IMPLEMENTING IFRS 16: LEASES

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 IFRS 16 LEASES
Session Overview
• Introduction to IFRS 16
• Scope
• Objective
• Identifying a lease
• Determining the lease term
• Recognition & measurement
• Presentation & disclosure
• Effective date, transitional options & practical expedients
• Risk Assessment & implementation questions

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 Introduction
What is being replaced by IFRS 16
• IAS 17 Leases
• IFRIC 4 Determining whether an arrangement contains a Lease
• SIC-27Evaluating the Substance of Transactions Involving the Legal
Form of a Lease
• SIC 15 Operating Lease Incentive

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 Introduction
The need for change
Leases are an important and flexible source of financing – listed
companies in the USA using IFRS or US GAAP are estimated to have
around US$3.3trillion lease commitments. Over 85% of these lease
commitments do not appear on the balance sheet today.
Therefore, it is difficult for investors and others to:
• Get an accurate picture of a company’s lease assets and liabilities
• Compare companies that lease assets with those that buy assets
• Estimate the amount of off-balance sheet obligation: often
overestimated

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 Introduction
What's changing for lessors and lessees?
Changes to lessor accounting
• Substantially carry forward IAS 17 accounting with some additional
disclosure requirements
Changes to lessee accounting
• Former operating leases are to be capitalized similar to today’s
finance lease
• Recognition exemptions – leases with underlying assets of low value
(5,000USD or less when new) or a lease term of less than 12 months
should be expensed (this is an option and not a requirement)

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 Which Industries are affected the most
IFRS 16 is expected to have a wide impact across most industries in particular those industries
with numerous and/or high value leases. Those industries that use extensive land and buildings
and valuable equipment will be strongly impacted. The following industries are particularly likely
to be impacted upon:

• Property and construction

• Airlines
• Retailers’ with multiple outlets
• Telecoms
• Transport & logistics
• Health care
• Mining
• Manufacturing
• Real estate

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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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 Scope of IFRS 16

IFRS 16 Leases applies to all leases, including subleases, except for:

• leases to explore for or use minerals, oil, natural gas and similar non-regenerative
resources;
• leases of biological assets held by a lessee (see IAS 41 Agriculture);
• service concession arrangements (see IFRIC 12 Service Concession Arrangements);
• licences of intellectual property granted by a lessor (see IFRS 15 Revenue from
Contracts with Customers); and
• rights held by a lessee under licensing agreements for items such as films, videos,
plays, manuscripts, patents and copyrights within the scope of IAS 38 Intangible Assets
A lessee can elect to apply IFRS 16 to leases of intangible assets, other than those items
listed above.

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 Identifying a lease

New definition of a lease

What is a lease under IFRS 16?

A contract is or contains a lease if the contract conveys the right to control the use
of an identified asset for a period of time in exchange for consideration (IFRS16,
par.9). This definition of lease is much broader than under the old IAS 17 and you
must assess all your contracts for potential lease elements.

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 Identifying a lease
New definition of a lease
 Under IFRS 16, you need to separate lease and non-lease
components in a service contract.
 E.g. if you rent a warehouse and rental payments include the fees for
cleaning services, then you should separate these payments between
the lease payments and service payments and account for these
elements separately.
• However, lessee can optionally choose not to separate these elements,
but account for the whole contract as a lease (this applies for the whole
class of assets).

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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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 Identifying a lease
Example 2: Substantive substitution rights for part of the lease term (Rights to direct the
use of an asset)
Technical guidance: IFRS 16.B15
‘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’
Fact patterns:
ABC Co. (lessee) enters into a 4-year rail car lease agreement on 30 June 20x1
Scenario A: Rail Co. (lessor) has substantive substitution rights for the remainder of the lease
term beginning on 1 July 20x3
Scenario B: Rail Co. can substitute the rail car throughout the term of the lease on the occurrence
of a specific event
Scenario C: Rail Co. can substitute the rail car at 1 July 20x3 only
Question:
What it the term of the lease and are the substitution rights substantive?
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 Identifying a lease

