IMPLEMENTING IFRS 16: LEASES

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 Objective IFRS 16

Objective: To specify the principles for recognition, measurement, presentation and

disclosure of leases to ensure that lessees and lessors provide relevant information
that faithfully represents those transactions

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 Identifying a lease

New definition of a lease

An entity determines whether a contract is or contains a lease by assessing whether:

1) The use of an identified asset is either explicitly or implicitly specified. A contract does not
involve the use of an identified asset if a supplier has the substantive right to substitute the
asset used to fulfill the contract. A supplier would have the substantive right to substitute an
asset if:

 It has the practical ability to substitute the asset; and

 It can benefit from exercising that right of substitution.

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 Identifying a lease
New definition of a lease
2) The customer controls the use of the identified asset. A contract conveys
the right to control the use of an identified asset if, throughout the period of
use, the customer has the right to:

 Direct the use of the identified asset; and

 Obtain substantially all of the economic benefits from directing the use of
the identified asset.

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 Identifying a lease
New definition of a lease
The customer has the right to operate the asset or to direct others to operate the
asset in a manner that it determines (with the supplier having no right to change those
operating instructions); or

The customer designed the asset, or caused the asset to be designed, in a way that
predetermines during the period of use:

 How and for what purpose the asset will be used; or

 How the asset will be operated.

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 Identifying a lease
New definition of a lease
• The customer has the right to direct the use of an identified asset whenever it has
the right to direct how and for what purpose the asset is used, including the right to
change how and for what purpose the asset is used, throughout the period of use.

• If neither the customer nor the supplier controls how and for what purpose the asset
is used throughout the period of use, the customer is considered to have the right to
direct the use of the identified asset in either of the following circumstances:

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 Identifying a lease

Determining a lease arrangement

You should carefully look at:

Can the asset be identified? E.g. is it physically distinct?

Can the customer decide about the asset’s use?

Can the customer get the economic benefit from the use of that asset?

If the answer to these questions is YES, then it’s probable that your contract contains a
lease.

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 Identifying a lease
Example 1
Example: You want to rent some space in a warehouse for storing goods. You enter into a 3-year rental
contract. The warehouse owner offers 2 options:

 You will occupy a certain area of XY cubic meters, exact spot to be determined by the owner, based on
actual usage of the warehouse and available free storage.

• You will occupy unit n. 13 of XY cubic meters in sector A of that warehouse. This place is assigned to
you and no one can change it during the contract duration.

Both contracts look like lease contracts, and indeed, in both cases, you would book the rental payments as
expense in profit or loss under older IAS 17.

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 Identifying a lease

Answer to example 1
With IFRS 16, firstly look at whether an underlying asset can be identified.
The first contract does not contain any lease, because no asset can be
identified. The supplier (warehouse owner) can exchange one place for
another and you lease only certain capacity. Therefore, you expense rental
payments in profit/loss.
The second contract does contain a lease, because an underlying asset
can be identified – you are leasing the unit n. 13 of XY cubic meters in the
sector A. Therefore, recognise asset and a liability in your balance sheet.

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 Determining the lease term
The lease term comprises

The non-cancellable period of the lease

Periods covered by an option to extend the lease if

the lessee is reasonably certain to exercise that
option

Periods covered by an option to terminate the lease

if the lessee is reasonably certain not to exercise that
option

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 Determining the lease term
A lease is not enforceable if
 The lessee has the right to terminate the lease without permission
from the lessor and with only an insignificant penalty
AND
 The lessor has the right to terminate the lease without permission
from the lessee and with only an insignificant penalty
To assess if there is an ‘insignificant penalty’ the analysis needs to
include both what is explicitly stated in the contract, as well as
other kinds of economic penalties that may not be included in the
contract. Termination clauses must have economic substance to be
considered.

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 Determining the lease term
Example 1: Lease Term
 Lessee A enters into a 14-year lease for a property
 The lease contract includes a termination clause every 2 years. This
can ONLY be exercised by Lessee A
 The lease contract does not require Lessee A to make a termination
payment to the lessor if it exercises the termination option
 Lessee A is reasonably certain that it will not exercise the termination
option for 10 years
Required
What is the lease term?

