the practical expedient in IFRS 16:15 is used)
and to allocate consideration to those non-lease components in aggregate, it does not specify how the aggregate allocation should be
apportioned between separate non-lease components nor the subsequent accounting for such consideration. These matters wil be
determined under other applicable Standards.
4.2.3 Relief from requirement to separate non-lease components from lease components – practi cal expedient
As a practical expedient, a lessee may elect not to separate non-lease components from lease components, and instead account for each
lease component and any associated non-lease components as a single lease component. This election should be made by class of
underlying asset. [IFRS 16:15]
Note that, if the practical expedient is adopted, an entity accounts for the combined lease and non-lease component as a single lease
component – it is not permitted to account for the combined lease and non-lease component as a service. Note also that IFRS 16:15
does not provide any relief from the requirement to account separately for individual lease components if the conditions in IFRS 16:B32
(see 4.1.2) are met; however, in some circumstances, an entity may be able to apply a portfolio approach (see 1.3).
Thinking it through
Separating non-lease components reduces the amounts recognised as the leased asset and lease liability. It wil also give a
smoother expense profile, but the expense related to the non-lease components is classified as operating.
Lessors are therefore required to allocate the consideration in a contract between lease and non-lease components using the
requirements in IFRS 15 regarding the allocation of the transaction price to performance obligations. This approach is designed to
ensure consistency for entities that are both a lessor and a seller of goods or services in the same contract. [IFRS 16:BC136]
Although IFRS 16 includes a practical expedient permitting lessees not to separate non-lease components from lease components (see
4.2.3), there is no equivalent practical expedient for lessors. The IASB believes that a lessor should be able to separate payments
for lease and non-lease components. This is because the lessor would need to have information about the value of each component, or a
reasonable estimate of it, when pricing the contract. [IFRS 16:BC135(a)]
30
Leases | A guide to IFRS 16
[IFRS 16:18]
• periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and
• periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option”.
See 5.5 to 5.7 for a discussion of lessor and lessee termination and extension options.
Thinking it through
In order to minimise the impact of applying IFRS 16, lessees may look to enter into leases with shorter terms than they have done
historically or to revisit their lease-buy strategies. Although shorter leases can potentially produce more desirable accounting
outcomes, operationally they may result in less security for lessees and lessors alike. In addition, lessees may wish to consider how
users of financial statements (e.g. analysts) might view such an approach. Historically, for the purpose of making comparisons,
analysts have often applied a specific multiple to operating lease expenses to approximate an IFRS 16-type liability; in the future,
they could make similar adjustments for those lessees with shorter/longer than average lease terms.
For the purposes of IFRS 16, a contract is considered to exist only when it creates rights and obligations that are enforceable. Any non-
cancellable period or notice period in a lease meets the definition of a contract and, therefore, should be included as part of the lease
term. Any options to extend or terminate the lease that are included in the lease term must also be enforceable.
In assessing the enforceability of a contract, an entity should consider whether the lessor can refuse a request from the lessee to extend
the lease. If optional periods are not enforceable (e.g. if the lessee cannot enforce the extension of the lease without the agreement of the
lessor), the lessee does not have the right to use the asset beyond the non-cancellable period. By definition, there is no contract beyond
the non-cancellable period (plus any notice period) if there are no enforceable rights and obligations existing between the lessee and lessor
beyond that term. [IFRS 16:BC127]
A lease is no longer enforceable when the lessee and the lessor each has the right to terminate the lease without permission from the
other party with no more than an insignificant penalty. [IFRS 16:B34]
31
Leases | A guide to IFRS 16
IFRS 16 makes an important distinction between the ‘inception date’ and the ‘commencement date’ of a lease. The inception date of the
lease is defined as the earlier of the date of the lease agreement and the date of commitment by the parties to the principal provisions of the
lease. [IFRS 16:Appendix A] This is the date on which an entity evaluates a contract to determine whether it is, or contains, a lease (see
section 3). For lessors, it is also the date at which the classification of a lease is determined (see section 8).
Therefore, although important assessments are made at the inception date, the assets, liabilities, income and expenses resulting from
a lease are not recognised in the financial statements or measured until the commencement date (see IFRS 16:BC142 to BC144 for further
discussion).
A lessee does not obtain and control its right to use the underlying asset until the commencement date. Before that date, the lessor has
not yet performed under the contract. Although a lessee may have a right and an obligation to exchange lease payments for a right-
of-use asset from the date of inception, the lessee is unlikely to have an obligation to make lease payments before the asset is made
available for its use. [IFRS 16:BC142]. If such circumstances do arise (i.e. if the entity is required to make payments for the right to use the
underlying asset before the commencement date), IFRS 16:B44 explicitly requires that they be included in lease payments (see 7.3.2).
Example 5.3
Lease payment s on assets not in use
Company X is planning a major expansion of its oil production capacity beginning in 20X2. In order to ensure suficient shipping capacity is
available when production increases, Company X enters into a lease contract on 1 January 20X1 for rail cars to ship the oil. The rail cars wil
be made available to Company X from 1 July 20X1. Company X does not expect to use the rail cars for its own shipping purposes until 20X2,
but it may consider other options (e.g. to rent out the cars to other producers) in the second half of 20X1. The sole reason for entering
into the lease contract in 20X1 is to ensure that the rail cars wil be available to Company X in 20X2.
The inception date of the lease is 1 January 20X1 (or any earlier date on which the parties committed to the principal provisions of the
lease). This is the date on which Company X evaluates the contract to determine whether it is, or contains, a lease. Assume that, having
regard to the requirements set out in 3.3 (identified assets, no substantive substitution rights and, from 1 July 20X1, the right to control
the use of the rail cars), Company X determines that the contract is a lease. [In fact, each of the rail cars may be considered a separate
lease component – see section 4. However, it is assumed that Company X applies the practical expedient in IFRS 16:B1 (see 1.3) and
accounts for the portfolio of leases together.]
The lessor makes the rail cars available for use by Company X on 1 July 20X1. Company X has the right to control the use of the rail cars from
that date. Although Company X does not intend to use the rail cars until 20X2, it has the right to determine how and for what purpose the
rail cars are used from 1 July 20X1. If Company X chooses to store the rail cars rather than use them for a period of time, this is a
demonstration of its control over those cars. Therefore, 1 July 20X1 is the commencement date of the lease and the assets, liabilities,
income and expenses resulting from the lease are recognised and measured from that date.
The depreciation of the right-of-use asset should commence from 1 July 20X1 (i.e. the commencement date – see 7.5.1.3) even if the rail
cars are not used until 20X2.
32
Leases | A guide to IFRS 16
A lessor’s right to terminate a lease is ignored when determining the lease term because, in that case, the lessee has an unconditional
obligation to pay for the right to use the asset for the period of the lease, unless and until the lessor decides to terminate the lease. [IFRS
16:BC128]
This principle applies for the determination of the lease term for the lessor as well as for the lessee – there is no assessment regarding
whether the lessor is reasonably certain not to terminate, as is the case with lessee termination options (see 5.6).
In contrast to lessor termination options, if the lessee has the right to extend or terminate the lease, there are enforceable rights and
obligations beyond the initial non-cancellable period and the parties to the lease are required to consider those optional periods in their
assessment of the lease term. [IFRS 16:BC128]
In accordance with IFRS 16:18 (see 5.1), the lease term wil be considered to extend beyond the non-cancellable period if the lessee
has an extension option that it is considered to be reasonable certain to exercise, or a termination option that it is considered to
be reasonably certain not to exercise.
At the commencement date, the entity should assess whether the lessee is reasonably certain:
[IFRS 16:B37]
In making these assessments, the entity considers all relevant facts and circumstances that create an economic incentive for the lessee to
exercise, or not to exercise, the option, including any expected changes in facts and circumstances from the commencement date until
the exercise date of the option. [IFRS 16:19 & B37]
Examples of factors to consider when making these assessments include, but are not limited to:
[IFRS 16:B37]
• contractual terms and conditions for the optional periods compared with market rates, such as: –
the amount of payments for the lease in any optional period;
– the amount of any variable payments for the lease or other contingent payments, such as payments resulting from termination
penalties and residual value guarantees; and
– the terms and conditions of any options that are exercisable after initial optional periods (e.g. a purchase option that is exercisable at the
end of an extension period at a rate that is currently below market rates);
33
Leases | A guide to IFRS 16
• significant leasehold improvements undertaken (or expected to be undertaken) over the term of the contract that are expected to
have significant economic benefit for the lessee when the option to extend or terminate the lease, or to purchase the underlying asset,
becomes exercisable;
• the importance of that underlying asset to the lessee’s operations (considering, for example, whether the underlying asset is a
specialised asset, the location of the underlying asset and the availability of suitable alternatives); and
• conditionality associated with exercising the option (i.e. when the option can be exercised only if one or more conditions are met), and
the likelihood that those conditions wil exist.
An option to extend or terminate a lease may be combined with one or more other contractual features (e.g. a residual value guarantee)
such that the lessee guarantees the lessor a minimum or fixed cash return that is substantially the same regardless of whether the option is
exercised. In such cases, and notwithstanding the guidance on in-substance fixed payments in IFRS 16:B42 (see 6.3), an entity should
assume that the lessee is reasonably certain to exercise the option to extend the lease, or not to exercise the option to terminate the
lease. [IFRS 16:B38]
The shorter the non-cancellable period of a lease, the more likely a lessee is to exercise an option to extend the lease or not to exercise an
option to terminate the lease. This is because the costs associated with obtaining a replacement asset are likely to be proportionately higher
the shorter the non-cancellable period. [IFRS 16:B39]
A lessee’s past practice regarding the period over which it has typically used particular types of assets (whether leased or owned), and its
economic reasons for doing so, may provide information that is helpful in assessing whether the lessee is reasonably certain to exercise, or
not to exercise, an option. For example, if a lessee has typically used particular types of assets for a particular period of time, or if the lessee
has a practice of frequently exercising options on leases of particular types of underlying assets, the lessee should consider the
economic reasons for that past practice in assessing whether it is reasonably certain to exercise an option on leases of those assets. [IFRS
16:B40]
[IFRS 16:20]
• affects whether the lessee is reasonably certain to exercise an option not previously included in its determination of the lease term, or
not to exercise an option previously included in its determination of the lease term.
34
Leases | A guide to IFRS 16
In principle, the IASB is of the view that users of financial statements receive more relevant information if lessees reassess extension,
termination and purchase options on a regular basis. However, requiring reassessment at each reporting date would be costly for an entity
with many leases that include options. In order to address that concern, while stil providing useful information to users of financial statements,
the Board decided that an appropriate balance would be achieved by requiring reassessment only if both of the criteria
in IFRS 16:20 are met. Consequently reassessment is required only upon the occurrence of a significant event or a significant change in
circumstances that is within the control of the lessee and that affects whether the lessee is reasonably certain to exercise, or not to
exercise, an option to extend a lease, to terminate a lease or to purchase an underlying asset. Limiting the reassessment requirement to
events within the control of the lessee means that a lessee is not required to reassess options in response to purely market-based
events or changes in circumstances. To assist lessees, IFRS 16:B41 (see below) includes some examples of possible triggering events to
help entities apply judgement in identifying significant events or significant changes in circumstances that trigger reassessment.
[IFRS 16:BC184 – BC186]
[IFRS 16:B41]
• significant leasehold improvements not anticipated at the commencement date that are expected to have significant economic benefit
for the lessee when the option to extend or terminate the lease, or to purchase the underlying asset, becomes exercisable;
• a significant modification to, or customisation of, the underlying asset that was not anticipated at the commencement date;
• the inception of a sublease of the underlying asset for a period beyond the end of the previously determined lease term; and
• a business decision of the lessee that is directly relevant to exercising, or not exercising, an option (e.g. a decision to extend the lease of a
complementary asset, to dispose of an alternative asset or to dispose of a business unit within which the right-of-use asset is employed).
[IFRS 16:21]
• the lessee exercises an option not previously included in the entity’s determination of the lease term;
• the lessee does not exercise an option previously included in the entity’s determination of the lease term;
• an event occurs that contractually obliges the lessee to exercise an option not previously included in the entity’s determination of the
lease term; or
• an event occurs that contractually prohibits the lessee from exercising an option previously included in the entity’s determination of the
lease term.
The lease term may also be revised following a reassessment as to whether an extension option is reasonably certain to be exercised, or
a termination option is reasonably certain not to be exercised (see 5.7). Although such a reassessment does not affect the non-
cancellable period, it affects the total lease term comprised of the non-cancellable period and reasonably certain extension periods (see
5.1).
35
Leases | A guide to IFRS 16
A number of the measurement requirements in IFRS 16 are determined by reference to the ‘lease payments’. Lease payments are defined
as payments made by a lessee to a lessor relating to the right to use an underlying asset during the lease term, comprising the following:
[IFRS 16:Appendix A]
• fixed payments (including in-substance fixed payments – see 6.3), less any lease incentives (see 6.4);
• the exercise price of a purchase option if the lessee is reasonably certain to exercise that option (see 6.6);
• payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease; and
In accordance with IFRS 16:18 (see 5.1), the lease term wil be considered to extend beyond the non-cancellable period if the lessee
has an extension option that it is considered to be reasonably certain to exercise, or a termination option that it is considered to
be
reasonably certain not to exercise. Therefore, lease payments include optional payments payable after the non-cancellable period if it is
considered reasonably certain that the lease wil extend beyond that period.
Lease payments exclude (1) variable lease payments linked to future performance or use of the underlying asset (see 6.5.3), and (2)
optional payments payable after the non-cancellable period if it is not considered reasonably certain that the lessee wil extend the
lease beyond that period.
Entities are generally required to separate lease and non-lease components of a contract (see section 4).
For a lessee, lease payments do not include payments allocated to non-lease components of a contract, unless the lessee has elected to
combine lease and non-lease components under the practical expedient permitted under IFRS 16:15 (see 4.2.3). [IFRS 16:Appendix A]
For a lessor, lease payments do not include payments allocated to non-lease components. [IFRS 16:Appendix A]
For a lessor, there is no practical expedient permitting lease and non-lease components to be combined (see 4.3).
Fixed payments are defined as “[p]ayments made by a lessee to a lessor for the right to use an underlying asset during the lease term,
excluding variable lease payments”. [IFRS 16:Appendix A]
‘In-substance’ fixed lease payments, which are specifically required to be included in lease payments (see 6.1), are payments that may,
in form, contain variability but that, in substance, are unavoidable. [IFRS 16:B42]
[IFRS 16:B42]
• payments are structured as variable lease payments, but there is no genuine variability in those payments. Those payments contain
variable clauses that do not have real economic substance. Examples of those types of payments include:
36
Leases | A guide to IFRS 16
– payments that must be made only if an asset is proven to be capable of operating during the lease, or only if an event occurs that has
no genuine possibility of not occurring; or
– payments that are initially structured as variable lease payments linked to the use of the underlying asset but for which the variability wil
be resolved at some point after the commencement date so that the payments become fixed for the remainder of the lease term.
Those payments become in-substance fixed payments when the variability is resolved;
• there is more than one set of payments that a lessee could make, but only one of those sets of payments is realistic. In this case, an
entity should include within lease payments the realistic set of payments; and
• there is more than one realistic set of payments that a lessee could make, but it must make at least one of those sets of payments. In this
case, an entity should include within lease payments the set of payments that aggregates to the lowest amount (on a discounted basis).
IFRS 16 requires a lessee to include in-substance fixed lease payments in the measurement of lease liabilities because those payments
are unavoidable and, therefore, are economically indistinguishable from fixed lease payments. [IFRS 16:BC164]
Such incentives may take the form, for example, of an up-front cash payment to the lessee or a reimbursement or assumption by the
lessor of costs of the lessee (e.g. relocation costs and costs associated with a pre-existing lease commitment of the lessee).
Such payments are offset against lease payments made by the lessee to the lessor (see 6.1). When any incentives are paid to the lessee,
even if they are not part of the formal lease agreement, they should be offset against lease payments.
[IFRS 16:BC163]
• price changes due to changes in a market rate or the value of an index. For example, lease payments might be adjusted for changes in a
benchmark interest rate or a consumer price index (see 6.5.2);
• the lessee’s performance derived from the underlying asset. For example, a lease of retail property may specify that lease payments
are based on a specified percentage of sales made from that property (see 6.5.3); or
• the use of the underlying asset. For example, a vehicle lease may require the lessee to make additional lease payments if the lessee
exceeds a specified mileage (see 6.5.3).
6.5.2.1 Lease liabilit y initi ally measured using the index or rate a s at the commencement date
Variable lease payments that depend on an index or a rate (which, as indicated in 6.1, should be included within lease payments) include,
for example, payments linked to a consumer price index, payments linked to a benchmark interest rate (such as LIBOR) or payments that
vary to reflect changes in market rental rates.[IFRS 16:28]
37
Leases | A guide to IFRS 16
When measuring a lessee’s lease liability (see 7.4.2.1) or a lessor’s net investment in a lease (see 9.1.1), such payments should initially be
measured using the index or rate as at the commencement date (see 5.3).
Variable lease payments that depend on an index or a rate are included in lease payments. They meet the definition of liabilities for the
lessee because they are unavoidable and do not depend on any future activity of the lessee. Any uncertainty, therefore, relates to the
measurement of the liability that arises from those payments and not to the existence of that liability. [IFRS 16:BC165]
At initial recognition, such payments are measured using the index or rate at the commencement date (without estimating changes in
the index or rate over the remainder of the lease term). The IASB considered that using forecasting techniques or forward rates to
estimate changes in the index or rate would be costly, and might introduce measurement uncertainty and reduce comparability
between entities. [IFRS 16:BC166]
The following example, which is reproduced from the illustrative examples accompanying IFRS 16, illustrates how a lessee accounts for
variable lease payments that depend on an index.
Example 6.5.2.2
Variable lease payments tha t depend on a n index
[IFRS 16:Illustrative example 14A]
Example 14A – Lessee enters into a 10-year lease of property with annual lease payments of CU50,000, payable at the beginning of each year.