Example 2: Substantive substitution rights for part of the lease term

Answer:
Scenario A: Since substitution right is not for the entire period of the
lease, it is not substantive, and the lease term is the period of the
contract of 4 years
Scenario B: Since the substitution right is only on the occurrence of an
event, it is not substantive, and the lease term is the period of the
contract of 4 years
Scenario C: Since the substitution right is only on a particular date, it is
not substantive, and the lease term is the period of the contract of 4
years
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 Identifying a lease

Example 3: Allocation of consideration to lease components and non-lease components

Technical guidance: IFRS 16.B15
‘Suitable methods for estimating the stand-alone selling price of a good or service include, but are
not limited to, the following:
(c) Residual approach—an entity may estimate the stand-alone selling price by reference to the
total transaction price less the sum of the observable stand-alone selling prices of other goods or
services promised in the contract. However, an entity may use a residual approach to estimate, in
accordance with paragraph 78, the stand-alone selling price of a good or service only if one of the
following criteria is met:
(i) the entity sells the same good or service to different customers (at or near the same time) for a
broad range of amounts (ie the selling price is highly variable because a representative stand-alone
selling price is not discernible from past transactions or other observable evidence); or
(ii) the entity has not yet established a price for that good or service and the good or service has not
previously been sold on a stand-alone basis (ie the selling price is uncertain).’

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 Identifying a lease
Example 3: Allocation of consideration to lease components and non-lease
components

Fact patterns:
ABC Co. (lessee) enters into a 4-year building lease agreement
Breakdown of amount of lease payment relating to cleaning services not included in the
lease agreement
ABC elects to separate lease and non-lease components
Question:
Can ABC Co. use the ‘residual approach’ to determine the stand-alone value for the
components?
Answer:
If the criteria in IFRS 16.B15 are met, ABC Co. is allowed to use the ‘residual approach;
however, given the requirements it is unlikely they will be able to.
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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
Example 4: Lease Term
 Lessee D enters into a 10-year lease for a property
 After the initial 10-year period, the lease includes a rolling 12-month extension option. There is no end date to the
number of potential extension options
 The lease therefore continues until EITHER party decides not to extend the lease
 If either party decides not to extend the lease after the initial 10-year period, no termination payments are required
to be made
 Assume:
• The lease contract is enforceable for the 10-year initial lease period
• At the end of year 10, the Lessee D extends the lease for an additional 12 months, and
• Lessee D had only included the initial 10-year period in its initial estimate of the lease term
Required
At the end of Year 10, can Lessee D apply the IFRS 16 short-term lease exemption to the lease for an additional 12
months

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 Determining the lease term
Example 4: Lease Term
Answer
 No. Lessee D must revise the lease term (refer to IFRS 16.20-21 for
information on reassessment of the lease term)
 The short-term lease exemption is not supposed to be used in these
circumstances. It was only intended as a cost-saving measure to get the
simple, and clearly short-term leases off balance sheet, e.g. car hires,
Christmas period pop-up shops, etc

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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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 Determining the lease term
IFRS 16 paragraph B34 penalty
Example 6
Fact pattern:
 ABC Co. enters into a 10-year warehouse lease
 Both the lessor and ABC Co. have the right to terminate the contract with no contractual
penalties
 ABC Co. has significant leasehold improvements in the warehouse
 Warehouse is located in a remote location where ABC Co. would have limited replacement
options
Question:
Are economic penalties considered in the determination of ‘more than an insignificant penalty’
in accordance with IFRS 16.B34?
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 Determining the lease term
IFRS 16 paragraph B34 penalty
Example 6
Answer:
 Yes, significant economic penalties are considered in terms of IFRS 16.B34
 Some additional examples of economic penalties would be (this list is not all inclusive):
Damage to market reputation
Damage to customer relationships
Importance of the asset to the operation of the entities business

