IFRS 16:

Leases
Compiled by: Murtaza Quaid, ACA
IFRS 16: Leases

 To specify the principles for recognition,

Objective measurement, presentation and disclosure
of LEASES

XXX IFRS 16 does not apply to:

► Leases to explore for / use of minerals, oil,

natural gas and similar
► Leases of biological assets (IAS 41)
► Intellectual property licenses (IFRS 15)
► Services concession arrangements (IFRIC 12)
► Rights under licensing agreements (IAS 38)
What is a “Lease”?
► A contract that conveys the right to use of an asset for aperiod of time in
exchange for consideration

Right to Use
of Asset

Consideration
(Lease payments)
Lessor Lessee
Entity that provides the Entity that obtains the right
right to use an underlying to use an underlying asset
asset for a period of time in for a period of time in
exchange for consideration. exchange for consideration.
What is an “Identified Assets”?
► The first criterion to be assessed in identifying the lease
is whether there is an identified asset.
► Typically, an asset will be explicitly identified in a
contract. Alternatively, identified asset may be implicitly
identified at the point at which it is made available for
use by the customer.

Capacity portion ► Capacity portion of asset may be an identified asset if:

 It is physically distinct OR  It represents substantially all of

the capacity of asset

Classroom Pipeline

- Specific Room - 90% capacity

- Any Room - 50% capacity

What is an “Identified Assets”?

Substitution Rights
► It is also possible for a contract to specify an asset, while at the same time the lessor retains a
substantive right to substitute the asset throughout the period of use. In such cases, the
‘specified asset’ criterion would not be met and the contract would not contain a lease. A
supplier’s right to substitute an asset would be substantive if both of the following conditions
are met:
- The supplier has the practical ability to substitute alternative assets throughout the period
of use; and
- The supplier would benefit economically from the exercise of its right to substitute the
asset.

Explanation
In situations where the asset is located at the lessee’s premises or elsewhere away from the
lessor, the cost to substitute the asset may outweigh any perceived benefit to the lessor.
In addition, a supplier’s right to substitute an asset for the purposes of repairs or maintenance
(if the asset is not operating properly) or to be upgraded when a technical update becomes
available, does not mean the lessor has a substantive right of substitution.
In situations where it is not readily determinable whether a supplier has substantive substitution
rights, a lessee must presume that any substitution right is not substantive.
What is a “Right to Use”?
Through out the period of use, the lessee has the both of the following rights to
the identified asset:

► Right to obtain substantially ► Right to direct the use of the

all economic benefits from AND asset i.e. how and for what
the use of the assets purpose the asset is used
throughout the period of use throughout the period of use.
► Protective rights do not limit
the right to direct the use

!!! If the lessee has the right to control

the use of an identified asset for only a
portion of the term of the contract, the
contract contains a lease for that portion
of the term.
What is an “Lease Term”?

► Non-cancellable period of the lease for which a lessee has

the right to use an underlying asset, together with both:
 Period covered by an option to extend the lease
(if lessee is reasonably certain to exercise the option)
 Period covered by an option to terminate the lease
(if lessee is reasonably certain not to exercise the
option)

Assess whether extension/termination option will be exercised by

considering:

► Terms and conditions of option ► Cost of terminating the lease

► Leasehold improvements ► Importance of underlying asset

What is an “Lease Term”?
Payments made by a lessee to a lessor for the right to use of an
underlying assets during the lease. It includes:
 Fixed payments (including in-substance fixed payments), less
any lease incentives;
 Variable lease payments dependent on an index or rate;
 Exercise price of a purchase option if the lessee is reasonably
certain to exercise that option; and
 Lease termination penalties, if a lessee termination option was considered in setting
the lease term.
Lease payments also include:
► For lessee, amounts expected to be payable by the lessee under residual value
guarantees.
► For lessor, any residual value guarantees provided to the lessor by the lessee, a party
related to the lessee or a third party unrelated to the lessor that is financially capable
of discharging the obligations under the guarantee.

“Residual value guarantee” is a guarantee made to a lessor by a party unrelated to the

lessor that the value (or part of the value) of an underlying asset at the end of a lease
will be at least a specified amount.
Lease Accounting (Lessee) - Initial Recognition & Measurement
 At the commencement date, the lessee
is required to recognize a right-of-use (1) Short Term Leases
asset representing its right to use the Optional
underlying leased asset and a lease Exemptions
(2) Low Value Leases
liability representing its obligation to
make lease payments.
!!! When lessor makes
the underlying asset At the Commencement Date
available to lessee for use