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 Determining the lease term
Example 1: Lease Term
Answer
 Lease term = 10 years (enforceable by lessee)
 Lessee A does not expect to exercise termination option for a period
of 10 years
 IFRS 16.B34 is N/A here (i.e. lease is only not enforceable if both
parties can terminate the lease)

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 Determining the lease term
Example 2: Lease Term
 Lessee B enters into a 14-year lease for a property
 The lease contract includes a termination clause every 2 years. This clause can be
exercised by BOTH Lessee B and the lessor
 The lease contract does not require either Lessee B or the lessor to make a
termination payment if either party exercise a termination clause
 Lessee B has installed expensive leasehold improvements that have an expected
useful life of approximately 10 years
 Lessor would incur significant costs in finding a new tenant
Required
What factors should Lessee B consider when determining the lease term?

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 Determining the lease term
Example 2: Lease Term

Answer
Step 1 –Determine if the lease is enforceable under IFRS 16.B34
 Must consider if either party has more than an insignificant penalty for terminating.
Types of penalties include:
• Cash penalty
• Having to relocate premises
• Undertaking leasehold improvements (not used for full useful life)
• Finding a new tenant
 If Lessee B considers there is no significant penalty of any type (for either party),
lease term = 2 years. Lessee B would be unlikely to conclude this is the case.

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 Determining the lease term
Example 2: Lease Term
Answer (continued)
Step 2 –If there is a significant penalty, contract is enforceable and lease term
needs to be determined
 In this fact pattern, it is likely that there is a significant penalty for Lessee B up until
the end of year 10 because of remaining useful life of its leasehold improvements.
There is also a significant penalty for Lessor because it would incur significant costs
to find a new tenant
 Lessee B is likely to assess the lease term as 10 years, being the length of time its
leasehold improvements are expected to be used (i.e. period it would be reasonably
certain NOT to exercise termination option).

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 Determining the lease term
Example 2: Lease Term
Answer (continued)
Step 2 –If there is a significant penalty, contract is enforceable and lease term needs to be determined
 In this fact pattern, it is likely that there is a significant penalty for Lessee B up until the end of year 10 because
of remaining useful life of its leasehold improvements. There is also a significant penalty for Lessor because it
would incur significant costs to find a new tenant
 Lessee B is likely to assess the lease term as 10 years, being the length of time its leasehold improvements
are expected to be used (i.e. period it would be reasonably certain NOT to exercise termination option).
Challenges in applying B34 in practice
 What constitutes ‘more than insignificant penalty’ is highly judgmental
 How do you know what lessor costs to find a new tenant will be?
 Lessee need to consider changing circumstances within its control when reassessing lease term (IFRS 16.20)

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 Determining the lease term
Example 3: Lease Term
 Lessee C enters into a 10-year lease for a property
 After the initial 10-year period, the lease continues until EITHER party
terminates the lease (with 3 month’s notice)
 The lease contract does not require either Lessee C, or the lessor, to
make a termination payment if either party exercises its termination
clause
Required
What factors should Lessee C consider when determining the lease term?

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 Determining the lease term
Example 3: Lease Term
Answer
Step 1 –consider if requirements of IFRS 16.B34 apply because BOTH lessee and lessor have
option of terminating lease after non-cancellable period of 10 years
 Must consider if either party has more than insignificant penalty for terminating. Types of penalties
include:
•Cash penalty
•Having to relocate premises
•Undertaking leasehold improvements (not used for full useful life)
•Finding a new tenant
 If either Lessee C or the lessor would suffer some form of economic loss for terminating the contract,
then there is a ‘more than an insignificant penalty’ and the lease contract is considered to be
enforceable. Lessee C would need to consider the lease term in the same way as it did in Part 1 above

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 Determining the lease term
Example 3: Lease Term
Answer (continued)
Step 2 –If there is more than a significant penalty, contract is enforceable and lease term needs
to be determined in the same way as PART 1 (above)
 This may be extremely difficult to assess in practice, and when deciding on the lease term,
the lessee would need to consider any factors, such as:
• Past practice
• Reasonable expectations of its lease term
 Wider economic factors, however, Lessee C considers that all types of penalties would be
insignificant for terminating the lease after the 10-year period, then the lease term would be
10 years