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 Determining the lease term
Revisions to the Lease Term
A lessee is required periodically to reassess whether it is reasonably certain to exercise extension and termination options and to revise
the lease term if there is a change. The lease term may also change due to modifications to the lease contract.
Reassessment of Original Estimate
Changes in the lease term may occur due to a change in an entity’s intentions, the entity’s business practice, and other circumstances
unforeseen since it was first estimated.
A lessee is required to reassess the likelihood of it exercising or failing to exercise options upon the occurrence of an event or a change
in circumstances that:
(a) Is within the control of the lessee; and
(b) Affects whether the lessee is reasonably certain to exercise an option not previously included in the determination of the lease term,
or not to exercise an option previously included in its determination of the lease term.
Revisions to original estimates of the lease term resulting from reassessments as to the likelihood of exercising options result in
remeasurement of the carrying value of leased assets and liabilities.
Remeasurements due to Modifications to the Lease Contract
The lease term may be changed if the lessee and lessor agree to modify the lease contract (as distinct from re-estimating the lease term
due to revising judgments about whether options will be exercised). Contract modifications also result in remeasurement of the lease
assets and liabilities.

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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:

+Fixed Payments from commencement date
+Certain Variable (only those linked to inflation or an index)
Lease Liability
+Payments Residual Value Guarantee
+Exercise Price of Purchase Options
+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
+Lease incentives received

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 Initial Recognition and measurement
Discount rate
The discount rate to use is the rate implicit in the lease, unless this cannot readily be
determined, in which case the lessee’s incremental borrowing rate is used instead. Incremental
borrowing is the rate of interest that a lessee would have to pay to borrow over a similar
term and with similar security, the funds necessary to obtain an asset of similar value to the
right-of-use asset in a similar economic environment.’

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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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 Right of Use asset - Subsequent measurement
Cost models
Under the cost model, an entity measures a right-of-use asset at:
 Cost as per IFRS 16
 Less accumulated amortisation (recognised in accordance with the depreciation
requirements of IAS 16) and accumulated impairment losses (recognised in accordance with
IAS 36);
 Adjusted for remeasurements as per IFRS 16
The right-of-use asset is amortised over the lease term, unless the initial recognition
contemplates the exercise of a purchase option or the lease transfers ownership of the
underlying asset to the lessee by the end of the lease term. In those cases, the right-of-use
asset is amortised over the useful life of the underlying asset.

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 Right of Use asset - Subsequent measurement
Revaluation Model
If right-of-use assets relate to a class of property, plant and equipment to which an entity
applies the revaluation model under IAS 16, a lessee may elect to apply the revaluation model
to those right-of-use assets. An entity must be consistent in its classification of a class of
property, plant and equipment, and right-of-use assets for the purposes of IAS 16 and IFRS 16.
The option to apply the revaluation model for right-of-use assets where the same class of
property, plant and equipment is revalued under IAS 16 results in the potential for inconsistency
because an entity is not required to apply the revaluation model to those right-of-use assets.
Therefore, an entity may have a group of owned assets (e.g. land and/or buildings) to which it
applies the revaluation model, whilst applying the cost model to property leases.

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 Right of Use asset - Subsequent measurement
Revaluation Model
If right-of-use assets relate to a class of property, plant and equipment to which an entity applies the
revaluation model under IAS 16, a lessee may elect to apply the revaluation model to those right-of-use
assets. An entity must be consistent in its classification of a class of property, plant and equipment, and
right-of-use assets for the purposes of IAS 16 and IFRS 16.
The option to apply the revaluation model for right-of-use assets where the same class of property, plant
and equipment is revalued under IAS 16 results in the potential for inconsistency because an entity is not
required to apply the revaluation model to those right-of-use assets. Therefore, an entity may have a group
of owned assets (e.g. land and/or buildings) to which it applies the revaluation model, whilst applying the
cost model to property leases.
Fair Value Model
If an entity applies the fair value model in IAS 40, the same model must also be applied to right-of-use
assets that meet the definition of investment property. In contrast to the revaluation model, which may be
used if applied to the same class of property, plant and equipment, the fair
value model must be applied to right-of-use assets meeting the definition of investment property where a
lessee applies the fair value model in IAS 40 to owned investment property.
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 Right of Use asset - Subsequent measurement
Revaluation Model
If right-of-use assets relate to a class of property, plant and equipment to which an entity applies the
revaluation model under IAS 16, a lessee may elect to apply the revaluation model to those right-of-use
assets. An entity must be consistent in its classification of a class of property, plant and equipment, and
right-of-use assets for the purposes of IAS 16 and IFRS 16.
The option to apply the revaluation model for right-of-use assets where the same class of property, plant
and equipment is revalued under IAS 16 results in the potential for inconsistency because an entity is not
required to apply the revaluation model to those right-of-use assets. Therefore, an entity may have a group
of owned assets (e.g. land and/or buildings) to which it applies the revaluation model, whilst applying the
cost model to property leases.
Fair Value Model
If an entity applies the fair value model in IAS 40, the same model must also be applied to right-of-use
assets that meet the definition of investment property. In contrast to the revaluation model, which may be
used if applied to the same class of property, plant and equipment, the fair
value model must be applied to right-of-use assets meeting the definition of investment property where a
lessee applies the fair value model in IAS 40 to owned investment property.
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 Right of Use asset - Subsequent measurement

