Choosing IFRS 16 transition options and

practical expedients
IFRS 16 Leases applies to an entity’s financial statements for annual periods beginning on or
after January 1, 2019. While the adoption of IFRS 16 may require significant work for many
lessees, there are various practical expedients you can use to reduce the transition effort. Here,
we outline the available practical expedients, the benefits of electing to use them and how they
will impact an entity’s financial results.

Background

IFRS 16 provides lessees with a choice between two transition approaches (which must be
applied to all leases):

 Full retrospective approach—with restatement of comparative information in accordance with

IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Under this approach, the
cumulative effect of initially applying IFRS 16 is recognized as an adjustment to equity at January
1, 2018 for a lessee that adopts IFRS 16 on the effective date and has a December 31 year-end.
Comparative figures for the year ended December 31, 2018 are also restated to reflect the
adoption of IFRS 16. This approach effectively restates the financial statements as if IFRS 16 had
always been applied, with the exception of optional transition relief discussed below.

 Modified retrospective approach. Under this approach, the cumulative effect of initially applying
IFRS 16 is recognized as an adjustment to equity at the date of initial application (DOIA) (e.g. 
January 1, 2019 for a lessee that adopts IFRS 16 on the effective date and has a December 31
year-end). Comparative figures for the year ended December 31, 2018 are not restated to
reflect the adoption of IFRS 16 but instead continue to reflect the lessee’s accounting policies
under IAS 17 Leases. If a lessee chooses modified retrospective application, a number of more
specific transition requirements and practical expedients also apply. These requirements and
practical expedients are discussed in further detail below.

When choosing which approach to use, a lessee should carefully consider the cost and benefits of
each alternative. In general, the full retrospective approach will provide users of the financial
statements with better information but it requires more data and analysis compared to the
modified retrospective approach. Some factors to consider include

 the volume and complexity of your leasing contracts;

 the importance of prior period comparative information to the users of your financial
statements; and
 the ease of accessing your leasing data. For example, the data gathering may be less time-
consuming if your leasing data is organized in a central database.

Lessors are not required to make any adjustments in respect of leases in place at the date of
transition, except for intermediate lessors (i.e. lessors with sub-leases). Instead, for lessors, IFRS
16 is applied prospectively from the date of transition.
IFRS 16 also provides both lessees and lessors with optional transition relief from reassessing whether
contracts in place at the DOIA are, or contain, a lease. If elected, this optional relief must be applied to
all lease contracts and allows both lessees and lessors to rely on the leases previously identified under
IAS 17 and IFRIC 4 Determining Whether an Arrangement Contains a Lease. The definition of a lease
under IFRS 16 will apply to leases entered into after the DOIA. 

Finally, the standard sets out mandatory transition requirements in relation to:

 Sale and leaseback transactions before the DOIA. An entity is not required to reassess
sale and leaseback transactions entered into before the date of initial application to
determine whether a sale occurred in accordance with IFRS 15 Revenue from Contracts
with Customers. For sale and leaseback transactions accounted for as a sale and finance
lease, the seller-lessee accounts for the leaseback in the same way as any finance lease
that exists at DOIA and continues to amortize any gain on the sale over the lease term.
For operating leases, the seller-lessee accounts for the leaseback in the same way as any
other operating lease that exists at DOIA and adjusts the right-of-use asset for any
deferred gains or losses that relate to off-market terms recognized on the balance sheet
immediately before DOIA.

 Leases assumed in previous business combinations. If a lessee previously recognized an

intangible asset for a favourable operating lease, or a liability for an unfavourable
operating lease, then it derecognizes that asset or liability on transition to IFRS 16. A
lessee also adjusts the carrying amount of the right-of-use asset by the amount of the
asset or liability derecognized.  

The practical expedients noted below apply to operating leases under IAS 17 for a lessee. No
changes are required under IFRS 16 for finance leases that were previously recognized under
IAS 17.

