Leases
IFRS 16 requires lessees to recognise a right-of-use asset and a lease liability for almost all leases, with limited recognition exemptions for short-term leases (12 months or less) and low-value assets. The lease liability is the present value of lease payments not paid at the commencement date, discounted at the interest rate implicit in the lease or, if not readily determinable, the lessee's incremental borrowing rate. The right-of-use asset comprises the initial liability plus initial direct costs, prepayments and estimated restoration costs, less lease incentives. Subsequently the liability is measured using the effective interest method and the asset is depreciated over the lease term or useful life where ownership transfers.
Traps
Candidates must identify whether a contract contains a lease (identified asset plus right to control use), and must handle lease modifications, remeasurement on index changes, purchase options and residual value guarantees. A frequent trap is the lessor accounting distinction: finance leases (transfer substantially all risks and rewards) versus operating leases, and the manufacturer/dealer lessor's selling profit. Watch for sale-and-leaseback transactions (recognise only the rights retained, with gain limited to rights transferred) and for the treatment of variable lease payments that depend on sales or usage (expensed, not included in the liability). Also know the disclosure requirements and the impact on key ratios.
Worked example / rule of thumb
A three-year lease with annual payments of $10,000 in arrears and an incremental borrowing rate of 5% gives a liability of $10,000 × 2.7232 = $27,232. Year one interest is $1,362; the liability reduces by $8,638. Rule of thumb: the interest rate implicit in the lease is preferred; use the incremental borrowing rate only when the implicit rate cannot be readily determined.