Componentisation of right-of-use assets

As IFRS 16 directs entities to record amortisation based on the requirements of IAS 16, and IAS 16.43 requires each
item with a cost that is significant in relation to the total cost be amortised separately. In our view, similar accounting is
required for right-of-use assets with significant components when the lessee is required to incur the cost of replacing or
maintaining such components. Componentising right-of-use assets into distinct units of account for amortisation
purposes would create significantly different amortisation expense for underlying assets that have differing useful lives
for sub-components.
For example, aircraft leases often contain clauses requiring lessees to perform major overhaul and maintenance of
aircrafts based on specific increments of time and/or flight hours. If an aircraft lease contained a 10-year lease term, but
the engines in the aircraft would require replacement after 4 years at the cost of the lessee, then the engines should be
amortised separately over their 4-year useful life. Determining the basis for componentising significant leased assets
may require significant judgment.

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 Right of Use asset - Subsequent measurement

Non-consecutive lease terms and amortisation impact

In amortising the right-of-use asset, special consideration should be made for leases with non-consecutive periods of
use. For example, a lessee enters into a lease where it will utilise retail space in a shopping centre for 3 months in each
calendar period (i.e. 15 months in total). Based on the initial recognition requirements of IFRS 16, the lessee recognises
the lease liability and right-of-use asset as at the commencement date of the lease as CU 150,000. In each period of
use (i.e. each 3-month period when the retail space is utilised), the lessee would recognise CU 10,000 of amortisation
expense (150,000/15 months of total use). The lessee would not record amortisation expense in the periods when the
retail space is not utilised, as IAS 16.60 states that the amortisation method used shall reflect the pattern in which the
asset’s future economic benefits are expected to be consumed. As no economic benefit is consumed in the period when
the retail space is not utilised, amortisation is only recorded during the periods of use by the lessee.

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 Remeasurement – Leases
Lease liabilities and right-of-use assets are remeasured in the following situations:
1. Change in original assessment of
lease term or purchase/termination
option
• Remeasure lease liability reflecting
revised estimate of lease term and
cash flows
• Discount revised payment using
current rate
• Adjust carrying amount of right-of-use
asset by the same amount so no gain
or loss recognised
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1. Change in estimate of residual
guarantee
2. Change in index or rate affecting
payments including market rent reviews
• Remeasure lease liability reflecting
revised estimate of lease term and
cash flows
• Discount revised payments using
original rate
• Adjust carrying amount of right-of-use
asset by the same amount so no gain
or loss recognised
 Lease Modifications
Lease modifications arise from changes to the underlying contract agreed between the lessee and the lessor
subsequent to commencement of the lease. The accounting for the modification depends on whether the modified
terms increase or decrease the scope of the lease, and whether increases in scope require consideration to be paid
that is commensurate with a ‘standalone price’ for the new scope of the lease.
Judgement must be applied to assess whether the extension of lease terms between existing parties are treated as
new leases or the modification of the original lease. For example, consider a lease that does not include any
renewal option. During the lease term, the parties enter into a new lease for the same identified asset that
commences when the original lease ends. This change is not accounted for as a separate lease as it does not
convey the right to use additional underlying assets; the asset in question is the same. As such, in our view, the
lease modification would be accounted for as at the time the agreement between the lessee and the lessor is
modified. The remeasurement would not be delayed until the end of the term on the original underlying lease, since
in substance, this is a modification to the contractual terms of the original lease.
A lease modification is accounted for as a separate lease if:
• 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 standalone price for the increase
in scope.
If both criteria are met, a lessee would follow the previous guidance in this publication on the initial recognition and
measurement of lease liabilities and right-of-use assets.