Debit: Right to Use Asset Credit: Lease Liability

1. Amount of lease liability; Recognizes a lease liability for the unpaid

2. Lease payments made at or before portion of lease payments, discounted at
the commencement date, less any  Interest rate implicit in the lease, if
lease incentives; readily determinable; or
3. Initial direct costs (Incurred by
 Otherwise, incremental borrowing rate
Lessee); and
4. Provision for dismantling costs.
Lease Accounting (Lessee) - Subsequent Measurement
After the commencement of lease

Debit: Right to Use Asset Credit: Lease Liability

Subsequent to initial recognition, an entity may apply After the commencement date, a lessee
three potential models to account for right-of-use assets: accounts for the lease liability by:
1) Cost Model (IAS 16)  Increasing the carrying amount to reflect
Under “cost model”, lessee measures ROU asset at cost interest on lease liability;
less accumulated depreciation and accumulated
impairment losses.  Reducing the carrying amount to reflect
lease payments made;
Depreciation period is the useful life of the asset if the
lease transfers ownership of the underlying asset;  Re-measuring the carrying amount to
otherwise earlier of the asset’s useful life and lease term reflect any reassessment and lease
2) Revaluation Model (IAS 16) modifications.
If a lessee applies “Revaluation model” to a class of asset,  Variable lease payments (that are not
it may elect to apply that model to the same class of dependent on rate/index) are not
right-of-use assets. included in the initial measurement of
3) Fair Value Model (IAS 40) the lease liability. Such payments are
If a lessee applies “Fair value model” to its investment recognized in P/L in the period in which
property, the lessee is required to apply that model to the event or condition that triggers such
ROU assets that meet the definition of investment payments occur.
property in IAS 40.
Lease Accounting (Lessee) - Subsequent Measurement

Depreciation of Right to Use Asset

If it is certain that asset will be

 Over useful life of the asset
transferred to lessee

Over lower of,

If it is NOT certain that asset  Useful life of the asset; or
will be transferred to lessee
 Lease term.

Economic life and useful life

Economic life is either:
Useful life is either:
 the period over which an asset is expected
 the period over which an asset is expected
to be economically usable by one or more
to be available for use by an entity; or
users; or
 the number of production or similar units
 the number of production or similar units
expected to be obtained from an asset by an
expected to be obtained from the asset by
entity.
one or more users.

!!! Notie that useful life is entity specific concept and economic life is not. Useful life is relevant to
calculation of depreciation while economic life is one of the factors considered while classifying
the lease contract.
Lease Accounting

Initial Direct Cost

► Increment costs of obtaining a lease that would NOT
have been incurred without the lease

 Legal fees (contract drafting)

 Commissions

 Certain legal advice for selecting lease

 Internal costs
Lease Accounting

Discount Rate

For Lessor For lessee

► Interest rate implicit in lease ► Interest rate implicit in the lease
► If interest rate implicit in the lease
is not available, Increment
borrowing rate of lessee

Interest Rate Implicit in Lease

Present Value of Lease Payments

=
Fair Value of Underlying Asset
+
+
Present Value of Unguaranteed
Lessor’s Initial Direct Cost
Residual Value
Lease Accounting

Variable Lease Payment

Do they depend on the index or rate?

► Include in the Lease Payment ► Exclude from the Lease Payment

► Measured at the rate prevalent ► Record in P/L in the period in
at the measurement date which they arise
Lease Accounting (Lessee) - Optional Exemptions

Short Term Lease Lease of Low Value Assets

► Can be applied to leases for low value items
► Can be applied to leases with a – i.e. assets with a value of USD 5,000 or less.
lease term ≤ 12 months.
► Low value assessment applies:
► Cannot be applied to leases
containing a purchase option  To the value of underlying asset when new;
► Apply the exemption by class  On an absolute basis: and
of underlying asset. A class of  Irrespective of materiality.
underlying asset is a grouping
of underlying assets of a similar ► Apply the exemption on a lease-by-lease basis.
nature and use in an entity’s ► Exemption cannot be applied
operations.
 if the underlying asset is highly dependent or
interrelated with other assets;
 if lessee cannot benefit from using the
underlying asset on its own or with other
readily available resources
 to the head lease in a sublease arrangement; or
 if the nature of the underlying asset, when new,
is not typically low value
Lease Accounting (Lessee) - Optional Exemptions

Lessee Accounting for Exempt Leases

► The lessee shall recognize the lease payments as

an expense on straight-line basis over the lease
term (or another systematic basis).
► No balance sheet assets and liabilities (other
than prepaid and accrued lease payments)
► Disclose expense relating to each exemption in
the notes to the financial statements
Lease Accounting (Lessee)

Remeasurement of Lease

► Re-measurement of lease(i.e. lease liability and ROU asset)

arises from revisions in estimates and judgements made on
initial recognition of the lease.
► Re-measurement that arises from modification to the
original contractual terms agreed between lessor and
lessee, is addressed in another section.