Prior to applying any of the practical expedients to its operating leases under IAS 17, a
lessee must first complete the following steps:

1. Measure the lease liability at the DOIA at the present value of the remaining lease
payments based on the lessee’s incremental borrowing rate over the remaining lease term.
The lease payments would include fixed payments, variable lease payments based on an
index or a rate, residual value guarantees, exercise price for purchase options reasonably
certain to be exercised, as well as termination penalties for termination options
reasonably certain to be exercised.
2. Measure the right-of-use (ROU) asset at either of the following amounts:
1. as if IFRS 16 has been applied since the inception of the lease but using the
incremental borrowing rate on the DOIA; or
2. the value of the lease liability (adjusted for any prepaid or accrued lease
payments).

This policy choice can be applied on a lease-by-lease basis.

Practical expedient #1: Discount rate

At the commencement date of the lease, a lessee must recognize a lease liabilty at the present
value of the lease payments remaining at that date. The discount rate to use is the interest rate
implicit in the lease or, if that rate is not available, the lessee’s incremental borrowing rate. The
interest rate implicit in the lease is the interest rate that causes the present value of the lease
payments and unguaranteed residual value to equal the sum of the fair value of the underlying
asset and any intiial direct costs of the lessor. In some cases, the fair value of the underlying asset
or the intial direct costs of the lessor may not be available to the lessee in which case a lessee
will default to using its incremental borrowing rate. This borrowing rate must reflect comparable
characteristics to the lease (similar term, with a similar security, the funds necessary to obtain an
asset of similar value to the ROU asset in a similar economic environment).

Instead of requiring a lessee to determine the incremental borrowing rate for every single lease,
IFRS 16 allows a lessee to 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).

Practical expedient #2: Initial direct costs

If the lessee decides to measure an ROU asset using the policy choice outlined in 2a above, the
ROU asset must include the initial direct costs incurred by the lessee to obtain the lease. This
requirement could present a challenge for lessees to gather the necessary data on DOIA,
especially when there is a large volume of leases or when the lease originated many years ago.

As a practical expedient, IFRS 16 allows a lessee to exclude initial direct costs from the
measurement of the ROU asset on transition. A lessee can apply this practical expedient on a
lease-by-lease basis.

Practical expedient #3: Use of hindsight for lease term

A lessee is required to determine the lease term at the DOIA, which includes purchase and
renewal options reasonably expected to be exercised and excludes termination options
reasonably expected to be exercised. If the lessee decides to measure its ROU asset using the
policy choice outlined in 2a above, the purchase, renewal and termination options to be included
in the ROU assets based on the assessment at the inception of the lease could be different from
those based on the information available on DOIA.

 To alleviate the burden of reconstructing a lessee’s initial assessment of the lease term and
subsequent changes thereafter, IFRS 16 allows a lessee to use hindsight to determine which
renewal and termination options to include or exclude. A lessee can apply this practical
expedient on a lease-by-lease basis.

Practical expedient #4: Onerous lease determination

Similar to other non-financial assets, ROU assets are subject to impairment testing under IAS 36
Impairment of Assets and a lessee is required to perform an impairment review for each of its
ROU assets at DOIA, which could be quite burdensome. As such, IFRS 16 allows a lessee to use
its onerous contract assessment under IAS 37 Provisions, Contingent Liabilities and Contingent
Assets immediately before transition instead of performing an impairment review under IAS 36.
The ROU asset is then reduced by any existing provision for related onerous leases. A lessee can
apply this practical expedient on a lease-by-lease basis.  

Practical expedient #5: Short-term leases

For leases with a remaining term of less than one year at the DOIA, the lessee may choose to
apply the short-term lease exemption in IFRS 16 and expense lease payments rather than
recognize an ROU asset and a lease liability at the DOIA. When using the short-term lease
exemption, a lessee is required to disclose the amount of lease payments expensed as a result of
using this expedient. A lessee can apply this practical expedient on a lease-by-lease basis