The contract specifies that lease payments will increase every two years on the basis of the increase in the Consumer Price Index for the preceding 24
months. The Consumer Price Index at the commencement date is 125. This example ignores any initial direct costs. The rate implicit in the lease is
not readily determinable. Lessee’s incremental borrowing rate is 5 per cent per annum, which reflects the fixed rate at which Lessee could borrow an
amount similar to the value of the right-of-use asset, in the same currency, for a 10-year term, and with similar collateral.
At the commencement date, Lessee makes the lease payment for the first year and measures the lease liability at the present value of
the remaining nine payments of CU50,000, discounted at the interest rate of 5 per cent per annum, which is CU355,391.
Lessee initially recognises assets and liabilities in relation to the lease as follows.
Lessee expects to consume the right-of-use asset’s future economic benefits evenly over the lease term and, thus, depreciates the right-of-use asset
on a straight-line basis.
38
Leases | A guide to IFRS 16
During the first two years of the lease, Lessee recognises in aggregate the following related to the lease.
At the beginning of the second year, Lessee makes the lease payment for the second year and recognises the following.
Cash CU50,000
At the beginning of the third year, before accounting for the change in future lease payments resulting from a change in the Consumer
Price Index and making the lease payment for the third year, the lease liability is CU339,319 (the present value of eight payments of
CU50,000 discounted at the interest rate of 5 per cent per annum = CU355,391 + CU33,928 – CU50,000).
At the beginning of the third year of the lease the Consumer Price Index is 135.
The payment for the third year, adjusted for the Consumer Price Index, is CU54,000 (CU50,000 × 135 ÷ 125). Because there is a change in
the future lease payments resulting from a change in the Consumer Price Index used to determine those payments, Lessee remeasures
the lease liability to reflect those revised lease payments, ie the lease liability now reflects eight annual lease payments of CU54,000.
At the beginning of the third year, Lessee remeasures the lease liability at the present value of eight payments of CU54,000 discounted at
an unchanged discount rate of 5 per cent per annum, which is CU366,464. Lessee increases the lease liability by CU27,145, which
represents the difference between the remeasured liability of CU366,464 and its previous carrying amount of CU339,319. The
corresponding adjustment is made to the right-of-use asset, recognised as follows.
At the beginning of the third year, Lessee makes the lease payment for the third year and recognises the following.
Cash CU54,000
39
Leases | A guide to IFRS 16
When variable payments depend on a rate, the accounting is a little different, as illustrated in the following example.
Example 6.5.2.3
In accordance with IFRS 16:27(b), the lease payments should initially be measured using the rate (i.e. LIBOR) as at the commencement
date. LIBOR at that date is 2 per cent; therefore, in measuring the lease liability, it is assumed that each year the payments wil increase
by 2 per cent, as follows.
CU CU
1 1000 1 1,000
8,806
40
Leases | A guide to IFRS 16
When a lease contract includes the potential for rent reviews (whether to market rates or upward only), the lease payments included in
the measurement of the lessee’s lease liability and the lessor’s net investment in the lease at the commencement date wil be the
payments agreed at inception, without consideration of future rent reviews.
Whether a lease specifies a rent of CU100 annually plus market increases, or CU100 annually resetting up or down to market every
five years, the lease payments recognised at the commencement date are CU100 annually. Any increase or decrease as a result of
subsequent rent reviews wil be recognised when the adjustment to the lease payments takes effect (see 8.5.2.7).
The basis of any rent review under a lease should be evaluated carefully to determine whether the rent review resets the lease
payments to market at the date of the review or whether, in substance, the amount of change in the lease payments at the date of the
review was fixed at inception. In the latter case, the changes in rent would represent ‘in-substance’ fixed payments (see 7.3) and would
therefore be included in lease payments from the commencement date.
6.5.3 Variable lease pay ment s linked to future per formance or use of a n underlying asset
Variable lease payments linked to future performance or use of an underlying asset are excluded from the measurement of lease
liabilities (see IFRS 16:BC168 and BC169 for a discussion of the IASB’s considerations in this regard).
Such payments are required to be recognised in profit or loss in the period in which the event or condition that triggers those payments
occurs (see 7.5.2.3).
The following example, which is reproduced from the illustrative examples accompanying IFRS 16, illustrates how a lessee accounts for
variable lease payments not included in the measurement of the lease liability.
Example 6.5.3
Variable lease payments linked to sales
[IFRS 16:Illustrative example 14B]
Assume the same facts as [example 6.5.2.2] except that Lessee is also required to make variable lease payments for each year of the lease,
which are determined as 1 per cent of Lessee’s sales generated from the leased property.
At the commencement date, Lessee measures the right-of-use asset and the lease liability recognised at the same amounts as in
[example 6.5.2.2]. This is because the additional variable lease payments are linked to future sales and, thus, do not meet the definition of
lease payments. Consequently, those payments are not included in the measurement of the asset and liability.
Right-of-use asset CU405,391
Lessee prepares financial statements on an annual basis. During the first year of the lease, Lessee generates sales of CU800,000 from the leased
property.
Lessee incurs an additional expense related to the lease of CU8,000 (CU800,000 × 1 per cent), which Lessee recognises in profit or loss in
the first year of the lease [see 6.5.2.3].
41
Leases | A guide to IFRS 16
Purchase options are required to be included in the measurement of a lessee’s lease liability and a lessor’s lease receivable in the same way
as options to extend the term of a lease (i.e. the exercise price of a purchase option is included in the measurement of a lease
liability/receivable if the lessee is reasonably certain to exercise that option). The IASB views a purchase option as effectively the ultimate
option to extend the lease term. A lessee that has an option to extend a lease for all of the remaining economic life of the underlying asset is,
economically, in a similar position to a lessee that has an option to purchase the underlying asset. [IFRS 16:BC173]
For a lessee, lease payments include amounts expected to be payable by the lessee under residual value guarantees. [IFRS 16:Appendix A]
A lessee should estimate the amount that it expects to pay to the lessor under a residual value guarantee and include that amount in the
measurement of its lease liability. This treatment reflects the fact that payments resulting from a residual value guarantee cannot be
avoided by the lessee – the lessee has an unconditional obligation to pay the lessor if the value of the underlying asset moves in a particular
way. Accordingly, any uncertainty relating to the payment of a residual value guarantee does not relate to whether the lessee has an
obligation. Instead, it relates to the amount that the lessee may have to pay, which can vary in response to movements in the value of the
underlying asset. In that respect, residual value guarantees are similar to variable lease payments that depend on an index or a rate for the
lessee (see 6.5.2). [IFRS 16:BC170 & BC171]
For a lessor, lease payments include any residual value guarantees provided to the lessor by the lessee, a party related to the lessee or a
third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee. [IFRS 16:Appendix A]
42
Leases | A guide to IFRS 16
[IFRS 16:22]
• a lease liability.
[IFRS 16:5]
• leases for which the underlying asset is of low value (see 7.2.3 and subject to the exception in 7.2.3.5).
For short-term leases or leases of low-value items to which this exemption is applied, lease payments are recognised as an expense over
the lease term (see 7.2.4).
Thinking it through
Some entities may decide that they do not wish to take advantage of these exemptions, perhaps because recognising lease
assets and liabilities and presenting the lease expense as interest and depreciation is considered preferable to an off-balance
sheet treatment with an operating expense. Or, for some lessees, while they may see benefit to having such leases off-balance
sheet, that benefit may not be suficient to justify the additional cost or complexity of having two lease accounting systems.
A lease that contains a purchase option cannot be classified as a short-term lease. [IFRS 16:Appendix A]
For the purposes of the definition of a short-term lease, the lease term should be determined under the general requirements of
IFRS 16 (see section 5). Consequently, lessees wil need to assess the effect of extension and termination options.
Note that the prohibition on a lease containing a purchase option being classified as a short-term lease applies for any lease containing a
purchase option, irrespective of the probability that the option wil be exercised.
Note also that there is no restriction on qualification as a short-term lease based on the value of the underlying asset or the amount of the
consideration paid. This exemption is available for high-value items that are leased for the short term.
43
Leases | A guide to IFRS 16
For example, consider an entity that has leased several items of ofice equipment – some for less than 12 months and some for longer
than 12 months, with none containing purchase options. Assuming that the items of ofice equipment are all considered to be of the same
class, if the entity wishes to use the short-term lease exemption it must apply that exemption for all of the leases with terms of 12
months or less. The leases with terms longer than 12 months wil be accounted for in accordance with the general recognition and
measurement requirements for lessees.
[IFRS 16:7]
• there is any change in the lease term (e.g. the lessee exercises an option not previously included in its determination of the lease term).
See 7.7 for the definition of lease modifications and the accounting treatment generally required. In the context of a short-term lease, any
lease modification (and, specifically, any change in the lease term) wil be considered a new lease which wil need to be reassessed to
determine if it qualifies for the short-term lease exemption.
See 1.4 for IFRS 16’s requirements regarding circumstances when two or more contracts that are interdependent should be combined
and accounted for as a single contract. One specific example cited in this regard is when a lessee enters into a number of one-year leases
at the same time and with the same counterparty, to follow sequentially such that the overall economic effect is a lease for the entire term.
In that situation, if the conditions in IFRS 16:B2 are met, the leases would be combined and accounted for as a single lease (which would
not qualify for the short-term lease exemption).
IFRS 16 does not provide an explicit definition for what is meant by ‘low-value’ assets. However, the Basis of Conclusions states that “[a]t
the time of reaching decisions about the exemption in 2015, the IASB had in mind leases of underlying assets with a value, when new, in the
order of magnitude of US$5,000 or less”. [IFRS 16:BC100]
Examples of low-value underlying assets can include tablet and personal computers, small items of ofice furniture and telephones. [IFRS
16:B8]
44
Leases | A guide to IFRS 16
Thinking it through
In practice, determining whether items are of 'low value' is going to be challenging given that the pointers in the guidance are so
limited. While US$5,000 may be considered 'low' in some jurisdictions, it may not be in others, and it is possible that
some lessees wil put more focus on the nature of the underlying assets (the Standard cites as examples tablet and personal
computers, small items of ofice furniture and telephones). It is likely that this wil continue to be a significant area of judgement
which may become clearer as practice develops.
A lease of an underlying asset does not qualify as a lease of a low-value asset if the nature of the asset is such that, when new, the asset is
typically not of low value. For example, leases of cars would not qualify as leases of low-value assets because a new car would typically not be
of low value. [IFRS 16:B6]
In particular, an entity is not required to consider the aggregate of the leases identified as relating to low-value assets to determine if the
overall effect is material (see also 7.2.3.2).
Subject to IFRS 16’s general requirements regarding the combination of interdependent contracts (see 1.4), and the specific
requirements in IFRS 16:B5 regarding assets that are highly interdependent or highly interrelated (see 7.2.3.5), each lease is assessed
separately.
For example, a hospital enters into a rental contract for a large number of hospital beds. Each bed within the contract constitutes an
identified underlying asset and the other conditions for identification of a lease are met. The value of an individual hospital bed would be
considered to be ‘low’, even though the contract for all of the beds is not. The conditions of IFRS 16:B5 are met (the hospital can benefit from
the use of an individual bed together with other resources that are already available, and each individual bed does not need other assets to
make it functional for patients). Consequently each bed qualifies as a low-value asset and the entity can elect to apply the low-value asset
exemption to all of the beds under the contract.
7.2.3.5 A ssets tha t are highly dependent on, or highly interrelated with, other asset s do not qualif y a s low-value asset s
A lease wil qualify for this exemption only if:
[IFRS 16:B5]
• the lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the
lessee; and
• the underlying asset is not highly dependent on, or highly interrelated with, other assets.
45
Leases | A guide to IFRS 16
Therefore, if either (1) the lessee cannot benefit from the underlying asset on its own or together with other readily available resources, or
(2) the underlying asset is highly dependent on, or highly interrelated with, other underlying assets, the recognition exemption
for low-value assets cannot be applied to that individual asset (unless the overall asset, combining the highly dependent or highly interrelated
assets, is itself low value). In this context, the IASB had in mind large assets made up of a number of individual leases of low-value assets
(such as IT equipment made up of individually low-value component parts).
See example 1.3 which sets out a scenario in which some items of IT equipment (laptop computers, desktop computers, hand held
computer devices, desktop printers and mobile phones) qualify for the low-value asset exemption but others (individual modules that
increase the storage capacity of mainframe servers) do not. Although each module within the servers, if considered individually, might be
an asset of low value, the leases of modules within the servers do not qualify as leases of low-value assets. This is because each module is
highly interrelated with other parts of the servers.
7.2.4 Recogniti on of lease payment s for shor t- term leases and leases of low-value assets
If a lessee elects to apply the exemption in IFRS 16:5 to either short-term leases or leases of low-value assets, it should recognise the lease
payments associated with those leases as an expense on either a straight-line basis over the lease term, or on another systematic basis if
that basis is more representative of the pattern of the lessee’s benefit. [IFRS 16:6]
For example, if the lease payments for an asset are based on the actual usage of that asset, or are revised periodically to reflect the
eficiency of the asset or current market rates, the amounts actually payable may be an appropriate measure.
The lease payments to be spread on a straight-line (or other systematic) basis are after deduction of any lease incentives (see 6.4).
The lease term includes any rent-free periods (see 5.4). The following examples illustrate the recognition of lease payments under
IFRS 16:6 when such features are present.
46
Leases | A guide to IFRS 16
Example 7.2.4A
Recognition of lease pay ments (including lease incentives) for low-value asset s
Entity A leases ofice equipment for 5 years. The total value of the equipment when new is CU5,000 (determined by Entity A to be ‘low
value’). Entity A elects to apply the low-value asset exemption.
In addition, the lessor provides a lease incentive with a value of CU500. The lessee’s benefit under the lease arises on a straight-line
basis over the full lease term.
Example 7.2.4B
Period over which lease incentives should be recognised
Entity B leases ofice equipment for 5 years. The total value of the equipment when new is CU5,000 (determined by Entity B to be ‘low
value’). Entity B elects to apply the low-value asset exemption.
The lease includes a clause requiring lease payments to be repriced to market rates part-way through the lease term. The lessor grants
an incentive to Entity B to enter into the lease arrangement.
Over what period should the lease incentive be recognised (i.e. over the whole of the lease term or over the period up to the repricing of
lease payments to market rates)?
The lease incentive should be recognised over the lease term. It should be recognised on a straight-line basis, unless another systematic
basis is more representative of the time pattern of Entity B’s benefit from use of the leased asset.
The IFRIC (now the IFRS Interpretations Committee) was asked to consider this issue in 2005 (in the context of SIC-15 Operating Leases –
Incentives, but equally applicable for entities applying the low-value asset exemption under IFRS 16). Specifically, the IFRIC was asked to
consider whether the lease incentive should be recognised over the shorter period ending when the lease payments are adjusted to
market rates on the basis that the lease expense of a lessee after a lease is repriced to market ought to be comparable with the lease
expense of an entity entering into a new lease at that same time at market rates. The IFRIC did not accept this argument and confirmed
that the general requirements for spreading lease incentives over the entire lease term should apply.
47
Leases | A guide to IFRS 16
7.3 Lessee involvement with the underlying asset before the commencement date
7.3.1 Costs of the lessee relati ng to the cons truc ti on or design of the underlying asset
Parties may negotiate a lease before the underlying asset is available for use by the lessee. For some leases, the underlying asset may
need to be constructed or redesigned for use by the lessee. Depending on the terms and conditions of the contract, a lessee may be
required to make payments relating to the construction or design of the asset. If a lessee incurs costs relating to the construction or
design of an underlying asset, the lessee should account for those costs applying other applicable Standards (e.g. IAS 16 Property, Plant
and Equipment). [IFRS 16:B43 & B44]
Such costs (e.g. amounts payable by an entity to construct a bespoke property that it wil ultimately lease from another entity –
sometimes referred to as ‘build-to-suit’ leases) do not qualify as initial direct costs (as discussed at 7.4.1.2); they are not included within the
carrying amount of the right-of-use asset under IFRS 16, but rather are accounted for as a separate asset (assuming the recognition
criteria of the relevant Standard are met).
7.3.2 Pay me nt s for the right to use the underlying asset made before the commencement date
Costs relating to the construction or design of an underlying asset (as described in 7.3.1) do not include payments made by the lessee for
the right to use the underlying asset. Payments for the right to use an underlying asset are payments for a lease, regardless of the timing of
those payments. [IFRS 16:B44] They are included within the initial measurement of the right-of-use asset (see 7.4.1)
If the lessee controls (or obtains control of) the underlying asset before that asset is transferred to the lessor, the transaction is a sale and
leaseback transaction accounted for by applying IFRS 16:98 to 103 (see section 10). [IFRS 16:B46]
However, if the lessee does not obtain control of the underlying asset before the asset is transferred to the lessor, the transaction is not a
sale and leaseback transaction. For example, this may be the case if a manufacturer, a lessor and a lessee negotiate a transaction for
the purchase of an asset from the manufacturer by the lessor, which is in turn leased to the lessee. The lessee may obtain legal title to the
underlying asset before legal title transfers to the lessor. In this case, if the lessee obtains legal title to the underlying asset but does not obtain
control of the asset before it is transferred to the lessor, the transaction is not accounted for as a sale and leaseback transaction, but as a
lease. [IFRS 16:B47]
48
Leases | A guide to IFRS 16
Expected
residual value Estimated
Penalty for
guarantee cost for
terminating
dismantling
(if reasonably
restoring
certain)
asset
Exercise price of
Initial direct
purchase option
costs
(reasonably
certain)
NPV=
Lease liability Right-of-use asset
[IFRS 16:24]
a) the amount of the initial measurement of the lease liability, as described in IFRS 16:26 (see 7.4.2);
b) any lease payments made at or before the commencement date (see 7.3.2), less any lease incentives received (see 6.4 for a definition of
lease incentives);
c) any initial direct costs incurred by the lessee (see 7.4.1.2); and
d) an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is
located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs
are incurred to produce inventories. The lessee incurs the obligation for those costs either at the commencement date or as a
consequence of having used the asset during a particular period (see 7.4.1.3).
