Accounting for Leases in Terms of IFRS 16
IFRS 16, the standard governing lease accounting, represents a significant shift in how lessees and lessors account for leases. Effective from January 1, 2019, IFRS 16 replaces IAS 17 and related interpretations. Its primary objective is to provide a more faithful representation of lease arrangements and improve comparability across financial statements. The standard minimises the off-balance sheet events that were common in IAS 17 where leases were categorised as Finance and Operating leases in the books of the Lessee, with the operating leases instalments expensed through Profit and without any record of the asset and liability in the Balance Sheet (Statement of Financial Position).
Scope of IFRS 16
IFRS 16 applies to all leases, including subleases, but excludes the following:
Leases to explore for or use minerals, oil, natural gas, and similar non-regenerative resources.
Leases of biological assets within the scope of IAS 41 Agriculture.
Service concession arrangements within the scope of IFRIC 12.
Licenses of intellectual property granted by a lessor within the scope of IFRS 15 Revenue from Contracts with Customers.
Rights held by a lessee under licensing agreements for items such as films, video recordings, and patents.
Entities can also elect not to apply IFRS 16 to short-term leases (less than 12 months) and leases of low-value assets.
Key Definitions
Lease: A contract, or part of a contract, that conveys the right to use an asset for a period in exchange for consideration.
Right-of-Use (ROU) Asset: The lessee’s right to use the underlying asset over the lease term.
Lease Liability: The obligation to make lease payments, measured at the present value of future lease payments.
Accounting by Lessees
Under IFRS 16, lessees adopt a single lease accounting model, removing the distinction between finance and operating leases. Key steps include:
Recognition of Right-of-Use (ROU) Asset and Lease Liability:
At the commencement date, a lessee recognises a ROU asset and a corresponding lease liability.
Initial measurement of the lease liability includes the present value of future lease payments, discounted using the interest rate implicit in the lease or the lessee’s incremental borrowing rate if the implicit rate is not readily determinable.
The ROU asset is initially measured at cost, including the lease liability amount, lease payments made at or before the commencement date, and any direct costs incurred.
Subsequent Measurement:
The lease liability is increased by interest accrued and reduced by lease payments made.
The ROU asset is depreciated over the shorter of the asset’s useful life or the lease term.
Lessees must remeasure the lease liability and adjust the ROU asset for changes in lease terms, payments, or discount rates.
Exemptions:
For short-term and low-value leases, lessees can opt for straight-line expense recognition over the lease term instead of capitalising the lease.
Accounting by Lessors
Lessors continue to classify leases as operating or finance leases:
Finance Leases:
Lessors derecognise the underlying asset and recognise a net investment in the lease.
Interest income is recognised over the lease term.
Operating Leases:
The underlying asset remains on the lessor’s balance sheet.
Lease income is recognised on a straight-line basis over the lease term.
Disclosure Requirements
IFRS 16 emphasises detailed disclosures to enable users of financial statements to understand the impact of lease transactions on the entity's financial position and performance. Lessees and lessors must disclose:
A maturity analysis of lease liabilities.
Qualitative and quantitative information about lease activities.
Significant judgments and assumptions made in determining lease amounts.
Key Challenges
Adopting IFRS 16 poses challenges, including:
Data Gathering: Entities must identify and gather detailed lease information.
Systems and Processes: Significant upgrades to accounting systems and processes are often required.
Judgment and Estimates: Determining the discount rate, assessing lease terms, and identifying embedded leases require professional judgment.
Impact on Financial Ratios: Recognition of lease liabilities can affect leverage and liquidity ratios, potentially influencing covenant compliance and stakeholder perceptions.
Practical Implications
The implementation of IFRS 16 affects various aspects of business operations, including:
Financial Reporting: Increased transparency in financial statements provides a clearer picture of an entity’s obligations.
Stakeholder Communication: Businesses need to explain changes to investors, lenders, and other stakeholders.
Contract Negotiations: Lessees may renegotiate contracts to manage lease terms and minimise reported liabilities.
Conclusion
IFRS 16 provides a comprehensive framework for accounting for leases, improving the transparency and comparability of financial statements. While the standard introduces complexities, especially during initial adoption, its long-term benefits for financial reporting outweigh these challenges. Accountants and finance professionals must stay informed and ensure robust processes for compliance with IFRS 16.
Join us at cpd.myciba for a webinar on Accounting for Leases click here to register
Date: 9 January, 2025
Time: Available from 08:00
Hours: 2 hours
CPD Units: 3
Category: Accounting
Group: Channel 2: Growth
Format: Webinar
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📢 Join us on 9 January for an insightful 2-hour webinar designed to help accountants confidently navigate the principles and requirements of IFRS 16.
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✅ Practical understanding of lease accounting under IFRS 16
✅ Knowledge of key differences between full IFRS
✅ Tools to accurately assess and account for leases in financial statements
✅ Practical guidance and disclosures.
🌟 Why attend?
Stand out by mastering these essential competencies and earn 3 CPD units in accounting.
👩🏫 Your Presenter:
Faith Ngwenya, a seasoned accounting professional and leader in academia and industry standards, brings her wealth of experience to guide you through this critical topic.
💻 Format: Webinar
📅 Date: 9 January 2025
⏰ Time: Duration: 2 hours
📚 CPD Units: 3
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