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 Lease Modifications
Modifications – Not Separate Leases
The accounting treatment required for lease modifications that are not accounted for as separate leases is
summarised below:
Decrease in scope
– Decrease right-of-use asset and lease liability by their relative amounts compared to the original lease taking the
difference to P&L
– Remeasure lease liability using revised discount rate * with off-set to right-of-use (ROU) asset
All other lease modifications
– Remeasure lease liability using revised discount rate **
– Remeasure right-of-use asset by same amount
– No P&L impact
The prevailing incremental borrowing rate at date of modification is used unless the implicit rate in the lease is readily
**

determinable.

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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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 Transitional Options
FULL RETROSPECTIVE APPROACH
 Comparative figures are restated as if IFRS 16 had always been in
effect
 Disclosure
 Current year per IFRS 16
 Comparative year per IFRS 16
 Restate retained earnings at the beginning of the comparative
year

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 Transitional Options
MODIFIED RETROSPECTIVE APPROACH #1
 The lease liability is net present value of the remaining (i.e. future) lease payments
using the incremental borrowing rate at the date of initial application
 The right-of-use (RoU) asset is recognized at the date of initial application as an
amount equal to the lease liability, using the prevailing incremental borrowing rate
at the date of initial application
 Adjusted for any prepaid or accrued lease payments relating to that lease that
were recognised in the statement of financial position immediately before the date
of initial application

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 Transitional Options
MODIFIED RETROSPECTIVE APPROACH #2
 Lease liability calculated in the same way as under the modified
retrospective approach #1
 That is, the lease liability is net present value of the remaining (i.e.
future) lease payments using the incremental borrowing rate at the
date of initial application
 The RoU asset is recognized as at the date of initial application as if
IFRS 16 had always been applied
 BUT calculated as if the prevailing incremental borrowing rate as at
the date of initial application also applied at lease commencement

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 Transitional Options
HAVE YOU DECIDED ON A TRANSITIONAL APPROACH?
 Preparers should consult with the relevant financial statement users
and those charged with governance (the Board and/or Audit
Committee) to assist them in determining which approach to
transition is most suitable for their needs
 Benefits of the full retrospective method
 Comparable information
 Benefits of the two modified retrospective approaches
 Simpler due to more practical expedients

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 Practical Expedients available on transition
1. PE#1: Apply the old definition of lease in line with IAS 17/IFRIC to existing leases on transition
date. Only apply the new definition of a lease in IFRS 16 to new leases post transition.
2. PE#2: Apply a single discount rate to a portfolio of leases with reasonably similar
characteristics
3. PE#3: Use onerous lease assessment and any provision recognised immediately before date
of application instead of an IAS 36 impairment test
4. PE#4: Exclude initial direct costs from the measurement of right-of-use assets at the date of
initial application
5. PE#5: No requirement to recognise leases when the term ends within 12 months of the date of
initial application
6. PE#6: Use hindsight, such as in determining the lease term, if the contract contains options to
extend or terminate the lease

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 How to apply the Optional Practical Expedients
available on transition

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 Transitional Options
EXAMPLE
 Entity A enters into a 10-year lease for a piece of equipment on 1 January 2017 and in the process,
incurs $500 of initial direct costs in the form of commissions, which were expensed under IAS 17
 Entity A will pay the lessor $1,500 per annum on 1 January of each year
 The lease does not contain any termination, extension or purchase options
 The rate implicit in the lease is 7%.
 Entity A’s incremental borrowing rate as at 1 January 2019 is 5%.
 The lease was previously classified as an operating lease under IAS 17
 The following additional assumptions are made:
• The contract meets the definition of a lease under both IAS 17 and IFRS 16
• The lease does not meet the low value or short-term lease exemptions under IFRS 16
• Entity A has a calendar year-end, so IFRS 16 is effective as of 1 January 2019
• Entity A will use the cost model to amortise the RoU asset

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 OVERALL QUESTIONS DIRECTORS SHOULD ASK
How could these new accounting standards impact shareholder value?
How can we mitigate the potential negative impact of these accounting
standards on shareholder value?
Would the organisation be able to continue to declare dividends? Would
these dividend declarations be aligned to our current dividend policy?
How do these accounting standards impact the profit of the organisation in
year of implementation and thereafter?
How do these accounting standards impact the balance sheet position
(assets, liabilities & equity) of the organisation in the year of
implementation and thereafter?