See example 7.6 for an illustration of the initial and subsequent measurement of a lessee’s right-of-use asset and lease liability.
49
Leases | A guide to IFRS 16
Initial direct costs are, typically, costs incurred in negotiating and securing lease arrangements. They exclude costs incurred by a lessee
relating to the construction or design of an underlying asset (see 7.3.1). See 9.1.1.3 for further discussion on the nature of initial direct
costs.
The lessee incurs the obligation for those costs either at the commencement date or as a consequence of having used the underlying
asset during a particular period. [IFRS 16:24(d)]
The costs described in IFRS 16:24(d) should be recognised as part of the cost of the right-of-use asset when the lessee incurs an obligation
for those costs. The lessee should apply IAS 2 Inventories to costs that are incurred during a particular period as a consequence of having
used the right-of-use asset to produce inventories during that period. The obligations for such costs accounted for applying IFRS 16 or
IAS 2 are recognised and measured applying IAS 37 Provisions, Contingent Liabilities and Contingent Assets. [IFRS 16:25]
At initial recognition, the estimated liability for such restoration costs is recognised as a provision under IAS 37 Provisions, Contingent
Liabilities and Contingent Assets if an obligating event has already occurred. It is not included as part of the lease liability.
As a consequential amendment arising from IFRS 16, the scope of IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar
Liabilities has been amended to include restoration costs of this nature that are recognised as part of the cost of a right-of-use asset
under IFRS 16:24(d). Therefore, any change in the entity’s estimate of such costs after initial recognition should be accounted for in
accordance with that Interpretation which, for right-of-use assets measured subsequent to initial recognition using a cost model, wil
result in such changes being added to, or deducted from, the cost of the right-of-use asset.
Sometimes lease contracts stipulate that the underlying asset must be returned to the lessor in the same condition as when originally
leased. The appropriate accounting in such circumstances depends on the particular lease clause. For example, the underlying asset may
suffer general wear and tear that is merely a result of being used. In such circumstances, it may be necessary gradually to build up a
provision to repair or maintain the asset over the lease term, so that it can be returned to the lessor in its original condition. Generally, in
these circumstances, it would be inappropriate to recognise a provision for all of the estimated maintenance costs at the outset of the
lease. Conversely, other contracts may require specific work to be performed; for example, the contract may stipulate that the asset must
be painted at the end of the lease before being returned to the lessor. In such circumstances, it may be appropriate to recognise
a provision at the outset of the lease because, by signing the lease contract, the entity has committed itself to painting the asset,
irrespective of any wear and tear suffered.
50
Leases | A guide to IFRS 16
7.4.2.1 Lease liability to be measured initi ally at the present value of unpaid lease pay ment s
At the commencement date, the lease liability should be measured at the present value of the lease payments that are not paid at that
date. [IFRS 16:26]
See section 6 for a discussion of the components of ‘lease payments’ for the purposes of this measurement.
Thinking it through
In some industries, analysts have historically applied a specific multiple to operating lease expenses under IAS 17 to arrive at a
proxy for the liability now being recognised under IFRS 16. For example, in the aviation industry, it has been common practice to
use a multiple of seven, regardless of the outstanding term of lease arrangements. Accordingly, the liability recognised under IFRS
16 may differ significantly to the proxies previously arrived at by analysts. In such circumstances, entities wil want to speak to their
investors and analysts to manage expectations and avoid ‘surprises’.
The liability may also be treated as ‘debt’ for some purposes, although this wil depend on the particular circumstances.
[IFRS 16:26]
• if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate.
The interest rate implicit in the lease is defined as “[t]he rate of interest that causes the present value of (a) the lease payments and (b) the
unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor”.
[IFRS 16:Appendix A] The unguaranteed residual value is defined as “[t]hat portion of the residual value of the underlying asset, the
realisation of which by a lessor is not assured or is guaranteed solely by a party related to the lessor". [IFRS 16:Appendix A]
The lessee’s incremental borrowing rate is defined as “[t]he rate of interest that a lessee would have to pay to borrow over a similar term,
and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic
environment". [IFRS 16:Appendix A]
51
Leases | A guide to IFRS 16
When the lease is denominated in a foreign currency, the lessee’s incremental borrowing rate should be the rate at which the lessee
could obtain funding for the asset in the foreign currency.
The IASB’s objective in specifying the discount rate to apply to a lease is to specify a rate that reflects how the contract is priced. With
this in mind, the IASB decided that, if readily determinable by the lessee, a lessee should use the interest rate implicit in the lease. [IFRS
16:BC160]
The interest rate implicit in the lease is likely to be similar to the lessee’s incremental borrowing rate in many cases. This is because both rates,
as they have been defined in IFRS 16, take into account the credit standing of the lessee, the length of the lease, the nature and quality of
the collateral provided and the economic environment in which the transaction occurs. However, the interest rate implicit in the lease is
generally also affected by a lessor’s estimate of the residual value of the underlying asset at the end of the lease, and may be affected by
taxes and other factors known only to the lessor, such as any initial direct costs of the lessor. Consequently, the IASB noted that it is likely
to be dificult for lessees to determine the interest rate implicit in the lease for many leases, particularly those for which the underlying asset
has a significant residual value at the end of the lease. [IFRS 16:BC161]
The IASB noted that, depending on the nature of the underlying asset and the terms and conditions of the lease, a lessee may be able to
refer to a rate that is readily observable as a starting point when determining its incremental borrowing rate for a lease (e.g. the rate that a
lessee has paid, or would pay, to borrow money to purchase the type of asset being leased, or the property yield when determining the
discount rate to apply to property leases). Nonetheless, because the lessee’s incremental borrowing rate is defined to take into account
the terms and conditions of the lease, a lessee should adjust such observable rates as needed to determine its incremental borrowing
rate. [IFRS 16:BC162]
Thinking it through
In attempting to arrive at an appropriate discount rate, some lessees may decide to approach lessors in order to obtain greater
insight into the pricing of contracts and returns being made by lessors. In some industries and for some lessors, this may not be
sensitive information and the lessors may readily provide it. In other cases, lessors may be reluctant to divulge such information for
commercial reasons and lessees wil need to consider whether the implicit rate is readily determinable by other means, before
resorting to the incremental borrowing rate.
[IFRS 16:30]
• less any accumulated depreciation and any accumulated impairment losses (see 7.5.1.3 and 7.5.1.4, respectively); and
• adjusted for any remeasurement of the lease liability specified in IFRS 16:36(c) (see 7.5.2.1).
52
Leases | A guide to IFRS 16
• if the lease transfers ownership of the underlying asset to the lessee by the end of the lease term, or if the cost of the right-of-use asset
reflects that the lessee wil exercise a purchase option, the right-of-use asset should be depreciated from the commencement date to the
end of the useful life of the underlying asset;
• otherwise, the right-of-use asset should be depreciated from the commencement date to the earlier of the end of the useful life of the
right-of-use asset and the end of the lease term.
The useful life of an asset is defined as “[t]he period over which an asset is expected to be available for use by an entity; or the number of
production or similar units expected to be obtained from an asset by an entity”. [IFRS 16:Appendix A]
Therefore, if the ownership of the underlying asset transfers to the lessee at the end of the lease term, or it is reasonably certain that
the lessee wil exercise a purchase option, depreciation is based on the useful life of the underlying asset. Otherwise, depreciation is
determined by reference to the useful life of the right-of-use asset (provided that is not longer than the lease term).
IFRS 16 has amended the scope of IAS 40 by defining investment property to include both owned investment property and investment
property held by a lessee as a right-of-use asset. A lessee is required to account for right-of-use assets that meet the definition of
investment property in a manner consistent with its policy for owned investment property – i.e. using either the cost model and disclosing
fair value, or using the fair value model. [IFRS 16:BC178]
7.5.1.6 Right-of-use assets t ha t relate to a clas s of revalued property, plant and equipment
If right-of-use assets relate to a class of property, plant and equipment to which the lessee applies the revaluation model in IAS 16, a lessee
may elect to apply that revaluation model to all of the right-of-use assets that relate to that class of property, plant and equipment.
[IFRS 16:35]
• if the class of owned assets to which right-of-assets relate is measured using the cost model, the right-of-use assets should also be
accounted for using the cost model; but
• if the class of assets to which right-of-use assets relate is measured using IAS 16’s revaluation model, a lessee can chose whether to
measure right-of-use assets at fair value. This choice is made on a class-by-class basis. This is in contrast to right-of-use assets that
meet the definition of investment property for which the accounting model to be followed is determined by the lessee’s accounting
policy for owned investment property (see 7.5.1.5).
53
Leases | A guide to IFRS 16
[IFRS 16:36]
b) reducing the carrying amount to reflect the lease payments made; and
c) remeasuring the carrying amount to reflect any reassessment or lease modifications specified in IFRS 16:39 to 46 (see 7.5.2.4), or to
reflect revised in-substance fixed lease payments (see 6.3).
Lease liabilities are measured on an ongoing basis similarly to other financial liabilities, using an effective interest method, so that the carrying
amount of the lease liability is measured on an amortised cost basis and the interest expense is allocated over the lease term. IFRS 16
does not require or permit a lessee to measure lease liabilities at fair value after initial measurement. [IFRS 16:BC182 & BC183]
Thinking it through
Accounting systems wil need to be able to cater for scenarios where remeasurement of the liability is required, potentially with an
updated discount rate. Basic spreadsheet solutions may struggle to cope with such demands as well as identifying when such
remeasurements are required.
[IFRS 16:38]
• variable lease payments not included in the measurement of the lease liability in the period in which the event or condition that triggers
those payments occurs (see also 6.5.3).
54
Leases | A guide to IFRS 16
Thinking it through
Because the interest expense on the lease liability wil be front-loaded, this leads to an overall front-loading of the expense when
combined with straight-line depreciation of the right-of-use asset. This means that, for an individual lease, the expense wil typically
be higher in the earlier years (compared to the previous IAS 17 expense) and lower in the later years. However, when an entity has
a portfolio of leases of varying maturities which are renewed on a rolling basis, the overall effect may stil resemble an approximately
straight-line expense, similar to that reported under IAS 17.
Recognising an interest and depreciation expense under IFRS 16, rather than an operating expense for rentals paid under IAS
17, means that metrics such as EBITDA wil increase compared to amounts reported when IAS 17 is applied. This may have a
knock-on effect on an entity’s KPIs, bonus targets, contingent consideration arrangements, lending covenants and more.
7.5.2.5 Remeasurements arising from a change in the lease te rm or reassessment of purchase option
The lease liability should be remeasured by discounting the revised lease payments using a revised discount rate, if either:
[IFRS 16:40]
• there is a change in the lease term (see 5.7 and 5.8), in which case the revised lease payments should be determined on the basis of the
revised lease term; or
• there is a change in the assessment of an option to purchase the underlying asset, assessed considering the events and circumstances
described in IFRS 16:20 and 21 (see 5.7 and 5.8) in the context of a purchase option, in which case the revised lease payments should be
determined to reflect the change in amounts payable under the purchase option.
In most cases, an entity should not reassess the discount rate during the lease term. However, IFRS 16 requires a lessee to remeasure
the lease liability using revised payments and a revised discount rate when there is a change in the lease term or a change in the
assessment of whether the lessee is reasonably certain to exercise an option to purchase the underlying asset. In the IASB’s view, in
those circumstances, the economics of the lease have changed and it is appropriate to reassess the discount rate to be consistent with
the change in the lease payments included in the measurement of the lease liability (and right-of-use asset). [IFRS 16:B193 & BC194]
In applying IFRS 16:40, the revised discount rate used should be:
[IFRS 16:41]
• the interest rate implicit in the lease for the remainder of the lease term; or
• if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate at the date of
reassessment.
7.5.2.6 Remeasurements arising from a change in the am o un t s expected to be payable under a residual value guarantee
The lease liability should be remeasured by discounting the revised lease payments (i.e. reflecting the change in the residual value guarantee)
using an unchanged discount rate, unless the change in the residual value guarantee results from a change in floating interest rates, in which
case the lessee should use a revised discount rate that reflects changes in the interest rate. [IFRS 16:42(a) & 43]
55
Leases | A guide to IFRS 16
7.5.2.7 Remeasurements arising from a change in future lease payment s resulti ng from a change in a n index or a rate
These requirements apply when there is a change in future lease payments resulting from a change in an index or a rate used to
determine those payments (including, for example, a change to reflect changes in market rental rates following a market rent review). In
such circumstances, the lease liability should be remeasured to reflect those revised lease payments only when there is a change in the
cash flows (i.e. when the adjustment to the lease payments takes effect – see example 7.5.2.7). [IFRS 16:42(b)]
The IASB decided that a lessee should reassess variable lease payments that are determined by reference to an index or a rate only
when there is a change in the cash flows resulting from a change in the reference index or rate. This approach is considered to be less
complex and costly to apply than requiring a lessee to reassess variable lease payments at each reporting date. [IFRS 16:BC190]
The revised lease payments for the remainder of the lease term should be determined based on the revised contractual payments. They
should be discounted using an unchanged discount rate, unless the change in the lease payments results from a change in floating interest
rates, in which case the lessee should use a revised discount rate that reflects changes in the interest rate. [IFRS 16:42(b) & 43]
IFRS 16 generally does not permit an entity to reassess the discount rate during the lease term. An exception is made when there is a
change in the lease term or a change in the assessment regarding a purchase option (see 7.5.2.5). The IASB also decided that, in a
floating interest rate lease, a lessee should use a revised discount rate to remeasure the lease liability when there is a change in lease
payments resulting from changes in the floating interest rate. This approach is consistent with the requirements in IFRS 9 Financial
Instruments for the measurement of floating-rate financial liabilities subsequently measured at amortised cost. [IFRS 16:BC195]
56
Leases | A guide to IFRS 16
Example 7.5.2.7
Remeasurements arising from a change in future lease pay ments resulti ng from a change in a n index
On 1 January 20X1, Entity A leases a property for a lease term of 8 years. The lease payments for the first three years have been agreed
at CU100 per year. The lease payments wil be reset on 1 January 20X4 (and, subsequently, on 1 January 20X7) on the basis of the
increase in the Retail Price Index (RPI) for the preceding three years. All lease payments are made at the end of the relevant year.
At 1 January 20X1 (the commencement date), the RPI is 100 and Entity A measures its lease liability at CU646 (8 payments of CU100
payable in arrears, discounted at the interest rate implicit in the lease of 5 per cent).
On 1 January 20X2, 20X3 and 20X4, respectively, the RPI is 103, 107 and 108. On 1 January 20X7, the RPI is 113.
In its financial statements for the years ended 31 December 20X1, 31 December 20X2 and 31 December 20X3, Entity A makes no
adjustment for increases in RPI because there is no change in cash flows in those years. In its financial statements for year ended 31
December 20X4 (and subsequently 20X7), Entity A recalculates its liability based on the increased RPI. These adjustments are added to
the carrying amount of the lease liability and the related right-of-use asset, subject to the requirements of IFRS 16:39 (see 7.5.2.4).
CU CU CU CU CU
a) Difference between five remaining payments of CU100 discounted at 5 per cent and five remaining payments of CU108 discounted at
5 per cent.
b) Difference between two remaining payments of CU108 discounted at 5 per cent and two remaining payments of CU113 discounted at
5 per cent.
IFRS 16 does not provide specific requirements as to how a lessee should account for the effects of foreign currency exchange
differences relating to lease liabilities that are denominated in a foreign currency. In line with other financial liabilities, a lessee’s lease liability is
a monetary item and consequently, if denominated in a foreign currency, is required to be remeasured using closing rates at the end
of each reporting period applying IAS 21 The Effects of Changes in Foreign Exchange Rates. Such foreign exchange differences are
recognised in profit in loss and not as an adjustment to the carrying amount of the right-of-use asset. [IFRS 16:BC196 – BC198]
57
Leases | A guide to IFRS 16
Thinking it through
In industries such as the aviation industry, it is common for leases to be denominated in US dollars (USD). For entities with functional
currencies other than USD, the effects of retranslating the liability and recognising a gain or loss in profit or loss may be significant.
Entities may wish to consider their treasury strategy and whether they can apply hedge accounting to address this volatility.
Example 7.6
Measurement by a lessee and accounti ng for a change in the lease term
[IFRS 16:Illustrative example 13]
Part 1 – Initial measurement of the right-of-use asset and the lease liability
Lessee enters into a 10-year lease of a floor of a building, with an option to extend for five years. Lease payments are CU50,000 per year during the
initial term and CU55,000 per year during the optional period, all payable at the beginning of each year. To obtain the lease, Lessee incurs initial
direct costs of CU20,000, of which CU15,000 relates to a payment to a former tenant occupying that floor of the building and CU5,000 relates to a
commission paid to the real estate agent that arranged the lease. As an incentive to Lessee for entering into the lease, Lessor agrees to reimburse
to Lessee the real estate commission of CU5,000 and Lessee’s leasehold improvements of CU7,000.
At the commencement date, Lessee concludes that it is not reasonably certain to exercise the option to extend the lease and, therefore,
determines that the lease term is 10 years.
The interest rate implicit in the lease is not readily determinable. Lessee’s incremental borrowing rate is 5 per cent per annum, which reflects the fixed
rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a 10-year term, and with similar
collateral.
At the commencement date, Lessee makes the lease payment for the first year, incurs initial direct costs, receives lease incentives from
Lessor and measures the lease liability at the present value of the remaining nine payments of CU50,000, discounted at the interest rate of
5 per cent per annum, which is CU355,391.
Lessee initially recognises assets and liabilities in relation to the lease as follows.
58
Leases | A guide to IFRS 16
Lessee accounts for the reimbursement of leasehold improvements from Lessor applying other relevant Standards and not as a lease
incentive applying IFRS 16. This is because costs incurred on leasehold improvements by Lessee are not included within the cost of the
right-of-use asset.
