Leases (IFRS 16)
IFRS 16 lessee model
This domain tests lease identification, lease term, measurement of the lease liability and right-of-use asset, lessor classification and sale-and-leaseback accounting. A lease exists if the contract conveys the right to control the use of an identified asset for a period in exchange for consideration. Control means the right to obtain substantially all economic benefits and the right to direct use.
- Lease liability: present value of fixed payments, variable payments based on an index or rate, residual guarantees, and purchase or termination options reasonably certain to be exercised.
- Discount using the rate implicit in the lease if readily determinable; otherwise use the incremental borrowing rate.
- Right-of-use asset: lease liability plus initial direct costs, prepaid payments, less incentives, plus restoration costs.
- Subsequent measurement: depreciate the right-of-use asset over the lease term, or useful life if ownership transfers; recognise interest on the liability.
- Lessor: a finance lease transfers substantially all risks and rewards; otherwise it is an operating lease.
Worked example
A 3-year lease requires 10,000 at each year-end. The incremental borrowing rate is 5%; initial direct costs are 2,000. The annuity factor is 2.7232, so the lease liability is 27,232 and the right-of-use asset is 29,232. Year 1 depreciation is 29,232/3 = 9,744; interest is 27,232 × 5% = 1,362; the 10,000 payment leaves a liability of 18,594. The expense pattern is front-loaded compared with an operating lease.
Traps
- Applying the short-term exemption to a lease containing a purchase option.
- Using the incremental borrowing rate when the implicit rate is readily determinable.
- Ignoring extension options that are reasonably certain.
- Recognising the full sale-and-leaseback gain instead of only the gain on rights transferred.