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 OVERALL QUESTIONS DIRECTORS SHOULD ASK
How have we updated and incorporated these new accounting standards into our
budgets and forecasts?
Would the organisation be able to continue to meet their current bank covenants?
Should the organisation renegotiate their bank covenants to minimise the
potential impact of the new accounting standards on their current bank covenants?
What is the impact of the new accounting standards on current remuneration
structures and incentives to key management personnel and other employees?
Does the organisation need to adjust performance hurdles and KPIs of key
management personnel and other employees, to reflect the impact of the new
accounting standards?

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 OVERALL QUESTIONS DIRECTORS SHOULD ASK
How are we going to communicate the immediate and future impact of the new
accounting standards to our shareholders and other users of our financial
statements?
Has the organisation performed and documented an impact and/or risk assessment
of the implementation of the new accounting standards?
Does the organisation have documented position papers to support and justify the
appropriate accounting treatment of existing transactions under the new accounting
standards?
Has the organisation updated their accounting policy manual to reflect the
requirements of the new accounting standards?
Has the organisation obtained independent accounting advice in relation to the
implementation of the new accounting standards?

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 OVERALL QUESTIONS DIRECTORS SHOULD ASK
Have the auditors of the organisation been involved in the discussions and impact
assessment of the new accounting standards on the organisation?
What research has been done on the potential impact of the new accounting
standards on the organization's industry?
Has the organisation considered their technology needs and required changes to
their existing systems and processes to deal with the new accounting standards?
How can the directors access further information on the requirements and potential
implications of the new accounting standards?

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 OVERALL QUESTIONS DIRECTORS SHOULD ASK
Has the organisation decided on an appropriate transitional approach?

What process did the organisation follow to decide on the appropriate transitional approach
in relation to AASB 16?
What is the impact of each of the three possible transitional approaches on the organisations:
 Retained earnings at the date of initial application
 Lease liabilities and right-of-use assets at the date of initial application
 Profit before tax (i.e. depreciation and interest expenses)

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 OVERALL QUESTIONS DIRECTORS SHOULD ASK
Does the organisation have a register of all leases?
Does the organisation have a copy of all lease agreements?
What process did the organisation follow to identify all leases, including embedded
leases?
How did the organisation decide whether it is reasonably certain to exercise lease
extension options, termination options and purchase options included in lease
agreements?
Does the organisation have a technology solution to manage leases on an ongoing
basis, i.e. after the date of initial application?

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 RISK ASSESSMENT QUESTIONS FOR MANAGEMENT
Are there any service agreements whereby the services provided to the entity rely
on the use of assets that are controlled by the entity?
Does the entity have agreements where the entity have the right to control the
assets?
Does the entity have agreements where the entity have sole use of the assets (or
right to substantially all of the assets)?
Does the entity have agreements where the lessor does not have substantive
rights to substitute the identified assets?
Does the entity have agreements where the entity have the ability to direct the
use of the identified assets?
Are the assets within these agreements of low value?
Are the assets leased for a short term (less than 12 month) period?

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 RISK ASSESSMENT QUESTIONS FOR MANAGEMENT
Does the right to use the asset also provide the entity with other services?
Are there any service agreements whereby the services provided to the entity rely on
the use of assets that are controlled by the entity?
Will the entity elect to apply the practical expedient on transition to grandfather the
IAS 17 / IFRIC 4 lease classification for all its contracts?
Does the lease contain one or more extension, purchase or termination options?
Is the entity reasonably certain to exercise (one or more of) the extension, purchase
or termination option(s)?
Does the arrangement involve fixed lease payments?
Do the lease payments include in-substance fixed lease payments?
Are the lease payments dependent on an index or rate?