Part 2 – Subsequent measurement and accounting for a change in the lease term
In the sixth year of the lease, Lessee acquires Entity A. Entity A has been leasing a floor in another building. The lease entered into by Entity A
contains a termination option that is exercisable by Entity A. Following the acquisition of Entity A, Lessee needs two floors in a building suitable for
the increased workforce. To minimise costs, Lessee (a) enters into a separate eight-year lease of another floor in the building leased that will be
available for use at the end of Year 7 and (b) terminates early the lease entered into by Entity A with effect from the beginning of Year 8.
Moving Entity A’s staff to the same building occupied by Lessee creates an economic incentive for Lessee to extend its original lease at the
end of the non-cancellable period of 10 years. The acquisition of Entity A and the relocation of Entity A’s staff is a significant event that is
within the control of Lessee and affects whether Lessee is reasonably certain to exercise the extension option not previously included in
its determination of the lease term. This is because the original floor has greater utility (and thus provides greater benefits) to Lessee than
alternative assets that could be leased for a similar amount to the lease payments for the optional period – Lessee would incur additional
costs if it were to lease a similar floor in a different building because the workforce would be located in different buildings. Consequently, at
the end of Year 6, Lessee concludes that it is now reasonably certain to exercise the option to extend its original lease as a result of its
acquisition and planned relocation of Entity A.
Lessee’s incremental borrowing rate at the end of Year 6 is 6 per cent per annum, which reflects the fixed rate at which Lessee could borrow an
amount similar to the value of the right-of-use asset, in the same currency, for a nine-year term, and with similar collateral. Lessee expects to
consume the right-of-use asset’s future economic benefits evenly over the lease term and, thus, depreciates the right-of-use asset on a straight-line
basis.
The right-of-use asset and the lease liability from Year 1 to Year 6 are as follows.
Year CU CU CU CU CU CU CU
59
Leases | A guide to IFRS 16
At the end of the sixth year, before accounting for the change in the lease term, the lease liability is CU186,162 (the present value of four
remaining payments of CU50,000, discounted at the original interest rate of 5 per cent per annum). Interest expense of CU8,865 is
recognised in Year 6. Lessee’s right-of-use asset is CU168,157.
Lessee remeasures the lease liability at the present value of four payments of CU50,000 followed by five payments of CU55,000, all
discounted at the revised discount rate of 6 per cent per annum, which is CU378,174. Lessee increases the lease liability by CU192,012,
which represents the difference between the remeasured liability of CU378,174 and its previous carrying amount of CU186,162. The
corresponding adjustment is made to the right-of-use asset to reflect the cost of the additional right of use, recognised as follows.
Following the remeasurement, the carrying amount of Lessee’s right-of-use asset is CU360,169 (ie CU168,157 + CU192,012). From the
beginning of Year 7 Lessee calculates the interest expense on the lease liability at the revised discount rate of 6 per cent per annum.
The right-of-use asset and the lease liability from Year 7 to Year 15 are as follows.
Year CU CU CU CU CU CU CU
The ‘effective date of the modification’ is “[t]he date when both parties agree to a lease modification”. [IFRS 16:Appendix A]
60
Leases | A guide to IFRS 16
[IFRS 16:44]
• the modification increases the scope of the lease by adding the right to use one or more underlying assets; and
• the consideration for the lease increases by an amount commensurate with the stand-alone price for the increase in scope and any
appropriate adjustments to that stand-alone price to reflect the circumstances of the particular contract.
When the conditions in IFRS 16:44 are met, the modification is considered to result in the creation of a new lease that is separate from the
original lease. [IFRS 16:BC202] The agreement for the right to use one or more additional assets is accounted for as a separate lease (or
leases) to which the requirements of IFRS 16 are applied independently of the original lease.
The following example, reproduced from the illustrative examples accompanying IFRS 16, illustrates a modification that should be
accounted for as a separate lease.
Example 7.7.2
Measurement by a lessee and accounti ng for a change in the lease term
[IFRS 16:Illustrative example 15]
Lessee enters into a 10-year lease for 2,000 square metres of ofice space. At the beginning of Year 6, Lessee and Lessor agree to amend the
original lease for the remaining five years to include an additional 3,000 square metres of ofice space in the same building. The additional
space is made available for use by Lessee at the end of the second quarter of Year 6. The increase in total consideration for the lease is
commensurate with the current market rate for the new 3,000 square metres of ofice space, adjusted for the discount that Lessee receives
reflecting that Lessor does not incur costs that it would otherwise have incurred if leasing the same space to a new tenant (for example,
marketing costs).
Lessee accounts for the modification as a separate lease, separate from the original 10-year lease. This is because the modification
grants Lessee an additional right to use an underlying asset, and the increase in consideration for the lease is commensurate with
the stand-alone price of the additional right-of-use adjusted to reflect the circumstances of the contract. In this example, the
additional underlying asset is the new 3,000 square metres of ofice space. Accordingly, at the commencement date of the new
lease (at the end of the second quarter of Year 6), Lessee recognises a right-of-use asset and a lease liability relating to the lease of
the additional 3,000 square metres of ofice space. Lessee does not make any adjustments to the accounting for the original lease of
2,000 square metres of ofice space as a result of this modification.
61
Leases | A guide to IFRS 16
7.7.3 Lease modificati ons tha t are not accounted for a s a separate lease
For a lease modification that is not accounted for as a separate lease, at the effective date of the lease modification, the lessee
should:
[IFRS 16:45]
a) allocate the consideration in the modified contract applying the requirements of IFRS 16: 13 to 16 (see 4.2);
b) determine the lease term of the modified lease applying the requirements of IFRS 16:18 and 19 (see section 5); and
c) remeasure the lease liability by discounting the revised lease payments using a revised discount rate. The revised discount rate is
determined as:
i) the interest rate implicit in the lease for the remainder of the lease term; or
ii) if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate at the effective
date of the modification.
The lessee should account for the remeasurement of the lease liability as follows:
[IFRS 16:46]
a) for lease modifications that decrease the scope of the lease, by decreasing the carrying amount of the right-of-use asset to
reflect the partial or full termination of the lease. Any gain or loss relating to the partial or full termination of the lease should be
recognised in profit or loss; and
b) for all other lease modifications, making a corresponding adjustment to the right-of-use asset.
For the lease modifications dealt with under IFRS 16:46(b), the original lease is not terminated because there is no decrease in
scope. The lessee continues to have the right to use the underlying asset identified in the original lease. For lease modifications
that increase the scope of a lease, the adjustment to the carrying amount of the right-of-use asset effectively represents the cost
of the additional right of use acquired as a result of the modification. For lease modifications that change the consideration paid for a
lease, the adjustment to the carrying amount of the right-of-use asset effectively represents a change in the cost of the right-of-
use asset as a result of the modification. The use of a revised discount rate in remeasuring the lease liability reflects that, in
modifying the lease, there is a change in the interest rate implicit in the lease (which the discount rate is intended to approximate).
[IFRS 16:BC203(b)]
62
Leases | A guide to IFRS 16
Example 7.7.3A
Modificati on th at increases the scope of the lease by extending the contrac tual lease term
[IFRS 16:Illustrative example 16]
Lessee enters into a 10-year lease for 5,000 square metres of ofice space. The annual lease payments are CU100,000 payable at the end of each
year. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the commencement date is 6
per cent per annum. At the beginning of Year 7, Lessee and Lessor agree to amend the original lease by extending the contractual lease term by
four years. The annual lease payments are unchanged (ie CU100,000 payable at the end of each year from Year 7 to Year 14). Lessee’s
incremental borrowing rate at the beginning of Year 7 is 7 per cent per annum.
At the effective date of the modification (at the beginning of Year 7), Lessee remeasures the lease liability based on: (a) an eight-year
remaining lease term, (b) annual payments of CU100,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum. The
modified lease liability equals CU597,130. The lease liability immediately before the modification (including the recognition of the interest
expense until the end of Year 6) is CU346,511. Lessee recognises the difference between the carrying amount of the modified lease liability
and the carrying amount of the lease liability immediately before the modification (CU250,619) as an adjustment to the right-of-use asset.
Example 7.7.3B
Modificati on th at decreases the scope of the lease
[IFRS 16:Illustrative example 17]
Lessee enters into a 10-year lease for 5,000 square metres of ofice space. The annual lease payments are CU50,000 payable at the
end of each year. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the
commencement date is 6 per cent per annum. At the beginning of Year 6, Lessee and Lessor agree to amend the original lease to reduce
the space to only 2,500 square metres of the original space starting from the end of the first quarter of Year 6. The annual fixed lease
payments (from Year 6 to Year 10) are CU30,000. Lessee’s incremental borrowing rate at the beginning of Year 6 is 5 per cent per annum.
At the effective date of the modification (at the beginning of Year 6), Lessee remeasures the lease liability based on: (a) a five-year
remaining lease term, (b) annual payments of CU30,000 and (c) Lessee’s incremental borrowing rate of 5 per cent per annum.
This equals CU129,884. Lessee determines the proportionate decrease in the carrying amount of the right-of-use asset on the basis of
the remaining right-of-use asset (ie 2,500 square metres corresponding to 50 per cent of the original right-of-use asset).
50 per cent of the pre-modification right-of-use asset (CU184,002) is CU92,001. Fifty per cent of the pre-modification lease liability
(CU210,618) is CU105,309. Consequently, Lessee reduces the carrying amount of the right-of-use asset by CU92,001 and the carrying
amount of the lease liability by CU105,309.
Lessee recognises the difference between the decrease in the lease liability and the decrease in the right-of-use asset (CU105,309 –
CU92,001 = CU13,308) as a gain in profit or loss at the effective date of the modification (at the beginning of Year 6).
Lessee recognises the difference between the remaining lease liability of CU105,309 and the modified lease liability of CU129,884 (which
equals CU24,575) as an adjustment to the right-of-use asset reflecting the change in the consideration paid for the lease and the revised
discount rate.
63
Leases | A guide to IFRS 16
Example 7.7.3C
Modificati on th at both increases and decreases the scope of the lease
[IFRS 16:Illustrative example 18]
Lessee enters into a 10-year lease for 2,000 square metres of ofice space. The annual lease payments are CU100,000 payable at the
end of each year. The interest rate implicit in the lease cannot be readily determined. Lessee’s incremental borrowing rate at the
commencement date is 6 per cent per annum. At the beginning of Year 6, Lessee and Lessor agree to amend the original lease to (a)
include an additional 1,500 square metres of space in the same building starting from the beginning of Year 6 and (b) reduce the lease
term from 10 years to eight years. The annual fixed payment for the 3,500 square metres is CU150,000 payable at the end of each year
(from Year 6 to Year 8). Lessee’s incremental borrowing rate at the beginning of Year 6 is 7 per cent per annum.
The consideration for the increase in scope of 1,500 square metres of space is not commensurate with the stand-alone price for that
increase adjusted to reflect the circumstances of the contract. Consequently, Lessee does not account for the increase in scope that
adds the right to use an additional 1,500 square metres of space as a separate lease.
The pre-modification right-of-use asset and the pre-modification lease liability in relation to the lease are as follows.
Year CU CU CU CU CU CU CU
6 421,236 368,004
At the effective date of the modification (at the beginning of Year 6), Lessee remeasures the lease liability on the basis of: (a) a three-year
remaining lease term, (b) annual payments of CU150,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum.
The modified liability equals CU393,647, of which (a) CU131,216 relates to the increase of CU50,000 in the annual lease payments from
Year 6 to Year 8 and (b) CU262,431 relates to the remaining three annual lease payments of CU100,000 from Year 6 to Year 8.
At the effective date of the modification (at the beginning of Year 6), the pre-modification lease liability is CU421,236. The remaining lease
liability for the original 2,000 square metres of ofice space is CU267,301 (ie present value of three annual lease payments of CU100,000,
discounted at the original discount rate of 6 per cent per annum).
64
Leases | A guide to IFRS 16
Consequently, Lessee reduces the carrying amount of the right-of-use asset by CU147,202 (CU368,004 – CU220,802), and the carrying
amount of the lease liability by CU153,935 (CU421,236 – CU267,301). Lessee recognises the difference between the decrease in the lease
liability and the decrease in the right-of-use asset (CU153,935 – CU147,202 = CU6,733) as a gain in profit or loss at the effective date of the
modification (at the beginning of Year 6).
Gain CU6,733
At the effective date of the modification (at the beginning of Year 6), Lessee recognises the effect of the remeasurement of the remaining
lease liability reflecting the revised discount rate of 7 per cent per annum, which is CU4,870 (CU267,301 – CU262,431), as an adjustment to
the right-of-use asset.
The modified right-of-use asset and the modified lease liability in relation to the modified lease are as follows.
Year CU CU CU CU CU CU CU
(115,716
)
65
Leases | A guide to IFRS 16
Example 7.7.3D
Modificati on th at is a change in considerati on only
[IFRS 16:Illustrative example 19]
Lessee enters into a 10-year lease for 5,000 square metres of ofice space. At the beginning of Year 6, Lessee and Lessor agree to amend the original
lease for the remaining five years to reduce the lease payments from CU100,000 per year to CU95,000 per year. The interest rate implicit in the
lease cannot be readily determined. Lessee’s incremental borrowing rate at the commencement date is 6 per cent per annum. Lessee’s
incremental borrowing rate at the beginning of Year 6 is 7 per cent per annum. The annual lease payments are payable at the end of each year.
At the effective date of the modification (at the beginning of Year 6), Lessee remeasures the lease liability based on: (a) a five-year
remaining lease term, (b) annual payments of CU95,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum. Lessee
recognises the difference between the carrying amount of the modified liability (CU389,519) and the lease liability immediately before the
modification (CU421,236) of CU31,717 as an adjustment to the right-of-use asset.
66
Leases | A guide to IFRS 16
Section 8
Classification of leases by lessors
8.1 Classificati on of leases – general
The key distinction to be made by lessors in accounting for leases under IFRS 16 is whether the lease in question is either:
• a simple short-term hire arrangement (an operating lease), whereby rentals are dealt with in profit or loss with the only impact on the
statement of financial position relating to the timing of payments; or
• in the nature of an arrangement for financing the acquisition of an asset (a finance lease), when the presentation in the financial
statements wil depart from the legal form of the transaction and be based on the economic substance (i.e. as if the underlying asset
had been sold to the lessee).
A lease modification is defined as “[a] change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and
conditions of the lease (for example, adding or terminating the right to use one or more underlying assets, or extending or shortening the
contractual lease term)”. [IFRS 16:Appendix A]
Changes in estimates (e.g. changes in estimates of the economic life or of the residual value of the underlying asset), or changes in
circumstances (e.g. default by the lessee), do not give rise to a new lease classification. [IFRS 16:66]
See 9.1.4 for the appropriate treatment for modifications to finance leases and 9.2.8 for the appropriate treatment for modifications to
operating leases.
If a lease contract includes terms and conditions to adjust the lease payments for particular changes that occur between the inception date
and the commencement date (e.g. a change in the lessor’s cost of the underlying asset or a change in the lessor’s cost of financing the lease),
for the purposes of classifying the lease, the effect of any such changes is deemed to have taken place at inception. [IFRS 16:B54]
There may be a time lag between the inception date and the commencement date (see 5.3 for an explanation of both terms), and the
amounts involved in the lease arrangement may change between the two – most commonly when the asset is being constructed and
the final cost is not known at inception.
When a group acquires a new subsidiary in a business combination, the classification of the subsidiary’s leases in which it is the lessor is not
reassessed at the date of the business combination for the purposes of the consolidated financial statements. The subsidiary’s leases wil
be classified in the consolidated financial statements on the basis of their terms at original inception, and without regard to the remaining
lease term from the acquisition date. Thus, in particular, if the acquiree has appropriately treated a lease as a finance
lease, that lease wil also be treated as a finance lease in the consolidated financial statements, even if the majority of the lease term has
expired before the acquisition date.
This treatment is required under paragraph 17 of IFRS 3 Business Combinations as an exception to that Standard’s general principle that
an acquirer should classify the assets acquired and liabilities assumed in a business combination on the basis of conditions as they
exist at the acquisition date. IFRS 3:17 requires the acquiree’s lease contracts in which it is the lessor to be classified on the basis of the
contractual terms and other factors at the inception of the contract (or, if the terms of the contract have been modified in a manner that
would change its classification, at the date of that modification, which might be the acquisition date).
67
Leases | A guide to IFRS 16
[IFRS 16:B53]
• The risks incidental to ownership include, but are not limited to, the possibility of losses from idle capacity or technological obsolescence, and
of variations in the future economic benefits expected to flow to the entity due to changing economic conditions.
• The rewards incidental to ownership include, but are not limited to, an expectation of profitable operation over the underlying asset’s
economic life and of gain from appreciation in value or realisation of a residual value.
8.2.4 Classi ficati on to be determined based on the substance of the tra nsac ti o n
Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract.
[IFRS 16:63]
[IFRS 16:63]
• the lease transfers ownership of the underlying asset to the lessee by the end of the lease term;
A lease can be considered to transfer ownership of the underlying asset when transfer of legal title, and thus continued ownership of
risks and rewards, is automatic either under the lease agreement or under a side agreement that forms part of the overall lease
arrangement (e.g. when the lessor has entered into a separate forward sale agreement with the lessee). This condition wil also be met, in
substance, when the lessor has a put option requiring the lessee to acquire legal title, and the option is structured in such a manner that
it is reasonably certain to be exercised by the lessor.
• the lessee has the option to purchase the underlying asset at a price that is expected to be suficiently lower than the fair value at the
date the option becomes exercisable such that, at the inception date, it is reasonably certain that the option wil be exercised;
68
Leases | A guide to IFRS 16
This condition extends that referred to in the previous bullet point to a lessee call option at a price that makes its exercise commercially likely
to occur. An option to purchase at a low or nominal amount is a typical example of this type of arrangement.
In some lease arrangements, rather than the lessee having a bargain purchase option, its parent (perhaps with no operations other than
to act as an investment holding company) has the option to acquire the underlying asset at a low or nominal value at the end of the lease
term. In these circumstances, it is reasonably certain that the parent wil exercise the option to acquire the underlying asset. Although the
option to acquire the underlying asset is not held by the lessee, the substance of the arrangement is that only the lessee wil have use of
the underlying asset. As a result, such arrangements wil normally lead to classification of the lease as a finance lease.