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 Determining the lease term

Leases with non-consecutive or intermittent periods of use

Technical guidance IFRS 16.B34: Definition of lease term
‘The non-cancellable period for which a lessee has the right to use an underlying asset,
together with both:
(a) periods covered by an option to extend the lease if the lessee is reasonably certain to
exercise that option; and
(b) periods covered by an option to terminate the lease if the lessee is reasonably certain not to
exercise that option.’
Definition of period of use: ‘The total period of time that an asset is used to fulfil a contract with
a customer (including any non-consecutive periods of time).’

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 Determining the lease term

Leases with non-consecutive or intermittent periods of use

Example 5
 Scenario 1 -Holiday Co. enters into a two-year lease agreement
• Months available for use are November, December and January
• Same store location to be provided for each year
 Scenario 2 -Sports Team Co. enters into a 15-year stadium lease agreement
• Available for use for 30 non-consecutive home games per year
Discussion question:
Would these leases with lease terms greater than 12 months be considered a short-term
lease?

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 Determining the lease term
Leases with non-consecutive or intermittent periods of use
Example 5
Answer:
 Scenario 1
• Lease term 2 years
• Period of use 6 months
• Short-term lease
 Scenario 2
• Lease term 15 years
• Period of use 450 days
• Long-term lease

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 Initial Recognition and measurement
At the commencement date of a lease, i.e. the date on which the lessor makes an underlying
asset available for use by a lessee, the lease liability and right-of-use asset comprise:

• Present value of:

Lease • +Fixed Payments from commencement date
Liability
• +Termination penalties
• +Lease Liability (as computed above)
• +Initial Direct Costs
Right of Use
Asset
• +Costs of removal and restoring
• +Payments made at or prior to
commencement

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 Right of Use asset - Subsequent measurement

Measurement models
 Cost Model (IAS 16)
 Revaluation Model (IAS 16)
 Fair Value Model Investment Property (IAS 40)
IFRS 16 references IAS 16 and IAS 40 for guidance on subsequent measurement, but it does
not state that the right-of-use asset in a lease contract is property, plant and equipment or
investment property. Right-of-use assets are, therefore, a class of asset distinct from both
property, plant and equipment and investment property.

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 Presentation of Leases
The requirements for the presentation of lease balances and transactions are summarised as follows:
Statement of financial
Position
• Right-of-use assets:
present in its own line
item or combine with
property, plant and
equipment, with separate
disclosure.
• Lease liabilities: present
separately or include with
other liabilities and
disclose which line item
they have been included.
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Statement of Profit or Loss
• Interest expense with
other finance costs.
• Amortisation of right-of-
use assets.
Statement of cashflow
• Cash payments of lease
liabilities as financing
activities.
• Cash payments for
interest in accordance
with IAS 7’s requirements
for interest paid.
• Short-term, low-value
and variable lease
payments within
operating Activities.
 Disclosure of Leases
IFRS 16 has extensive disclosure requirements for lessees in both qualitative and quantitative form. Quantitative
disclosure requirements by primary statement include:
Quantitative Disclosure Requirements
Statement of financial Position Statement of Profit or Loss Statement of cashflow
• Additions to right-of-use • Depreciation for assets by • Total cash outflow for leases.
assets. class.
• Carrying value of right-of- • Interest expense on lease
use assets at the end of the liabilities.
reporting period by class. • Short-term leases expensed
• Maturity analysis of lease • Low-value leases expensed.
liabilities separately from • Variable lease payments
other liabilities based on expensed.
IFRS 7 • Income from subleasing.
• Financial Instruments: • Gains or losses arising from
Disclosures requirements. sale and-leaseback
transactions.

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 Qualitative Disclosure Requirements
A summary of the nature of the entity’s leasing activities;
 Potential cash outflows the entity is exposed to that are not included in the lease liability,
including:
•Variable lease payments;
•Extension options and termination options;
•Residual value guarantees; and
•Leases not yet commenced to which the lessee is committed.
 Restrictions or covenants imposed by leases; and
 Information about sale-and-leaseback transactions.

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