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 RISK ASSESSMENT QUESTIONS FOR MANAGEMENT
Do the lease payments include variable lease payments?
Do the payments under the lease involve contingent rental?
Are amounts expected to be payable under residual value guarantees?
Is the interest rate implicit in the lease known or readily determinable?
Were any direct costs incurred when entering into the lease?
At the end of the lease term, will costs be incurred to restore or
remove the asset?
Were any lease payments made at or before commencement of the
lease?

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 RISK ASSESSMENT QUESTIONS FOR MANAGEMENT

Were any lease incentives (including rent free periods) received?

Has a significant event or change in circumstances occurred which
would trigger a reassessment of the lease term?
Has the entity changed its assessment of the likelihoold of exercising
extension, purchase or termination options (and hence has the lease
term changed)?
Does the lease contain a residual value guarantee?

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 RISK ASSESSMENT QUESTIONS FOR MANAGEMENT

Have there been any lease modifications?

Does the modification increase the scope of the lease (i.e. does it add the right to
use one or more underlying assets)?
Is the increase in the consideration payable commensurate with the standalone
price for the increase in scope?
Does the modification decrease the scope of the lease (i.e. is the modification (or
part of the modification) a partial or full termination of the lease)?
Is the interest rate implicit in the lease following the modification known or readily
determinable?

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 RISK ASSESSMENT QUESTIONS FOR MANAGEMENT

For contracts entered into prior to the date of initial application, has the entity
determined whether to apply the practical expedient to use the IAS assessment made
under IAS 17 / IFRIC 4 as to whether or not the contract is or contains a lease?
Does the entity intend to apply the full retrospective approach on transition (instead
of the modified retrospective approach)?
Was the lease previously accounted for as a finance lease?
Is the remaining term of the lease, as at the date of initial application, less than
twelve months?
Does the entity have a portfolio of similar leases (such as leases with a similar
remaining lease term for a similar class of underlying asset in a similar economic
environment)?

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 RISK ASSESSMENT QUESTIONS FOR MANAGEMENT
Is the lease a lease of investment property (i.e. an investment property of the
lessee)?
On transition the entity has the choice to measure the RoU asset by (1) adjusting the
lease liability for prepaid / accrued lease payments or (2) as if IFRS 16 had always
been applied (but using the incremental borrowing rate at the date of initial
application. Will the entity choose to measure the RoU asset using method (2)
(adjusting the lease liability)?
Will the entity NOT use hindsight in calculating the RoU asset on transition?
Does the entity intend to exclude initial direct costs from measurement of the RoU
asset on transition?
Does the entity intend to rely on its previous onerous lease assessment in
determining if RoU assets are impaired on transition?

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 RISK ASSESSMENT QUESTIONS FOR MANAGEMENT

Has the entity entered into any sale and leaseback transactions (as a lessee (seller))
since the date of initial application?
Are both the sale and lease payments at market rates?
Does the entity have any sale and lease back transactions existing at the date of
initial application?

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 Effective date

Annual Periods beginning on or after 1 January 2019

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 Impact on the financials of the lessee
Balance sheet
 Leased Assets (Increase)
 Financial liabilities (Increase)
 Equity (Decrease)
Income statement
 Operating expenses (Decrease)
 Finance costs (Increase)
 Total lease expense – front-loading

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 Impact on the financials of the lessee

Statement of cashflow
 Operating cash outflows (Decrease)
 Financing cash outflows (Increase)

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 Impact on lessee's performance metrics

• Earnings per share (EPS) – will decline in early stages of the lease
• Financial gearing – will increase
• Interest cover – will decease
• Asset turnover – will decrease
• Return on Investment – will decrease
• EBITDA – will increase
• Valuation multiples e.g. P/E ratio
• Compliance with your covenants on existing loans

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 Broader business impact

• Investor relations – analysts queries (KPI e.g. EPS), credit rating

• Strategy – lease vs buy, lease structuring sale & leaseback
• Systems – leasing database & ERP integration
• Treasury – covenant, credit rating & regulatory capital (banks)
• Employee benefits – management remuneration KPIs
• Finance – transition options, data collection, tax & KPIs

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 Questions?

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