Understanding the IFRS 16 Leases Accounting Standard
IFRS 16 is a new accounting standard issued by the International Accounting Standards Board (IASB) that sets out the accounting rules for leases. It replaced the previous standard, IAS 17, and became effective for annual periods beginning January 1, 2019.
The standard applies to annual reporting periods beginning on or after January 1, 2019. Entities can apply IFRS 16 for these periods, transitioning from the previous lease accounting standard, IAS 17.
Under IFRS 16, lessees must recognize a right-of-use asset and a lease liability on their balance sheet for most lease contracts.
This represents a significant change from the previous standard, where many leases could be treated as operating leases and were not required to be recognized on the balance sheet. Under the new standard, all lessee leases are now classified as finance leases, capitalizing leases, and recognizing depreciation and interest expenses, affecting balance sheets and income statements.
The right-of-use asset represents the lessee’s right to use the underlying asset over the lease term. In contrast, the lease liability represents the lessee’s obligation to make lease payments over the same period.
The lease liability is calculated as the present value of the lease payments, discounted using the lessee’s incremental borrowing rate. The right-of-use asset is initially recognized at the same amount as the lease liability, adjusted for any prepayments, lease incentives, and initial direct costs incurred by the lessee.
Lease liabilities are recognized from leaseback arrangements, impacting gains or losses associated with the rights retained by the seller-lessee.
After initial recognition, the lease liability is reduced as lease payments are made, and the right-of-use asset is depreciated over the lease term.
The depreciation is recognized in the income statement, while the interest expense on the lease liability is recognized separately. This creates a more front-loaded expense profile than the previous standard, where operating lease payments were typically recognized straight-line.
Lessees may treat COVID-19-related rent concessions as not being lease modifications, allowing for a simplified accounting approach. Lease modifications may lead to a remeasurement of the lease liability and adjustments to the right-of-use asset, impacting financial reporting and balance sheets.
IFRS 16 applies to all leases, with some limited exceptions for short-term leases (defined as leases with a term of 12 months or less) and leases of low-value assets.
The standard also requires additional disclosures in a company’s financial statements, including information about the nature of its lease arrangements, the significant assumptions and judgments made in determining the lease liability and right-of-use asset, and the impact of the standard on the company’s financial position and performance.
Variable lease payments based on an index or rate are included in the lease liability calculation at lease commencement. In contrast, payments not included are recognized in profit or loss when the triggering event occurs.
Overall, IFRS 16 represents a significant change in how companies account for their leases and is intended to provide a more accurate representation of a company’s financial position. Companies must ensure they have the necessary systems and processes to comply with the new standard and should work with their auditors and advisors to ensure a smooth transition.