When a lease involves identical put and call options (at the end of the lease term, the lessee has a call option to acquire the underlying asset
at a specified price and the lessor has a corresponding put option for the same value), the substance is that of a forward contract. At the
end of the lease term, the lessee wil exercise the call option if the market value of the underlying asset exceeds the exercise price of the
option; the lessor wil exercise the put option if the market price is less than the exercise price of the option. Therefore, either the put
option or the call option is reasonably certain to be exercised at the end of the lease term, and the lessee wil acquire the underlying asset
at the end of the lease term. Consequently, the lease should normally be classified as a finance lease.
• the lease term is for the major part of the economic life of the underlying asset, even if title is not transferred;
This condition covers the circumstances when substantially all the economic benefits of the underlying asset are consumed over the
lease term during which the lessee controls the underlying asset. There is no specific threshold in IFRS 16 delineating the 'major part' of
an asset’s economic life and thresholds established by other GAAPs should not be considered definitive. Instead, it is necessary
to consider the substance of a lease and to classify it according to whether the agreement transfers substantially all of the risks and
rewards of ownership as discussed at 8.2.3.
69
Leases | A guide to IFRS 16
Example 8.3
Evaluati ng the economic life of a building
Company A constructs a building and, on completion of construction, leases it to Company B for 25 years. At the end of the lease term, the
title to the land and building is retained by Company A. If the economic life of the building is 50 years, this lease apparently is not for the major
part of the economic life of the building; therefore, in the absence of other indicators that the lease is a finance lease, it is likely that
Company A would classify the building as an operating lease. To determine the economic life of the building, Company A should consider a
number of factors:
• if all important maintenance and refurbishment costs are paid by the lessee and this obligation forms part of the lease,
this requirement should be taken into account because it may extend the economic life;
• if the lease requires Company B to maintain the building in the same condition as at the inception of the lease ('making good
dilapidations'), this requirement could extend the economic life;
• if the building is unlikely to be leased for any additional period in its present condition because of an aspect of its design, operation or
location (i.e. it is 'functionally obsolete'), the economic life may be shorter; and
• if the building is considered to be functionally obsolete, but a tenant stil wants to rent it, the building wil retain a degree of
economic life.
This list is not exhaustive and each building should be considered separately based on the specific facts and circumstances.
Consideration of the economic life of a building wil often reveal a difference between the life of the shell of the building and the life of the
interior of the building. In many scenarios, the shell of the building wil be key to the overall economic life of that asset.
For example, in the case of shops or ofices, the interior of the building is usually regularly refurbished by the lessee (often as required under
the lease) in order for it to continue to be an economically viable property for the lessee. If refurbishment of the interior is carried out at
regular (e.g. 10-year) intervals, consideration of the economic life of the building based on the expected life of the shell of the property may
be appropriate. Regular repair and refurbishment would extend the expected economic life of the asset and, when this is contractually
required under the lease, should be taken into account in the assessment of economic life at the inception of the lease.
Note that when renewal or purchase options exist, these should be assessed at the inception date (see 5.3) to determine whether it is
reasonably certain that the option wil be exercised. The lease term wil include the further term when, at the inception date, exercise of
the option is assessed to be reasonably certain.
• at the inception date, the present value of the lease payments amounts to at least substantially all of the fair value of the
underlying asset;
This condition tests whether the lessor receives a full return of its initial investment. As with economic life, there is no specific threshold in
IFRS 16 delineating what constitutes 'substantially all' of the fair value of an underlying asset and thresholds established by other GAAPs
should not be considered definitive. Instead, as discussed above, it is necessary to consider the substance of a lease and determine its
classification based on whether the agreement transfers substantially all of the risks and rewards of ownership.
When the lease term has been extended by renewal or purchase options (as discussed in the previous point), the lease payments wil
include payments due with respect to this further term.
70
Leases | A guide to IFRS 16
• the underlying asset is of such a specialised nature that only the lessee can use it without major modifications.
When this condition is met, it is likely that the underlying asset wil have been constructed to the lessee’s specifications such that its
market value is limited. It follows that the lessor wil seek to recover its investment from the primary lease term.
Other indicators that, individually or in combination, could also lead to a lease being classified as a finance lease are:
[IFRS 16:64]
• if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee;
• gains or losses from fluctuations in the fair value of the residual accrue to the lessee (e.g. in the form of a rent rebate equalling most of the
sales proceeds at the end of the lease);
If the lessee does not acquire legal title by the end of the lease, it may nevertheless bear the risk of variation in the residual value of the
underlying asset; leases wil commonly provide for a substantial fixed final rental (a 'balloon rental') followed by a repayment equal to all or
substantially all of the sales proceeds from disposal of the underlying asset.
When the risk of variation in the residual value of the underlying asset is shared between the lessor and the lessee, it is necessary to
consider the specific facts and circumstances in order to assess whether the risk retained by the lessor is significant. A risk of variation in the
residual value of the asset retained by the lessor that may be significant only in circumstances considered to be remote may suggest that
the lease is appropriately classified as a finance lease.
• the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.
A bargain renewal option exists when a lessee has the ability to continue the lease for a secondary period at a rent that is substantially
lower than market rent. The rent for a secondary period would be considered substantially lower than market rent if it would be
economically rational for the lessee to continue the lease at that lower rent.
Rental for a secondary period either at a nominal amount or substantially below market rates suggests both that (1) the lessor has
received the required return from its initial investment, and (2) that the lessee is likely to choose to enter into such a secondary period.
• the possibility of higher operating and maintenance costs over the secondary rent period; and
• costs to be incurred by the lessor to find a new lessee and to prepare the underlying asset for a new lessee.
71
Leases | A guide to IFRS 16
Assume that the rental payments in the renewal period are equal to a specified percentage of the original monthly payments. One
approach to assessing whether this represents a bargain would be to compare the implicit interest rates determined by assuming that
(1) the lease is terminated at the end of the original lease term, and (2) that the lease is renewed at the reduced rental payments.
Appropriate estimates of the residual value of the underlying asset at the end of the original term and at the end of the renewal period
should be included in the computations. If the implicit interest rate increases or remains substantially the same when the renewal option is
assumed to be exercised, it is appropriate to conclude that the renewal option is not a bargain. The assessment of whether the interest
rate differential is a bargain is made at the inception date and wil depend on both the economic conditions prevailing in the relevant
jurisdiction and the circumstances of the parties to the lease agreement.
Although the factors set out above are intended to identify the key characteristics of a finance lease, they are not always conclusive.
IFRS 16 underlines the requirement to consider the whole of the arrangement, and the extent to which the risks and rewards incidental to
ownership are transferred. Although a lease may appear to fall within the definition of a finance lease, having regard to the characteristics
referred to above, there may be other features that demonstrate that the lease does not transfer substantially all of the risks and rewards
incidental to ownership of the underlying asset. By way of example, the Standard cites circumstances in which ownership of the asset
transfers at the end of the lease, but in exchange for a variable payment equal to its then fair value. Similarly, if there are variable lease
payments, as a result of which the lessee does not have substantially all of the risks and rewards incidental to ownership of the underlying
asset, the lease wil not be classified as a finance lease. [IFRS 16:65]
The following examples illustrate how the exercise of an option wil not affect the classification of a lease, which is only reassessed if there
is a lease modification (see 8.1.2).
Example 8.4A
Exercise of a renewal option in a n operating lease arrangement
Company A leases a property to Company B for 10 years. The lease includes a renewal option under which Company B may extend the
lease contract at the end of the lease. At the inception of the lease, exercise of the renewal option is not considered to be reasonably
certain, and the lease is classified as an operating lease.
Company B must give notice no later than two years before the end of the lease term if it intends to exercise the renewal option.
The commercial rationale for this deadline is to allow Company A to market the leased asset for sale or lease to another party if
Company B chooses not to exercise the renewal option. Towards the end of the eighth year of the lease, Company B serves notice that
it wil renew the lease contract, thereby extending the lease.
The notification that a renewal option wil be exercised does not require reassessment of the classification of the lease because it does not
represent a lease modification as defined in IFRS 16:Appendix A as follows.
" A change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease (for
example, adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term)”.
[IFRS 16:Appendix A]
72
Leases | A guide to IFRS 16
In the circumstances described, the lease contains a renewal option but, at the inception date, exercise of the option is not considered to
be reasonably certain. Subsequent notification by Company B represents a change in circumstance indicating the intention to renew, but this
option was part of the original terms and conditions of the lease; consequently, the lease is not reassessed. When the lease is renewed at
the end of the lease term, Company A effectively enters into a new lease that is classified in accordance with the general requirements of
IFRS 16 (see 8.3). The inception of the new lease wil occur on the date of exercise of the option, but the commencement date wil be two
years later, at the end of the original lease.
However, if (1) the original lease did not include a renewal option and the lease is renegotiated in Year 8 to include one, or (2) the terms of
an existing renewal option in a lease are changed, such an adjustment constitutes a modification in accordance with IFRS 16. In such
circumstances, classification of the lease should be reassessed at the date of modification (i.e. in Year 8).
Example 8.4B
Exercise of a renewal option in a finance lease arrangement
An asset is leased under a finance lease under which the lease term is shorter than the useful life of the leased asset. Subsequent to initial
recognition, an option to renew the lease is exercised. At the inception of the lease, it was not reasonably certain that the option would
be exercised and, consequently, the renewal option was not taken into account in assessing the lease term.
In substance, the renewal of the lease is a separate lease agreement; therefore, the existing lease should continue to be accounted for as a
finance lease to the end of its original term. Subsequently, the renewed lease should be classified as a finance lease or an operating lease
according to the facts and circumstances and accounted for in accordance with IFRS 16’s requirements for finance or operating leases, as
appropriate.
Example 8.4C
Exercise of a purchase option in a lease arrangement
Company A leases a property to Company B for 10 years. The lease includes an option under which Company B may purchase the asset
at the market price of the asset at the end of the lease. Company B may exercise the option no later than two years before the lease
expires. The commercial rationale for this is to allow Company A to market the leased asset for sale or lease to a third party if Company B
chooses not to exercise the purchase option. At the inception date, Company A assesses that it is not reasonably certain that the
purchase option wil be exercised and the lease is classified as an operating lease.
Towards the end of Year 8, Company B serves notice that it wil purchase the property, thereby creating a binding purchase commitment.
Company B wil not acquire legal title to the property until exercise of the option at the end of Year 10.
Notification that the purchase option wil be exercised does not lead to reassessment of the classification of the lease because it does not
represent a lease modification as defined in IFRS 16:Appendix A (see example 8.4A). In the circumstances described, the purchase price
for the asset wil be determined at the end of the original 10-year lease term, and paid for on exercise of the option at the end of Year 10.
The original terms of the operating lease agreement have not been modified. Company A continues to account for the operating lease until
the purchase option is exercised at the end of Year 10, when Company A wil account for a sale of the property.
However if, at the date of notification, the option price is renegotiated to be the market price for the asset at the date of notification and
the original lease term is shortened to eight years, this would constitute a lease modification (see 9.1.4), and would be accounted for
accordingly.
73
Leases | A guide to IFRS 16
8.5.1 Requirement to assess the classificati on of land and buildings elements separately
When a lease includes both land and buildings elements, a lessor should assess the classification of each element as a finance or an
operating lease separately in accordance with IFRS 16:62 to 66, B53 and B54 (see 8.2). In determining whether the land element is an
operating lease or a finance lease, an important consideration is that land normally has an indefinite economic life. [IFRS 16:B55]
Leases of land are assessed in the same way as all other leases. Land normally has an indefinite economic life, so it is unlikely that the
lease term wil be for the major part of the economic life of the asset. Nevertheless, some of the other characteristics described at
8.2 may be met, in which case a lease of land may be a finance lease. In particular, if, at the inception date, the present value of the lease
payments amounts to at least substantially all of the fair value of the underlying asset, it is possible that a lease of land wil be a finance lease.
Note, however, that leases of land (and buildings) for long periods wil often be subject to rent reviews, which may mean that the lessor has
not transferred substantially all the risks and rewards incidental to ownership.
Note that this split is not on the basis of the relative fair values of the land and buildings. The IASB concluded that the allocation of the
minimum lease payments should reflect the extent to which they are intended to compensate the lessor for the use of the separate
elements. The future economic benefits of a building are likely to be consumed to some extent over the term of a lease. Therefore, the
lease payments allocated to the buildings should reflect not only the lessor’s return on its investment in the buildings, but also the
recovery of the value of the buildings consumed over the lease term. In contrast, land with an indefinite useful life should maintain its value
beyond the lease term and, therefore, the lessor does not normally need compensation for any consumption of the economic benefits
inherent in the land. [IFRS 16:BCZ246 & BCZ247]
If the lease payments cannot be allocated reliably between the land and buildings elements, the entire lease is classified as a finance lease,
unless it is clear that both elements are operating leases, in which case the entire lease is classified as an operating lease. [IFRS 16:B56]
One of the most common applications of the previous paragraphs is likely to be in legal jurisdictions where the ownership of property is
held only via leasehold interests. Typically, the government retains ownership of all land, and leasehold interests in land and buildings are
the only means of purchasing such assets. In these circumstances, because similar land and buildings are not sold or leased separately, it
may not be possible to arrive at a meaningful allocation of the lease payments.
For a lease of land and buildings under which the amount for the land element is immaterial to the lease, IFRS 16 allows that the land and
buildings may be treated as a single unit for the purpose of lease classification. The IASB considers that, in such circumstances, the
benefits of separating the two elements and accounting for each separately may not outweigh the costs. The lease is classified in
accordance with the general criteria discussed in 8.2. In such cases, the economic life of the buildings is regarded as the economic life of the
entire underlying asset. [IFRS 16:B57 & BCZ249]
74
Leases | A guide to IFRS 16
8.6 Subleases
IFRS 16 requires an intermediate lessor to account for a head lease and a sublease as two separate contracts, applying both the lessee
and lessor accounting requirements. This approach is considered to be appropriate because, in general each contract is negotiated
separately, with the counterparty to the sublease being a different entity from the counterparty to the head lease. Accordingly, for an
intermediate lessor, the obligations that arise from the head lease are generally not extinguished by the terms and conditions of the
sublease. [IFRS 16:BC232]
In classifying a sublease, an intermediate lessor should classify the sublease as a finance lease or an operating lease as follows:
[IFRS 16:B58]
• if the head lease is a short-term lease that the entity, as a lessee, has accounted for applying IFRS 16:6 (see 7.2), the sublease should be
classified as an operating lease;
• otherwise, the sublease should be classified by reference to the right-of-use asset arising from the head lease, rather than by reference to
the underlying asset (e.g. the item of property, plant or equipment that is the subject of the lease).
In classifying a sublease by reference to the right-of-use asset arising from the head lease, an intermediate lessor wil classify more
subleases as finance leases than it would have done if those same subleases were classified by reference to the underlying asset.
The intermediate lessor only has a right to use the underlying asset for a period of time. If the sublease is for all of the remaining term of the
head lease, the intermediate lessor has in effect transferred that right to another party. [IFRS 16:BC234]
The following examples, reproduced from the illustrative examples accompanying IFRS 16, illustrate the application of the requirements in
IFRS 16 for an intermediate lessor that enters into a head lease and a sublease of the same underlying asset.
Example 8.6.1A
Sublease classified a s a finance lease
[IFRS 16:Illustrative example 20]
Head lease – An intermediate lessor enters into a five-year lease for 5,000 square metres of ofice space (the head lease) with Entity A
(the head lessor).
Sublease – At the beginning of Year 3, the intermediate lessor subleases the 5,000 square metres of ofice space for the remaining three years of
the head lease to a sublessee.
The intermediate lessor classifies the sublease by reference to the right-of-use asset arising from the head lease. The intermediate
lessor classifies the sublease as a finance lease, having considered the requirements in [IFRS 16:61 to 66].
75
Leases | A guide to IFRS 16
When the intermediate lessor enters into the sublease, the intermediate lessor:
a) derecognises the right-of-use asset relating to the head lease that it transfers to the sublessee and recognises the net investment in
the sublease;
b) recognises any difference between the right-of-use asset and the net investment in the sublease in profit or loss; and
c) retains the lease liability relating to the head lease in its statement of financial position, which represents the lease payments owed to
the head lessor.
During the term of the sublease, the intermediate lessor recognises both finance income on the sublease and interest expense on the
head lease.
Example 8.6.1B
Sublease classified a s a n operati ng lease
[IFRS 16:Illustrative example 21]
Head lease – An intermediate lessor enters into a five-year lease for 5,000 square metres of ofice space (the head lease) with Entity A
(the head lessor).
Sublease – At commencement of the head lease, the intermediate lessor subleases the 5,000 square metres of ofice space for two years to a
sublessee.
The intermediate lessor classifies the sublease by reference to the right-of-use asset arising from the head lease. The intermediate
lessor classifies the sublease as an operating lease, having considered the requirements in [IFRS 16:61 to 66].
When the intermediate lessor enters into the sublease, the intermediate lessor retains the lease liability and the right-of-use asset
relating to the head lease in its statement of financial position.
a) recognises a depreciation charge for the right-of-use asset and interest on the lease liability; and
76
Leases | A guide to IFRS 16
IFRS 16 does not include requirements relating to the presentation of subleases. The IASB decided that specific requirements
were not warranted because there is suficient guidance in other Standards. In particular, applying the requirements for offsetting in IAS
1 Presentation of Financial Statements, an intermediate lessor should not offset assets and liabilities arising from a head lease and a
sublease of the same underlying asset, unless the financial instruments requirements for offsetting are met. The IASB considered
whether to create an exception that would permit or require an intermediate lessor to offset assets and liabilities arising from a head
lease and a sublease of the same underlying asset. However, the IASB noted that the exposures arising from those assets and liabilities are
different from the exposures arising from a single net lease receivable or lease liability, and concluded that presenting these on a net basis
could provide misleading information about an intermediate lessor’s financial position, because it could obscure the existence of some
transactions. [IFRS 16:BC235]
For the same reasons, the IASB also decided that an intermediate lessor should not offset lease income and lease expenses relating to a
head lease and a sublease of the same underlying asset, unless the requirements for offsetting in IAS 1 are met. [IFRS 16:BC236]
77
Leases | A guide to IFRS 16
Initially, the lessor wil recognise a finance lease receivable under IFRS 16:67, at the amount equal to the net investment in the lease.
