IFRS 16 “Leases”

(Effective for annual periods beginning on or after 1 January 2019)

Executive Summary

 IFRS 16 sets out the comprehensive model for the identification of lease arrangements and their
treatment in the financial statements of both lessees and lessors.

 IFRS 16 applies a control model, similar to risk and reward model of IAS 17, for the identification of
leases, distinguishing between leases and service contracts on the basis of whether there is an
identified asset controlled by the customer.

 Both lessees and lessors are entitled to grandfather assessments / conclusion reached previously
under IAS 17 or IFRIC 4 as to whether a contract existing at the date of initial application of IFRS 16
contains a lease so that entities are not required to incur the cost of detailed assessment.

 One of the most notable aspects of IFRS 16 is that the lessee and lessor accounting models are
asymmetrical. While the IASB has retained IAS 17’s finance lease / operating lease distinction for
lessors (and carried into IFRS 16 the related requirements virtually intact), the distinction is no
longer relevant for lessees.

 For lessors, the changes introduced by IFRS 16 are not significant and, except in respect of
subleases, a lessor is not required to make any adjustments on transition for leases in which it is a
lessor. Additional requirements have been introduced for subleases and lease modifications, and
lessor disclosure requirements have been expanded.

 For lessees, the picture is fundamentally different and IFRS 16 can be expected to have a significant
impact, particularly for entities that have a previously kept a large proportion of their financing ‘off-
balance sheet’ in the form of operating leases. This operating lease-style accounting treatment is no
longer available, except for short-term leases (lease term 12 months or less) and leases of low value
assets (‘low value’ is not specifically defined but the IASB has indicated that it has in mind assets
with a value, when new, in the order of magnitude of USD 5,000 or less).

 Except for the short-term or low value leases, as stated above, all other leases within the scope of
IFRS 16 are required to be brought on-balance sheet by lessees – recognizing a right-of-use asset
and the related lease liability at commencement of the lease, with subsequent accounting generally
similar to the finance lease model under IAS 17.

 How these new requirements affect a lessee’s financial statements will obviously depend on the mix
of lease arrangements in place, and also on which of the IFRS 16’s exceptions are practical
expedients are applied. However, the expectations for lessees will be:
  An increase in recognized assets and liabilities (right-of-use assets: present in its own line item
or combine with property plant and equipment, with separate disclosure and lease liabilities:
present separately or include with other liabilities and disclose which line item includes them
recognized other than for short-term and low value leases).

 More lease expenses recognized in the early period of lease, and less in later periods (front-
loaded finance charge on lease liability versus straight-line expense under IAS 17’s operating
lease approach).

 A shift in lease expense classification from operating expenses to financing cost and depreciation
(i.e. moving below metrics such as operating profit, EBITDA). There are some exceptions: any
variable lease payments not included in the initial measurement of the lease liability are
classified as operating expenses, as are the expenses associated with the short-term and low
value assets leases for which recognition exemptions are applied; and

 For entities that present cash flows related to interest on leases as financing flows, a shift of the
payments previously associated with operating leases to the financing category (unless they
change their policy regarding presentation of interest cash flows). Cash from operations and
financing activity outflows will both increase for the entities.

 A number of aspects of the application of IFRS 16 will require the exercise of judgement –
particularly in respect of the definition of a lease, assessment of the lease term, identification of
appropriate rate to discount the lease payments.

Lessees Accounting

Initial recognition and measurement

Lessees are required to initially recognize a lease liability for the obligation to make lease payments and
a right-of-use asset for the right to use the underlying asset for the lease term.

The lease liability is measured at the present value of the lease payments to be made over the lease
term.

Subsequent measurement

Lessees accrete the lease liability to reflect interest and reduce the liability to reflect lease payments
made. The related right-of-use asset is depreciated in accordance with the depreciation requirements of
IAS 16 Property, Plant and Equipment. Lessees remeasure the lease liability upon the occurrence of
certain events (e.g., change in the lease term, change in variable rents based on an index or rate), which
is generally recognized as an adjustment to the right-of-use asset.

Presentation

Right-of-use assets are either presented separately from other assets on the balance sheet or disclosed
separately in the notes. Similarly, lease liabilities are either presented separately from other liabilities on
the balance sheet or disclosed separately in the notes. Depreciation expense and interest expense
cannot be combined in the income statement. In the cash flow statement, principal payments on the
lease liability are presented within financing activities; interest payments are presented based on an
accounting policy
election in accordance with IAS 7 Statement of Cash Flows.

Lessor Accounting
The accounting by lessors under the new standard is substantially unchanged from today’s accounting in
IAS 17. Lessors classify all leases using the same classification principle as in IAS 17 and distinguish
between two types of leases: operating and finance leases.

Impact on financial ratios of lessee

Profit/loss Balance sheet Ratios

EBITDA Total assets Gearing

EPS (in early years) Net assets Interest cover

Dealing with transition

IFRS 16 provides Significant transitional exemptions and simplifications to entities as follows:

An entity is permitted to follow one of two approaches in adopting IFRS 16: the full retrospective
approach or the modified retrospective approach. For entities with significant lease arrangements it
will be important to give due consideration to which transition method is followed as each method will
likely result in a significantly different impact on reported financial position and financial performance.

Practical expedients relating to recognition and measurement within the core body of the standard (e.g.
the recognition exemptions relating to low value assets and short-term leases and the expedient relating
to the separation of lease components in a contract) are available to entities applying either transition
approach.

Full retrospective approach

This approach requires entities to apply the provisions in IFRS 16 retrospectively in accordance with IAS
8 Accounting Policies, Changes in Accounting Estimates and Errors. This means:

 For all leases held at the date of transition the recognition and measurement provisions of IFRS 16
are applied in full;
 Comparative financial information is restated; and
 An adjustment is made to equity at the beginning of the earliest period presented.
Modified retrospective approach

The modified retrospective approach does not require restatement of comparative periods, instead the
cumulative impact of applying IFRS 16 is accounted for using the following methodology:

 Leave comparatives as previously reported

 Any difference between asset and liability recognized in opening retained earnings at transition
 Carry forward existing finance leases liabilities
 Calculate outstanding liability for existing operating leases using the incremental borrowing rate at
date of transition
 Disclose the effect of applying modified retrospective approach
 Measure right-of-use asset on lease-by-lease basis using one of the following two options:

 Measure right-of-use asset as if IFRS 16 had been applied from lease commencement but using
incremental borrowing rate at the date of transition.

 Measure right-of-use asset at an amount equal to the lease liability, adjusted by the amount of
any prepaid or accrued lease payments relating to that lease recognized in the statement of
financial position immediately before the date of initial application.

There are numerous practical expedients available to entities applying this approach. On a lease-by-
lease basis, a lessee may:

 Apply a single discount rate to a portfolio of leases with reasonably similar characteristics
 Not recognize leases whose term ends within 12 months of the date of initial application
 Exclude initial direct costs from the measurement of the right-of-use asset at the date of initial
application
 Use hindsight such as in determining the lease term if the contract contains options to extend or
terminate the lease.