IFRS 16

Leases

1Objective and scope

IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases, ensuring lessees and lessors provide relevant information that faithfully represents lease transactions. Its most significant change from the previous standard, IAS 17, is eliminating the lessee's old operating/finance lease distinction: almost every lease is now recognised on the lessee's statement of financial position.

2Key definitions

Right-of-use (ROU) asset

An asset representing a lessee's right to use an underlying asset for the lease term.

Lease liability

A lessee's obligation to make lease payments, initially measured at the present value of the lease payments not yet paid at the commencement date.

Incremental borrowing rate

The rate 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 - used to discount lease payments when the rate implicit in the lease is not readily determinable.

Short-term lease

A lease with a lease term of 12 months or less at the commencement date, with no purchase option - eligible for an exemption from on-balance-sheet recognition.

3Lessee accounting

At the commencement date, a lessee recognises a right-of-use asset and a lease liability, unless it elects one of two exemptions: short-term leases (12 months or less), or leases of low-value underlying assets - both are instead expensed on a straight-line basis over the lease term.

Initial measurement

Lease liability = present value of lease payments not yet paid, discounted at the rate implicit in the lease (or, if not readily determinable, the lessee's incremental borrowing rate).

Right-of-use asset = initial lease liability + lease payments made at or before commencement - any lease incentives received + initial direct costs + an estimate of dismantling/restoration costs.

Subsequently, the lease liability is increased by interest (using the effective interest method) and reduced by lease payments made. The right-of-use asset is depreciated, generally on a straight-line basis, over the shorter of its useful life and the lease term (or over its useful life if ownership transfers, or a purchase option is reasonably certain to be exercised, at the end of the lease), and is tested for impairment under IAS 36. The lease term includes any periods covered by an option to extend the lease that the lessee is reasonably certain to exercise, and excludes periods covered by a termination option the lessee is reasonably certain to exercise.

4Lessor accounting and disclosure

Lessor accounting is substantially unchanged from the previous standard: a lessor classifies each lease as a finance lease (if it transfers substantially all the risks and rewards incidental to ownership of the underlying asset) or an operating lease (if it does not). Under a finance lease, the lessor derecognises the underlying asset and recognises a lease receivable instead; under an operating lease, the lessor keeps the underlying asset on its own statement of financial position and recognises lease income, normally on a straight-line basis over the lease term.

For lessees: depreciation charge for right-of-use assets and interest expense on lease liabilities shown separately, a maturity analysis of lease liabilities, and the expense relating to short-term and low-value asset leases
For lessors: a maturity analysis of lease payments receivable for finance leases, and a description of leasing activities for operating leases

5Examinable focus

What KASNEB tests

Computing the initial lease liability and right-of-use asset, then building the lease liability amortisation table (interest unwind and payments) and the right-of-use asset depreciation schedule, is one of the most heavily and numerically examined KASNEB topics, alongside the short-term/low-value exemptions and lessor finance vs operating lease classification.