Subsequently, finance income wil be recognised at a constant rate on the net investment under IFRS 16:75 (see 11.3). During any 'rent-
free' period, this wil result in the accrued finance income increasing the finance lease receivable.
The interest rate implicit in the lease is the rate of interest that causes the present value of (a) the lease payments, and (b) the
unguaranteed residual to equal to the sum of (i) the fair value of the underlying asset, and (ii) any initial direct costs of the lessor.
[IFRS 16:Appendix A]
If the lessor grants any incentives to the lessee, such as an initial rent-free period, then, at the inception of the lease, the calculation of the
minimum lease payments and determination of the interest rate implicit in the lease wil factor in nil payments by the lessee during such a
rent-free period.
This definition is consistent with the definition of incremental costs of obtaining a contract in IFRS 15 Revenue from Contracts with
Customers. Consequently, the costs incurred by a lessor to obtain a lease are accounted for consistently with costs incurred to obtain
other contracts with customers. [IFRS 16:BC237]
For lessors (other than a manufacturer or dealer lessor), initial direct costs should be included in the initial measurement of the investment in
the lease, and reduce the amount of income recognised over the lease term. The definition of the interest rate implicit in the lease set out at
9.1.1.2 results in such costs being included automatically in the finance lease receivable; there is no need to add them separately. [IFRS
16:69]
These costs should include only costs that are incremental, and that are directly attributable to negotiating and arranging a lease (e.g.
commissions, legal fees and incremental internal costs). General overheads, such as costs of sales and marketing, are excluded.
If a lessor employs permanent staff to negotiate and arrange new leases, it is not appropriate for the salary costs of those staff to be
included within the initial measurement of finance lease receivables.
78
Leases | A guide to IFRS 16
IFRS 16: Appendix A defines initial direct costs as “incremental costs of obtaining a lease that would not have been incurred if the lease had
not been obtained, except for such costs incurred by a manufacturer or dealer lessor in connection with a finance lease”. (Emphasis
added).
Internal fixed costs do not qualify as incremental costs. Only those costs that would not have been incurred if the lease had not been
obtained should be included in the initial measurement of the finance lease receivable.
This issue has been considered and afirmed by the IFRS Interpretations Committee (see IFRIC Update, March 2014). Although the
Committee were dealing with IAS 17 at that time, a similar definition of initial direct costs is carried forward to IFRS 16 and, therefore, the same
principle applies. Note that although the IFRS Interpretations Committee considered this issue specifically in the context of finance leases,
the guidance applies equally to initial direct costs incurred in negotiating and arranging an operating lease (which are added to the carrying
amount of the underlying asset and expensed over the lease term under IFRS 16:83 – see 9.4.3).
9.1.1.4 Initi al measurement of the lease pay ment s included in the net investment in the lease
At the commencement date, the lease payments included in the measurement of the net investment in the lease comprise the following
payments for the right to use the underlying asset during the lease term that are not received at the commencement date:
[IFRS 16:70]
• fixed payments (including in-substance fixed payments as described in IFRS 16:B42 – see 6.3), less any lease incentives payable;
• variable lease payments that depend on an index or a rate, initially measured using the index or rate as at the commencement date (see
6.5.2);
• any residual value guarantees provided to the lessor by the lessee, a party related to the lessee or a third party unrelated to the lessor
that is financially capable of discharging the obligations under the guarantee;
• the exercise price of a purchase option if the lessee is reasonably certain to exercise that option (assessed considering the factors
described in IFRS 16:B37 – see 6.6); and
• payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease.
9.1.2 Recogniti on and measu re ment a t the commencement date – m anu fa c tu r e r and dealer lessors
At the commencement date, a manufacturer or dealer lessor should recognise the following for each of its finance leases:
[IFRS 16:71]
• revenue, which is the fair value of the underlying asset, or, if lower, the present value of the lease payments accruing to the lessor,
discounted using a market rate of interest;
• the cost of sale, which is the cost (or carrying amount if different) of the underlying asset less the present value of the unguaranteed
residual value; and
• selling profit or loss (which is the difference between revenue and the cost of sale) in accordance with its policy for outright sales to
which IFRS 15 Revenue from Contracts with Customers applies. The selling profit or loss on a finance lease should be recognised at the
commencement date, regardless of whether the lessor transfers the underlying asset as described in IFRS 15.
79
Leases | A guide to IFRS 16
Manufacturers or dealers often offer to customers the choice of either buying or leasing an asset. A finance lease of an asset by a
manufacturer or dealer lessor gives rise to profit or loss equivalent to the profit or loss resulting from an outright sale of the underlying
asset, at normal selling prices, reflecting any applicable volume or trade discounts. [IFRS 16:72]
Manufacturer or dealer lessors sometimes quote artificially low rates of interest in order to attract customers. The use of such a rate would
result in a lessor recognising an excessive portion of the total income from the transaction at the commencement date. If artificially low rates
of interest are quoted, the selling profit should be restricted to that which would apply if a market rate of interest were charged. [IFRS 16:73]
Costs incurred by a manufacturer or dealer lessor in connection with obtaining a finance lease should be recognised as an expense at the
commencement date because they are mainly related to earning the manufacturer or dealer’s selling profit. Such costs are excluded from
the definition of initial direct costs (see 9.1.1.3) and, accordingly, are excluded from the net investment in the lease. [IFRS 16:74]
Changes in the unguaranteed residual value of the underlying asset wil only affect the finance lease receivable if the changes indicate
impairment of the receivable and, subsequently, reversal of impairment.
IFRS 16:67 requires the lessor’s net investment in the finance lease to be shown as a finance lease receivable. The net investment
in the finance lease is equal to the unguaranteed residual value accruing to the lessor plus the lease payments receivable, discounted at
the interest rate implicit in the lease. The subsequent measurement of the lease receivable is specified by IFRS 16 and by the
derecognition and impairment requirements of IFRS 9 Financial Instruments (or, for entities that have not yet adopted IFRS 9,
IAS 39 Financial Instruments: Recognition and Measurement). The recognition of finance income is based on a constant rate of return
on the net investment. Finance income is recognised at the rate implicit in the lease on the total net investment including the
unguaranteed residual value.
80
Leases | A guide to IFRS 16
[IFRS 16:79]
• the modification increases the scope of the lease by adding the right to use one or more underlying assets; and
• the consideration for the lease increases by an amount commensurate with the stand-alone price for the increase in scope and any
appropriate adjustments to that stand-alone price to reflect the circumstances of the particular contract.
The IASB considers that a modification meeting both of the conditions in IFRS 16:79 in substance represents the creation of a new lease
that is separate from the original lease. This requirement is substantially aligned with equivalent requirements in IFRS 15 Revenue from
Contracts with Customers that require a seller to account for modifications that add distinct goods or services as separate contracts if
those additional goods or services are priced commensurately with their stand-alone selling price. [IFRS 16:BC238]
9.1.4.2 Modificati ons to finance leases not accounted for a s separate leases
For a modification to a finance lease that is not accounted for as a separate lease, a lessor should account for the modification as follows:
[IFRS 16:80]
• if the lease would have been classified as an operating lease had the modification been in effect at the inception date, the lessor should: –
account for the lease modification as a new lease from the effective date of the modification; and
– measure the carrying amount of the underlying asset as the net investment in the lease immediately before the effective date of the
lease modification;
• otherwise, the lessor should apply the requirements of IFRS 9 Financial Instruments (or, for entities that have not yet adopted IFRS 9,
IAS 39 Financial Instruments: Recognition and Measurement).
For modifications to a finance lease that are not accounted for as a separate lease (i.e. modifications that do not meet both of the
conditions set out in IFRS 16:80, IFRS 16 requires a lessor to account for the modification applying IFRS 9 (unless the lease would have
been classified as an operating lease if the modification had been in effect at the inception date). The IASB expects that this approach wil
not result in any substantive change to previous lessor accounting for modifications of finance leases. This is because, although IAS 17 did
not include requirements relating to lease modifications, the IASB understands that a lessor generally applied an approach that was
consistent with the requirements in IFRS 9 (or the equivalent requirements in IAS 39) to the net investment in a finance lease. [IFRS
16:BC239]
81
Leases | A guide to IFRS 16
IFRS 16:81 requires lease payments under an operating lease to be recognised as income on a straight-line basis over the lease term,
unless another systematic basis is more representative of the pattern in which benefit from the use of the underlying asset is
diminished. The question arises as to whether variable lease payments in an operating lease should be estimated at the inception date
and recognised on a straight-line basis over the lease term.
IFRS 16:70 specifies that, for finance leases, the lease payments included in the measurement of the net investment in a lease at
commencement date include variable lease payments that depend on an index or a rate; other variable payments (e.g. those linked
to future performance or use of an underlying asset) are excluded from the measurement of the net investment and are instead
recognised as income when they arise. The treatment adopted for variable lease payments under operating leases should be consistent
with these requirements.
Therefore, variable lease payments under operating leases, other than those that are dependent on an index or a rate, should not be
estimated and included in the total lease payments to be recognised on a straight-line basis over the lease term; instead, they should be
recognised as income in the period in which they are earned.
In July 2006, in the context of IAS 17 Leases, the IFRIC (now the IFRS Interpretations Committee) considered whether an estimate of
contingent rents payable (receivable) under an operating lease should be included in the total lease payments (lease income) to be
recognised on a straight-line basis over the lease term. The IFRIC noted that, although IAS 17 is unclear on this issue, this has not, in
general, led to contingent rents being included in the amount to be recognised on a straight-line basis over the lease term. Accordingly, the
IFRIC decided not to add this issue to its agenda. This conclusion is equally valid under IFRS 16.
Some contracts provide for annual payments in an operating lease to increase by a fixed annual percentage over the life of the lease. It is
sometimes suggested that, if such increases are intended to compensate for expected annual inflation over the lease period, it may be
acceptable to recognise them in each accounting period as they arise.
Such a treatment is not appropriate. The lease payments should be recognised on a straight-line basis over the lease term unless
another systematic basis is more representative of the time pattern of the user’s benefit.
This was confirmed by the IFRIC (now the IFRS Interpretations Committee) in the November 2005 IFRIC Update in the context of IAS 17;
the conclusion is equally valid under IFRS 16.
See 9.1.1.3 for further discussion on the nature of initial direct costs.
82
Leases | A guide to IFRS 16
A problem of income and cost matching may arise when a lessor arranges specific finance for the purchase of an asset that is leased under
an operating lease. When the finance is repaid from cash generated by rental receipts, the application of the previous paragraphs wil result
in:
• finance costs front-end loaded because they wil be charged as a constant percentage of capital outstanding.
The effect may be that the three items taken together show a loss in earlier years, and a profit in later years. It is sometimes argued that
one way to address this issue is to view the leased asset as having some of the attributes of a financial asset. A method of depreciation that
would be consistent with viewing the asset as having attributes of a financial asset is one which reflects the time value of money, for example
the annuity method. This would result in a lower depreciation charge in earlier years and a more constant net profit after interest.
However, use of the annuity method of depreciation is not permitted. IFRS 16:84 states that the lessor should apply its normal
depreciation policy for similar assets and the depreciation expense should be calculated on the basis set out in IAS 16. IAS 16:60 states
that the depreciation method used should reflect the pattern in which the asset’s economic future benefits are expected to be
consumed. The method should be based on the economic depreciation of the asset, not on the return from the asset. Therefore, the
consideration of the time value of money in the depreciation calculation is not permitted.
Entities that, in the course of their ordinary activities, routinely sell items that they have held for rental to others are required to transfer
those assets to inventories at their carrying amount when they cease to be rented and become held for sale.
The approach set out in IFRS 16:87 is consistent with the approach required by IFRS 15 if, at the time of a contract modification (that is
accounted for as a separate contract), the remaining goods or services to be transferred are distinct from the goods or services already
transferred. It is also expected that this approach wil not result in any substantive change to previous lessor accounting.
[IFRS 16:BC240]
83
Leases | A guide to IFRS 16
Section 10
Sale and leaseback transactions
10.1 Sale and leaseback t rans ac ti o ns – general
If an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and leases that asset back from the buyer-lessor, both
the seller-lessee and the buyer-lessor are required to account for the transfer contract and the lease applying IFRS 16:99 to 103 (see 10.2
to 10.4). [IFRS 16:98]
In considering whether a transaction should be accounted for as a sale and leaseback transaction, an entity should consider not only
those transactions structured in the form of a legal sale and leaseback, but should also consider other forms of transactions for which
the economic effect is the same as a legal sale and leaseback (e.g. a sale and leaseback transaction may be structured in the form of a
lease and leaseback). [IFRS 16:BC261]
Transfer assets
Seller-lessee Buyer-lessor
Lease asset s
84
Leases | A guide to IFRS 16
IFRS 16 provides no additional application guidance regarding the determination as to whether there is a sale in a sale and leaseback
transaction (i.e. regarding how to apply the IFRS 15 requirements relating to the satisfaction of performance obligations to sale and
leaseback transactions). This is because the IASB considers that the principles in IFRS 15 can be applied appropriately and consistently to
sale and leaseback transactions without any further guidance. [IFRS 16:BC264]
[IFRS 16:100]
• the seller-lessee should measure the right-of-use asset arising from the leaseback at the proportion of the previous carrying amount of
the asset that relates to the right of use retained by the seller-lessee. Accordingly, the seller-lessee should recognise only the amount of
any gain or loss that relates to the rights transferred to the buyer-lessor; and
• the buyer-lessor should account for the purchase of the asset applying applicable IFRSs, and for the lease applying the lessor accounting
requirements in IFRS 16.
Thinking it through
For a sale and operating leaseback under IAS 17, the seller-lessee would have recognised the full profit on sale at fair value.
Therefore, from an accounting perspective, IFRS 16's restriction of the gain to those rights of the asset transferred may not seem
as attractive. However, whether this wil affect the volume of such transactions in future is likely to depend on whether the primary
driver was the accounting result or improved cash flows.
If either (1) the fair value of the consideration for the sale of an asset does not equal the fair value of the asset, or (2) the payments for the
lease are not at market rates, the following adjustments are required to measure the sale proceeds at fair value:
[IFRS 16:101]
• any below-market terms should be accounted for as a prepayment of lease payments; and
• any above-market terms should be accounted for as additional financing provided by the buyer-lessor to the seller-lessee.
The entity should measure any potential adjustment required by IFRS 16:101 (see above) on the basis of the more readily determinable of:
[IFRS 16:102]
• the difference between the fair value of the consideration for the sale and the fair value of the asset; and
• the difference between the present value of the contractual payments for the lease and the present value of payments for the lease at
market rates.
The following example, reproduced from the illustrative examples accompanying IFRS 16, illustrates the application for the requirements in
IFRS 16:99 to 102 for a seller-lessee and a buyer-lessor.
85
Leases | A guide to IFRS 16
Example 10.3
Sale and leaseback trans ac ti o n
[IFRS 16:Illustrative example 24]
An entity (Seller-lessee) sells a building to another entity (Buyer-lessor) for cash of CU2,000,000. Immediately before the transaction, the
building is carried at a cost of CU1,000,000. At the same time, Seller-lessee enters into a contract with Buyer-lessor for the right to use
the building for 18 years, with annual payments of CU120,000 payable at the end of each year. The terms and conditions of the
transaction are such that the transfer of the building by Seller-lessee satisfies the requirements for determining when a performance
obligation is satisfied in IFRS 15 Revenue from Contracts with Customers. Accordingly, Seller-lessee and Buyer-lessor account for the
transaction as a sale and leaseback. This example ignores any initial direct costs.
The fair value of the building at the date of sale is CU1,800,000. Because the consideration for the sale of the building is not at fair value,
Seller-lessee and Buyer-lessor make adjustments to measure the sale proceeds at fair value. The amount of the excess sale price of
CU200,000 (CU2,000,000 – CU1,800,000) is recognised as additional financing provided by Buyer-lessor to Seller-lessee.
The interest rate implicit in the lease is 4.5 per cent per annum, which is readily determinable by Seller-lessee. The present value of the
annual payments (18 payments of CU120,000, discounted at 4.5 per cent per annum) amounts to CU1,459,200, of which CU200,000
relates to the additional financing and CU1,259,200 relates to the lease—corresponding to 18 annual payments of CU16,447 and
CU103,553, respectively.
Seller-lessee
At the commencement date, Seller-lessee measures the right-of-use asset arising from the leaseback of the building at the proportion of
the previous carrying amount of the building that relates to the right of use retained by Seller-lessee, which is CU699,555. This is calculated
as: CU1,000,000 (the carrying amount of the building) ÷ CU1,800,000 (the fair value of the building) × CU1,259,200 (the discounted lease
payments for the 18-year right-of-use asset).
Seller-lessee recognises only the amount of the gain that relates to the rights transferred to Buyer-lessor of CU240,355 calculated as
follows. The gain on sale of building amounts to CU800,000 (CU1,800,000 – CU1,000,000), of which:
(a) CU559,645 (CU800,000 ÷ CU1,800,000 × CU1,259,200) relates to the right to use the building retained by Seller-lessee; and
(b) CU240,355 (CU800,000 ÷ CU1,800,000 × (CU1,800,000 – CU1,259,200)) relates to the rights transferred to Buyer-lessor.
86
Leases | A guide to IFRS 16
Cash CU2,000,000
Building CU1,000,000
Buyer-lessor
Building CU1,800,000
Cash CU2,000,000
After the commencement date, Buyer-lessor accounts for the lease by treating CU103,553 of the annual payments of CU120,000 as lease
payments. The remaining CU16,447 of annual payments received from Seller-lessee are accounted for as (a) payments received to settle
the financial asset of CU200,000 and (b) interest revenue.
[IFRS 16:103]
• the seller-lessee should continue to recognise the transferred asset and should recognise a financial liability equal to the transfer
proceeds. It should account for the financial liability applying IFRS 9 Financial Instruments (or, for entities that have not yet adopted
IFRS 9, IAS 39 Financial Instruments: Recognition and Measurement); and
• the buyer-lessor should not recognise the transferred asset and should recognise a financial asset equal to the transfer proceeds. It
should account for the financial asset applying IFRS 9 (or, for entities that have not yet adopted IFRS 9, IAS 39).
In such circumstances, no sale is recognised by the seller-lessee and no purchase is recognised by the buyer-lessor. Instead, the seller-
lessee and buyer-lessor are required to account for any amounts received or paid relating to the leaseback as a financial asset or a financial
liability applying IFRS 9 (or IAS 39). This is because such a transaction represents, in substance, a financing arrangement. [IFRS 16:BC265]
87
Leases | A guide to IFRS 16
[IFRS 16:C1]
• applies IFRS 15 Revenue from Contracts with Customers at or before the date of initial application of IFRS 16.
The ‘date of initial application’ is the beginning of the annual reporting period in which an entity first applies IFRS 16. [IFRS 16:C2]
Therefore, for example, for an entity adopting IFRS 16 for the first time in the year beginning 1 January 2019, the date of initial application is 1
January 2019 irrespective of whether the Standard is applied with full retrospective effect (see 11.5).
The IASB is conscious of the significant costs that entities could incur on transition to IFRS 16. The Standard includes a number of
transition reliefs and practical expedients designed to allow an entity to minimise those costs without significantly compromising the quality
of the financial information reported.
Both lessees and lessors are permitted to grandfather assessments regarding whether a contract existing at the date of initial
application contains a lease (see 11.3). If an entity decides not to use this practical expedient, it may incur significant costs in re-
examining all of its contracts to determine if they contain a lease.
For lessors, apart from one specific exception in respect of subleases, no adjustments are required on transition from IAS 17 to IFRS 16
because lessor accounting under IFRS 16 is largely consistent with the requirements of IAS 17 (see 11.4).
The situation is more complex for lessees, who need to focus on a number of key decisions. The most significant choices available to a
lessee on transition (i.e. in addition to the choice regarding whether it wil reassess its contracts, as discussed at 11.3) are set out below.
88
Leases | A guide to IFRS 16
1 Whether to apply IFRS 16 to all of its leases If the lessee opts for full retrospective application, all of its leases (both finance and
retrospectively in accordance with IAS 8 Accounting operating under IAS 17) will be required to be restated in accordance with IFRS 16. No
Policies, Changes in Accounting Estimates and Errors or further reliefs are available. See 11.3 for further discussion.
using the cumulative catch-up approach.
If the lessee opts for the cumulative catch-up approach, it does not restate amounts
previously reported and it applies specific rules for measuring right-of-use assets
and lease liabilities (see 11.6.2 for leases previously identified as finance leases and
11.6.3 for leases previously identified as operating leases). It also has the option to
apply specific transition reliefs and practical expedients in respect of leases previously
identified as operating leases (see following points).
2 Under the cumulative catch-up approach, whether On a lease-by-lease basis, the practical expedient permits such leases to be accounted
to apply the practical expedient for leases previously for as short-term leases, irrespective of whether the original lease term was for more
classified as operating leases and ending within 12 than 12 months (see 11.6.3.2).
months of the date of initial application.
3 Under the cumulative catch-up approach, whether (on On a lease-by-lease basis, an entity can choose to:
initial recognition) to apply the practical expedients
permitted in respect of the measurement of lease • apply a single discount rate to a portfolio of leases with reasonably similar
liabilities arising from leases previously classified as characteristics; and/or
operating leases.
• use hindsight, such as in determining the lease term if the contract contains options
to extend or terminate the lease.
4 Under the cumulative catch-up approach, whether (on On a lease-by-lease basis, an entity can choose to:
initial recognition) to apply the practical expedients
permitted in respect of the measurement of right-of- • adjust the right-of-use asset by the amount of any provision for onerous leases
use assets arising from leases previously classified as recognised under IAS 37 so as to approximate impairment; and/or
operating leases.
• exclude initial direct costs from the measurement of the right-of-use asset.
IFRS 16 also specifies disclosure requirements for lessees applying the cumulative catch-up approach (see 11.6.3.8), requirements for
sale and leaseback transactions (see 11.7) and requirements for assets or liabilities previously recognised by a lessee in a business
combination relating to favourable or unfavourable terms of an operating lease (see 11.8).
[IFRS 16:C3]
• to apply IFRS 16 to contracts that were previously identified as leases applying IAS 17 Leases and IFRIC 4 Determining whether an
Arrangement contains a Lease. The entity should apply the transition requirements in IFRS 16:C5 to C18 (see 11.4 to 11.7) to those leases;
and
• not to apply IFRS 16 to contracts that were not previously identified as containing a lease applying IAS 17 and IFRIC 4.
[IFRS 16:C4]
• consequently, apply IFRS 16’s requirements regarding the identification of leases (see section 3) only to contracts entered into
(or modified) on or after the date of initial application.
89
Leases | A guide to IFRS 16
This relief applies for both lessees and lessors. It permits an entity to retain its existing assessment as to whether a contract contains a
lease for all ongoing contracts entered into before the date of transition. The entity assumes that existing leases continue to be leases
under IFRS 16 and existing service contracts continue to be service contracts – it is only required to apply the IFRS 16 definition of a lease
to contracts entered into on or after the date of transition. The IASB has allowed this practical expedient so that entities are not required
to incur the costs of detailed reassessments when it is expected that the determination wil not change for the vast majority of contracts.
If the practical expedient is applied, it is required to be applied to all of the entity’s contracts – no ‘cherry-picking’ is permitted.
If an entity does not apply this expedient, it is required to examine all of its contracts in the context of IFRS 16 to determine whether they
contain a lease. This may be a costly exercise and entities wil need to consider whether the benefits of identifying potential differences in
assessment under IFRS 16 justify the cost. The IASB’s view is that, although IFRS 16 contains more detailed guidance on the identification
of a lease, there are not many contracts where the lease versus service contract assessment wil differ under the new Standard.
Whether this practical expedient is applied or not does not restrict a lessee’s ability to choose between retrospective application of
IFRS 16 or the cumulative catch-up approach (see 11.5).
As described in section 9, the accounting requirements for lessors under IFRS 16 are substantially unchanged from those in IAS 17.
Consequently, a lessor is not generally required to make any adjustments on transition to IFRS 16.
[IFRS 16:C15]
• reassess subleases that were previously classified as operating leases and are ongoing at the date of initial application, to determine
whether each sublease should be classified as an operating lease or a finance lease applying IFRS 16. The intermediate lessor should
perform this assessment at the date of initial application on the basis of the remaining contractual terms and conditions of the head
lease and sublease at that date; and.
• for subleases that were classified as operating leases under IAS 17, but finance leases under IFRS 16, account for the sublease as a new
finance lease entered into at the date of initial application.
IFRS 16 requires an intermediate lessor to evaluate the classification of a sublease by reference to the right-of-use asset arising from the
head lease and not by reference to the underlying asset as was required under IAS 17. As a result, in some cases, subleases that were
classified by an intermediate lessor as operating leases applying IAS 17 may be classified as finance leases applying IFRS 16. If an
intermediate lessor were to continue to apply previous operating lease accounting to such subleases, it would recognise the right-of-use
asset arising from the head lease, despite the fact that, in effect, it no longer has a right to use the underlying asset. To avoid this
misleading outcome, IFRS 16:C15 requires an intermediate lessor to reassess a sublease that was classified as an operating lease
applying IAS 17 at the date of initial application to determine whether the sublease should be classified as an operating lease or a finance
lease applying IFRS 16, and to account for it accordingly. [IFRS 16:BC289 – BC291]
90
Leases | A guide to IFRS 16
11.5 Transiti on for lessees – choice between full retrospecti ve applicati on and ‘cumulative catch - up approach’
A lessee can choose to apply IFRS 16 to its leases either:
[IFRS 16:C5]
a) retrospectively to each prior reporting period presented, applying IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
(see below); or
b) using the cumulative catch-up approach – under which the Standard is applied retrospectively with the cumulative effect recognised at
the date of initial application in accordance with IFRS 16:C7 to C13 (see 11.6).
Whichever option is selected under IFRS 16:C5 should be applied consistently to all leases in which the entity is a lessee. [IFRS 16:C6]
If a lessee chooses under IFRS 16:C5 to apply IFRS 16 retrospectively in accordance with IAS 8, it is required to apply the requirements of
that Standard in full to all of its leases. This means that it is required to:
• restate comparative information for all periods presented, potentially requiring a third statement of financial position; and
Under the general requirements for retrospective application in IAS 8, an entity is required to adjust the opening balances in the earliest
period presented for the cumulative effect of applying IFRS 16 up to that date. Therefore, if an entity applies IFRS 16 for the first time in an
annual period beginning 1 January 2019, and it presents one year of comparative information, it is required to determine and recognise
the cumulative effect of applying the new Standard at 1 January 2018 and also to restate the amounts reported for the year ended 31
December 2018, which wil originally have been reported under IAS 17. In accordance with the requirements of IAS 1 Presentation of
Financial Statements, this wil potentially require inclusion of a third statement of financial position. This means that the
entity wil need to run parallel systems for 2018 in order to capture the required information, which is likely to be very costly. It is for this
reason that the IASB decided to permit the cumulative catch-up approach (see 11.6).
Lessees opting for full retrospective application are not permitted to take advantage of any of the reliefs described in 11.6 (so, for
example, right-of-use assets and lease liabilities must be measured in accordance with the general requirements described in 7.4 and
7.5). However, such entities are permitted to ‘grandfather’ assessments made under IAS 17 and IFRIC 4 regarding whether a contract
contains a lease (i.e. they are permitted to apply the practical expedient described in 11.3).
91
Leases | A guide to IFRS 16
• it recognises the cumulative effect of initial application at the date of initial application (i.e. if an entity applies IFRS 16 for the first time in an
accounting period beginning 1 January 2019, it recognises the cumulative effect of application by adjusting balances at 1 January 2019);
• it does not restate comparative information – if there is a difference between the assets and liabilities introduced, an adjustment is
made to opening retained earnings;
• it carries forward amounts previously recognised in respect of leases classified as finance leases (see 11.6.2);
• it is permitted to apply a number of additional transition reliefs and practical expedients for leases previously classified as operating
leases (see 11.6.3); and
• it is required to disclose the effect of applying the cumulative catch-up approach (see 11.6.3.8).
Importantly, the lessee is not required to run parallel systems at any point; information in comparative periods is reported on an IAS 17
basis and reporting moves to the IFRS 16 basis on the first day of the first accounting period in which the new Standard is applied.
Note that the treatment set out in IFRS 16:C11 for finance lease assets and liabilities is mandatory – unless a lessee has opted for full
retrospective application of IFRS 16 (see 11.5), it is not permitted to restate such assets and liabilities on transition to IFRS 16.
The lessee accounting model in IFRS 16 is similar to the accounting requirements for finance leases in IAS 17. The availability of the
practical expedient in IFRS 16:C3 to avoid reassessing whether a contract contains a lease (see 11.3) and the requirement to carry
forward balances previously recognised under IAS 17 as set out in IFRS 16:C11 mean that lessees in finance leases are unlikely to
encounter significant issues on transition.
11.6.3.2 Leases ending within 12 mo nth s of the date of initi al applicati on – practic al expedient
As a practical expedient, available on a lease-by-lease basis, lessees applying the cumulative catch-up approach are permitted not to
recognise right-of-use assets or lease liabilities in respect of leases previously classified as operating leases for which the lease term ends
within 12 months of the date of initial application. When this option is taken, the lessee:
92
Leases | A guide to IFRS 16
[IFRS 16:C10(c)]
• accounts for such leases in the same way as short-term leases as described in IFRS 16:6 (see 7.2); and
• includes the cost associated with those leases within the disclosure of short-term lease expense in the annual reporting period that
includes the date of initial application.
This additional relief is a pragmatic measure introduced to allow lessees to avoid incurring costs for little benefit. The relief effectively extends
the short-term recognition exemption generally available for lease terms of 12 months or less to lease terms expected to end within 12
months of the date of initial application irrespective of when the lease term commenced. On a lease-by-lease basis, a lessee can choose to
continue to account for such leases as it did under IAS 17.
Note that, if this relief is taken, so that the expense in relation to such leases is included in the amount disclosed for the short-term lease
expense under IFRS 16:53(c), this may trigger the disclosure requirement in IFRS 16:55.
When applying the cumulative catch-up approach for leases previously classified as operating leases, therefore, the lessee:
• ignores lease payments already made. The lease liability is measured by reference to the lease payments for the remainder of the
lease term; and
• ignores any information it has regarding the interest rate implicit in individual leases or the lessee’s incremental borrowing rate at the
commencement of individual leases. The lessee’s incremental borrowing rate at the date of initial application is not necessarily a single
discount rate; it wil vary among leases according to the term of the lease and the nature of the security held (see 7.4.2.2). However,
lessees are permitted to use a single rate for a portfolio of leases with reasonably similar characteristics (see 11.6.3.4).
11.6.3.4 Lease liabiliti es for leases previously classified a s operati ng leases – practic al expedients
On a lease-by-lease basis, an entity can choose to use one or both of the following practical expedients in respect of the measurement of
lease liabilities relating to leases previously classified as operating leases:
• apply a single discount rate to a portfolio of leases with reasonably similar characteristics (such as leases with a similar remaining lease term
for a similar class of underlying asset in a similar economic environment); [IFRS 16:C10(a)] and/or
• use hindsight, such as in determining the lease term if the contract contains options to extend or terminate the lease. [IFRS 16:C10(e)].
For example, consider an entity that entered into a lease a number of years before the date of initial application of IFRS 16 and that
determined at the commencement of the lease that it was not reasonably certain to exercise an extension option. If, at the date of initial
application, the entity has become reasonably certain to exercise the extension option, under IFRS 16:C10(e) it is permitted to measure the
lease liability based on its assessment at the date of initial application (i.e. it is not required to reconstruct the accounting on the basis of its
original assessment).
93
Leases | A guide to IFRS 16
[IFRS 16:C8(b)]
i) retrospectively, as if IFRS 16 had been applied since the commencement date, but discounted using the lessee’s incremental borrowing
rate at the date of initial application; or
ii) at an amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments relating to that
lease recognised in the statement of financial position immediately before the date of initial application.
The selection of measurement basis for right-of-use assets under IFRS 16:8(b) is made on a lease-by-lease basis.
Entities are free to determine which measurement basis to apply to which leases. If a lessee elects retrospective measurement of a right-of-
use asset under IFRS 16:C8(b)(i), it needs to have the necessary historical information to arrive at the carrying amount of the asset at the
commencement of the lease and to calculate depreciation from that date, although it wil use the incremental borrowing rate at the date of
initial application. It may be costly to reconstruct such information. However, it is anticipated that entities wil be wiling to incur such costs for
high-value items so as to avoid the recognition of higher lease-related costs in profit or loss in the years after transition (normally, because
the lease liability falls more slowly under amortised cost accounting than the right-of-use asset, setting the asset equal to the liability part-way
through the lease wil mean that the carrying amount of the asset is higher than it would otherwise be, thus producing a higher
depreciation expense post-transition). It is expected that lessees wil generally apply IFRS 16:C8(b)(ii) for high-volume low-value leases for
which the costs of applying a more accurate transition approach outweigh the benefit of achieving a ‘correct’ post-transition income
statement. [IFRS 16:BC283 – BC286]
IAS 36 Impairment of Assets should also be applied to right-of-use assets at the date of initial application, unless the lessee applies the
practical expedient in IFRS 16:C10(b) (see 11.6.3.7). [IFRS 16:C8(c)]
• not required to make any adjustments on transition for leases previously accounted for as investment property using the fair value model
in IAS 40 Investment Property. The right-of-use asset and the lease liability arising from those leases should be accounted for under IAS 40
and IFRS 16 from the date of initial application; and
• required to measure the right-of-use asset at fair value at the date of initial application for leases previously accounted for as operating
leases and that wil be accounted for as investment property using the fair value model in IAS 40 from the date of initial application. The
lessee’s right-of-use asset and the lease liability arising from those leases are required to be accounted for under IAS 40 and IFRS 16 from
the date of initial application.
94
Leases | A guide to IFRS 16
[IFRS 16:C10]
• rely on its assessment as to whether leases are onerous applying IAS 37 Provisions, Contingent Liabilities and Contingent Assets immediately
before the date of initial application as an alternative to performing an impairment review. If a lessee chooses this practical expedient, it should
adjust the right-of-use asset at the date of initial application by the amount of any provision for onerous leases recognised in the statement
of financial position immediately before the date of initial application; and
In accordance with IFRS 16:C8(c) (see 11.6.3.5), lessees are required to consider whether right-of-use assets are impaired at the date of
initial recognition. This practical expedient offers lessees a simplified approach based on the fact that if a right-of-use asset is impaired at the
date of initial application, the equivalent operating lease wil have been an onerous lease under IAS 37. IFRS 16 therefore permits a lessee to
adjust the right-of-use asset on transition by the amount of any previously recognised onerous lease provision; this expedient is not
expected to have a significant effect on reported information. [IFRS 16:BC287]
• exclude initial direct costs from the measurement of the right-of-use asset at the date of initial application.
As discussed in 7.4.1.2, initial direct costs are incremental costs that a lessee would not have incurred if it had not entered the lease
contract. Such costs are generally included in the initial measurement of a right-of-use asset. This practical expedient permits a lessee to
exclude such costs from right-of-use assets recognised for the first time when IFRS 16 is first applied; the choice is available on a lease-by-
lease basis. It allows an entity to avoid the costs of identifying initial direct costs which may have been incurred several year’s previously.
11.6.3.8 Disclosure requirements for lessee’s applying the cumulati ve catch - up approach
Lessees applying the cumulative catch-up approach are required to disclose information about initial application required by paragraph 28 of
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors except for the information specified in paragraph 28(f) of IAS 8. Instead
of the information specified in IAS 8:28(f), the lessee is required to disclose:
[IFRS 16:C12]
• the weighted average lessee’s incremental borrowing rate applied to lease liabilities recognised in the statement of financial position at the
date of initial application; and
– operating lease commitments disclosed applying IAS 17 at the end of the annual reporting period immediately preceding the date of
initial application, discounted using the incremental borrowing rate at the date of initial application as described in IFRS 16:C8(a)
(see 11.6.3.3); and
– lease liabilities recognised in the statement of financial position at the date of initial application.
If a lessee uses one or more of the specified practical expedients in IFRS 16:C10 (see 11.6.3.2, 11.6.3.4 and 11.6.3.7), it is required to
disclose that fact. [IFRS 16:C13]
95
Leases | A guide to IFRS 16
11.7 Sale and leaseback t rans ac ti ons before the date of initi al applicati on
An entity should not reassess sale and leaseback transactions entered into before the date of initial application to determine whether the
transfer of the underlying asset satisfies the requirements in IFRS 15 Revenue from Contracts with Customers to be accounted for as
a sale. [IFRS 16:C16]
If a sale and leaseback transaction was previously accounted for as a sale and a finance lease, the seller-lessee should:
[IFRS 16:C17]
• account for the leaseback in the same way as it accounts for any other finance lease that exists at the date of initial application; and
If a sale and leaseback transaction was accounted for as a sale and an operating lease under IAS 17, the seller-lessee should:
[IFRS 16:C18]
• account for the leaseback in the same way as it accounts for any other operating lease that exists at the date of initial application; and
• adjust the leaseback right-of-use asset for any deferred gains or losses that relate to off-market terms recognised in the statement of
financial position immediately before the date of initial application.
The transition provisions for sale and leaseback transactions are consistent with the general transition requirements for all leases. A
seller-lessee should not perform any retrospective accounting specific to the sale element of a sale and leaseback transaction on
transition to IFRS 16. A seller-lessee is required to account for the leaseback on transition to IFRS 16 in the same way as it accounts for
any other lease that is in existence at the date of initial application.
A seller-lessee should apply the approach to gain or loss recognition on sale and leaseback transactions in IFRS 16 (see section 10) only
to sale and leaseback transactions entered into after the date of initial application of IFRS 16. The IASB concluded that the costs of applying
a retrospective approach would outweigh the benefits in terms of reported information. [IFRS 16:BC292 – BC294]
11.8 A ssets or liabilities previously recognised by a lessee relati ng to favourable or unfavourable term s of a n operati ng lease
If a lessee previously recognised an asset or a liability applying IFRS 3 Business Combinations relating to favourable or unfavourable terms of an
operating lease acquired as part of a business combination, the lessee should derecognise that asset or liability and adjust the carrying
amount of the right-of-use asset by a corresponding amount at the date of initial application. [IFRS 16:C1]
96
Leases | A guide to IFRS 16
Appendix 1
Illustrative examples – identification of
a lease
The illustrative examples accompanying IFRS 16 include 10 examples of how an entity determines whether a contract is, or contains, a
lease. These examples are summarised in a tabular format below, in each case highlighting the key determinants as to whether the
contract is, or contains, a lease. Please refer to the full text of the illustrative examples accompanying IFRS 16 for complete details in each
case.
1B – Contract between No. Supplier has large pool Yes. Alternatives are No. Supplier selects which No. Customer is purchasing
Customer and Supplier of similar items and none are readily available at minimal are used for each delivery freight capacity (service).
requires Supplier to specified in the contract. cost. Supplier benefits and obtains substantially
transport a specified economically by using its all of the economic benefits
quantity of goods by using pool of available rolling stock from use of the rail cars.
a specified type of rail car in the most eficient manner.
in accordance with a stated
timetable for five years.
2 – Coffee company No. Many areas available for Yes. Alternatives are No. Supplier selects No. Customer is purchasing
(Customer) enters into a Customer to locate its kiosk readily available at minimal which space is allocated space, which can be changed
contract with an airport and none specified in the cost. Supplier benefits to Customer and obtains at the discretion of the
operator (Supplier) to use a contract. economically by using its substantially all of the supplier, and is a service.
space in the airport to sell retail space in the most economic benefits from use
its goods for a three-year efi cient manner. of the concession space.
period.
97
Leases | A guide to IFRS 16
98
Leases | A guide to IFRS 16
99
Leases | A guide to IFRS 16
100
Leases | A guide to IFRS 16
101
Leases | A guide to IFRS 16
Appendix 2
Presentation and disclosure
checklist – lessees
Reference Presentati on/disclosure requirement
PRESENTATION
Presentati on – st atement of financial positi on
IFRS 16:47 A lessee should either present in the statement of financial position, or disclose in the notes:
IFRS 16:47 If right-of-use assets are not presented separately in the statement of financial position, the lessee should:
• include right-of-use assets within the same line item as that within which the corresponding underlying assets
would be presented if they were owned; and
• disclose which line items in the statement of financial position include those right-of-use assets.
IFRS 16:47 If lease liabilities are not presented separately in the statement of financial position, the lessee should disclose which line
items in the statement of financial position include those liabilities.
IFRS 16:48 The requirement for separate presentation of right-of-use assets does not apply to right-of-use assets that meet the
definition of investment property, which should be presented in the statement of financial position as investment
property.
• the interest expense on the lease liability should be presented separately from the depreciation charge for the
right-of-use asset; and
• the interest expense on the lease liability is a component of finance costs which, in accordance with paragraph 82(b)
of IAS 1 Presentation of Financial Statements (, is required to be presented separately in the statement of profit or
loss and other comprehensive income.
• cash payments for the principal portion of the lease liability within cash flows from financing activities;
• cash payments for the interest portion of the lease liability applying the requirements in IAS 7 Statement of Cash
Flows for interest paid; and
• short-term lease payments, payments for leases of low-value assets and variable lease payments not included in
the measurement of the lease liability within cash flows from operating activities.
102
Leases | A guide to IFRS 16
Notes:
IFRS 16:51 1. The objective of IFRS 16’s disclosure requirements for lessees is that suficient information is disclosed in the notes, taken
together with the information provided in the statement of financial position, statement of profit or loss and statement of
cash flows, to provide a basis for users of financial statements to assess the effect that leases have on the financial
position, financial performance and cash flows of the lessee. IFRS 16:52 to 60 (see below) specify requirements designed to
meet this objective.
IFRS 16:52 2. A lessee should disclose information about its leases for which it is a lessee in a single note or separate section in its
financial statements. However, a lessee need not duplicate information that is already presented elsewhere in the financial
statements, provided that the information is incorporated by cross-reference in the single note or separate section about
leases.
c) the expense relating to short-term leases accounted for under IFRS 16:6 (see 7.2). This expense need not include
the expense relating to leases with a lease term of one month or less;
d) the expense relating to leases of low-value assets accounted for applying IFRS 16:6 (see 7.2). This expense should
not include the expense relating to short-term leases of low-value assets reported under (c) above;
e) the expense relating to variable lease payments not included in the measurement of lease liabilities (see 7.5.2.3);
j) the carrying amount of right-of-use assets at the end of the reporting period by class of underlying asset.
Notes:
IFRS 16:54 1. The disclosures specified in IFRS 16:53 should be reported in a tabular format, unless another format is more appropriate.
2. The amounts disclosed under IFRS 16:53 should include costs that a lessee has included in the carrying amount of
another asset during the reporting period.
103
Leases | A guide to IFRS 16
IFRS 16:56 Right-of-use assets meeti ng the definiti on of inves tment property
If right-of-use assets meet the definition of investment property, the disclosure requirements of IAS 40 Investment
Property should be applied. In that case, a lessee is not required to provide the disclosures in IFRS 16:53(a), (f), (h) or
(j) (see above) for those right-of-use assets.
• future cash outflows to which the lessee is potentially exposed that are not reflected in the measurement of lease
liabilities. This includes exposure arising from:
– variable lease payments (see below for further details);
– extension options and termination options (see below for further details); –
residual value guarantees (see below for further details); and
– leases not yet commenced to which the lessee is committed;
104
Leases | A guide to IFRS 16
• whether that information is relevant to users of financial statements. A lessee should provide additional
information as specified in IFRS 16:59 (see above) only if that information is expected to be relevant to users of
financial statements. In this context, this is likely to be the case if it helps those users to understand:
– the flexibility provided by leases (e.g. if a lessee can reduce its exposure by exercising termination options or
renewing leases with favourable terms and conditions);
– restrictions imposed by leases (e.g. if the entity is required to maintain particular financial ratios); –
sensitivity of reported information to key variables (e.g. to future variable lease payments);
– exposure to other risks arising from leases; and
– deviations from industry practice (e.g. unusual or unique lease terms and conditions that affect a lessee’s lease
portfolio); and
• whether that information is apparent from information either presented in the primary financial statements or disclosed
in the notes. A lessee need not duplicate information that is already presented elsewhere in the financial statements.
• enabling a lessee to apply judgement to identify the information that is relevant to users of financial statements and focus its
efforts on providing that information.
Additi onal informati on relati ng to variable lease payments (see illustrative example 22 accompanying
IFRS 16:B49 IFRS 16)
Additional information relating to variable lease payments that, depending on the circumstances, may be needed to
satisfy the disclosure objective in IFRS 16:51 (see above) could include information that helps users of financial
statements to assess, for example:
• the lessee’s reasons for using variable lease payments and the prevalence of those payments;
• key variables upon which variable lease payments depend and how payments are expected to vary in response to
changes in those key variables; and
105
Leases | A guide to IFRS 16
• the lessee’s reasons for using extension options or termination options and the prevalence of those options;
• the prevalence of the exercise of options that were not included in the measurement of lease liabilities; and
• the lessee’s reasons for providing residual value guarantees and the prevalence of those guarantees;
• the nature of underlying assets for which those guarantees are provided; and
IFRS 16:B52 Additi onal informati on relati ng to sale and leaseback t rans ac ti o ns
Additional information relating to sale and leaseback transactions that, depending on the circumstances, may be
needed to satisfy the disclosure objective in IFRS 16:51 (see above) could include information that helps users of
financial statements to assess, for example:
• the lessee’s reasons for sale and leaseback transactions and the prevalence of those transactions;
• the cash flow effect of sale and leaseback transactions in the reporting period.
106
Leases | A guide to IFRS 16
Appendix 3
Disclosure checklist – lessors
Reference Disclosure requirement
Notes:
IFRS 16:89 1. The objective of the disclosure requirements for lessors is for lessors to disclose information in the notes that, together with
the information provided in the statement of financial position, statement of profit or loss and statement of cash flows, gives
a basis for users of financial statements to assess the effect that leases have on the financial position, financial performance
and cash flows of the lessor. IFRS 16:90 to 97 (see below) specify requirements designed to meet this objective.
2. The lessor disclosure requirements in IFRS 16 are more extensive than those in IAS 17 to enable users of financial
IFRS 16:BC251 statements to better evaluate the amount, timing and uncertainty of cash flows arising from a lessor’s leasing activities.
The disclosure requirements have been expanded to address the perception that the lessor accounting model in IAS 17
did not provide suficient information relating to all elements of a lessor’s leasing activities.
c) income relating to variable lease payments not included in the measurement of the net investment in the lease.
• provide a qualitative and quantitative explanation of the significant changes in the carrying amount of the net
investment in finance leases;
• disclose a maturity analysis of the lease payments receivable, showing the undiscounted lease payments to be
received on an annual basis for a minimum of each of the first five years and a total of the amounts for the
remaining years; and
• reconcile the undiscounted lease payments to the net investment in the lease. This reconciliation should identify the
unearned finance income relating to the lease payments receivable and any discounted unguaranteed residual value.
Note:
Finance lease assets fall within the definition of financial instruments as set out in IAS 32 Financial Instruments:
Presentation. Therefore, in addition to the specific disclosure requirements set out above, an entity must also meet the
requirements of IFRS 7 Financial Instruments: Disclosures in respect of its finance lease arrangements.
In particular, because the derecognition and impairment requirements of IFRS 9 Financial Instruments (or, for entities
that have not yet adopted IFRS 9, IAS 39 Financial Instruments: Recognition and Measurement) apply to a lessor’s net
investment in a lease, the relevant requirements under IFRS 7 are also applicable. These are the disclosure requirements
for transfers of financial assets in accordance with IFRS 7:42A and the disclosure requirements regarding credit risk under
IFRS 7.35A et seq.
107
Leases | A guide to IFRS 16
IFRS 16:95 For items of property, plant and equipment subject to an operating lease, a lessor should apply the disclosure
requirements of IAS 16 Property, Plant and Equipment. For this purpose, each class of property, plant and equipment
should be segregated into assets subject to operating leases and assets not subject to operating leases (i.e. the
disclosures required by IAS 16 should be provided separately for assets subject to an operating lease (by class of
underlying asset) and owned assets held and used by the lessor.
IFRS 16:96 The disclosure requirements in IAS 36 Impairment of Assets, IAS 38 Intangible Assets, IAS 40 Investment Property and
IAS 41 Agriculture should be applied for assets subject to operating leases.
IFRS 16:97 A lessor should disclose a maturity analysis of lease payments, showing the undiscounted lease payments to be
received on an annual basis for a minimum of each of the first five years and a total of the amounts for the remaining
years.
• how the lessor manages the risk associated with any rights it retains in underlying assets. In particular, a lessor
should disclose its risk management strategy for the rights it retains in underlying assets, including any means by
which the lessor reduces that risk. Such means may include, for example, buy-back agreements, residual value
guarantees or variable lease payments for use in excess of specified limits.
108
Leases | A guide to IFRS 16
Appendix 4
Comparison with US GAAP
The FASB issued its new leasing standard, ASU 2016-02, in February 2016. Although the IASB and the FASB started the initiative to
improve the accounting for leases as a joint project, with the aim of producing a fully converged standard, in the end there are a number of
differences in approach between IFRS 16 and ASU 2016-02, the most significant of which are highlighted in the table below.
Scope Scope includes leases of all assets (with specified Scope includes leases of all property, plant, and
exceptions – see section 2). Also, lessees can elect to equipment and excludes:
apply the guidance to leases of intangible assets.
• leases of intangible assets;
Leases of low- A lessee may recognise the payments on leases of low- No equivalent exemption under US GAAP. However,
value assets value assets on a straight-line basis over the lease term (in the FASB believes that an entity wil be able to adopt a
a manner similar to recognition of an operating lease reasonable capitalisation policy under which the entity wil
under IAS 17) – see 7.2). When the exemption is applied, not recognise lease assets and liabilities that are below a
such leases are not reflected on the lessee’s balance certain threshold.
sheet.
Lessee All leases are ‘on-balance sheet’ (subject to exemptions All leases are ‘on-balance sheet’ (subject to exemption
accounting for short-term leases and leases of low-value assets – for short-term leases).
model see 7.2).
No distinction between finance and operating leases. Distinction between finance (capital) and operating
leases is retained.
As of the lease commencement date, a lessee
recognises: The accounting for finance leases is similar to the IFRS
16 approach. The right-of-use asset is generally
amortised on a straight-line basis. This amortisation,
• a liability for its lease obligation (initially measured at the
when combined with the interest on the lease liability,
present value of the future lease payments not yet paid
results in a front-loaded expense profile in which interest
over the lease term) (see 7.4.2); and
and amortisation are presented separately in the income
• an asset for its right to use the underlying asset (equal statement.
to the lease liability, adjusted for lease payments made
at or before lease commencement, lease incentives, For operating leases:
and any initial direct costs) (see 7.4.1).
• the lease liability is measured as under IFRS 16 but
The lessee uses the effective interest rate method to without a requirement to reassess variable lease
subsequently account for the lease liability (see 7.5.2), payments; and
and the right-of-use asset is generally amortised on a
straight-line basis (see 7.5.1). • the lease expense is generally recognised on a straight-
line basis and is presented as a single line item in the
income statement.
109
Leases | A guide to IFRS 16
Lessor Retains the current lessor accounting approach for Retains the current lessor accounting approach for
accounting operating and finance leases (see sections 8 and 9). operating and capital (direct financing and sales-type)
A dealer’s profit for a finance lease is recognised up-front leases.
without regard to the revenue guidance in IFRS 15
(see 9.1.2). However, the lease classification criteria wil change, and
the treatment of dealer’s profit, if any, wil be affected as
follows:
Subleases The intermediate lessor is required to classify a sublease The intermediate lessor is required to classify a sublease
as either an operating lease or a finance lease by by reference to the underlying asset of the head lease.
reference to the right-of-use asset arising from the head
lease (see 8.6).
Sale-and- For transactions that qualify as a sale, the gain or loss If the transaction qualifies as a sale, the entire gain on
leaseback recognised by a seller-lessee is limited to the amount of the transaction is recognised.
arrangements any gain or loss that relates to the rights transferred to
the buyer-lessor (see section 10).
110
Leases | A guide to IFRS 16
Key contacts
Veronica Poole
Americas
Asia- Pacific
Europe-Africa
111
Leases | A guide to IFRS 16
Notes
112
Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), a UK private company limited by guarantee, and its network of member firms, each of which is a
legally separate and independent entity. Please see www.deloitte.co.uk/about for a detailed description of the legal structure of DTTL and its member firms.
This publication has been written in general terms and therefore cannot be relied on to cover specific situations; application of the principles set out wil depend upon the
particular circumstances involved and we recommend that you obtain professional advice before acting or refraining from acting on any of the contents of this publication.
Deloitte LLP would be pleased to advise readers on how to apply the principles set out in this publication to their specific circumstances. Deloitte LLP accepts no duty of care or
liability for any loss occasioned to any person acting or refraining from action as a result of any material in this publication.
Deloitte LLP is a limited liability partnership registered in England and Wales with registered number OC303675 and its registered ofice at 2 New Street Square, London
EC4A 3BZ, United Kingdom. Tel: +44 (0) 20 7936 3000
Fax: +44 (0) 20 7583 1198.