► When there is a change in original

► When there is a change in estimate of
assessment of lease term; or
guarantee residual value; or
► When there is a change in original
► When there is a change in future lease
assessment of exercise of purchase /
payment due to change in index/rate.
termination options.

Re-measure the lease liability using revised

Re-measure the lease liability using revised
estimate of lease term and cash flows and
estimate of lease term and cash flows and
discounting at revised interest rate i.e.
discounting at original interest rate.
current rate.
Lease Accounting (Lessee)

Remeasurement of Lease

Re-measurement of lease liability is adjusted against the

carrying value of ROU asset. Therefore, there is no
immediate gain or loss. However, If reduction in carrying
value of lease liability is greater than carrying value of
ROU asset, the asset is reduced to ‘zero’ and excess
reduction in lease liability is recognized in P/L.

Debit: Lease liability XXX

Debit: ROU Asset XXX
Credit: ROU Asset XXX
Credit: Lease liability XXX
Credit: Profit and loss XXX
Lease Accounting (Lessee) - Lease Modification
► A change in scope or consideration of a lease that was not part of the original
terms and conditions of the lease. For e.g. adding or terminating the right to use
one or more underlying assets, or extending or shortening the contractual lease
term.
► Accounting for lease modification depends on whether modified terms increase
or decrease the scope of lease, and whether the consideration for increase in
scope is commensurate with a ‘standalone price’ for the new scope of the lease.
No
Does modification increases the LEASE MODIFICATION = CHANGE IN EXISTING LEASE
scope of the lease by adding the
right to use of one or more
underlying assets?  Decrease ROU asset and lease
liability by their relative scope
compared to the original lease
Yes
Decrease in scope taking the difference to P&L
Does the increase in  Re-measure lease liability using
consideration commensurate revised discount rate with off-set to
with the stand-alone price for ROU asset
the increase in scope? No
 Re-measure lease liability using
Yes Other modification:
revised discount rate
 Increase in scope
 Re-measure ROU asset by same
LEASE MODIFICATION =  Change in amount
SEPARATE LEASE consideration
 No P&L impact
Lease Accounting (Lessor)

Classification of Lease
A lessor classifies a lease as either a finance lease or an operating lease.

Are substantial risk and rewards of ownership of the underlying asset is

transferred to lessee?
(Legal title may or may not be transferred)

Yes No

Finance Lease Operating Lease

Lease Accounting (Lessor)

Classification of lease
Lease is finance lease if:
► Ownership transferred to lessee by the end of lease term;
► Option to purchase the asset at price < Fair value of asset at the end of lease;
► Lease term ≥ Major part of economic life of asset (75% or more);
► PV of lease payments ≥ Fair value of asset at the start of lease (90% or more); or
► Lease asset is of specialized nature;

Other indicators

► If lessee can cancel the lease, lessor’s losses are to be borne by lessee;
► Gain / loss from fluctuation of residual value accrues to the lessee;
► Lessee can continue the lease for secondary period at rent < market rent
Lease Accounting (Lessor)

Finance Lease – Initial and Subsequent Measurement

At the commencement of lease

Debit: Lease Receivable Credit: Property, Plant

(Net Investment in lease) & Equipment

► Lease payments not paid at the

commencement date; and Credit: Initial Direct Cost
► Unguaranteed Residual Value (Borne by Lessor)

Discounted @ Credit: Gain on sale of PPE

Interest Rate Implicit in Lease (Debit if loss)
Lease Accounting (Lessor)

Finance Lease – Initial and Subsequent Measurement

After the commencement of lease

Lease Receivable
(Net Investment in lease)

► Interest Income on Lease Receivable ► Recovery of Rentals

Debit: Lease Credit: Interest Debit: Cash / Credit: Lease

Receivable Income P/L Bank Receivable
Lease Accounting (Lessor)

Operating lease

Continue to recognize the underlying asset.

Any indirect direct costs incurred in connection with

obtaining the lease is capitalized and amortized over the
lease term.

Recognize lease income over the lease term on a straight line

basis (or other systematic basis).
Finance Lease by Manufacturer/ Dealer Lessor

A finance lease of an asset by a manufacturer / dealer lessor gives rise to two

types of income:

Finance Lease income over

Selling profit or loss
the lease term

► If artificially low rate of interest is ► Sales revenue is recognized at lower of:

charged by manufacturer / dealer
 Fair value of the underlying asset;
lessor, selling profit is restricted to that
and
which would apply if a market rate of
interest were charged. This is done by  PV of lease payments discounted at
discounting future lease payments market rate of interest.
using market rate of interest. ► Cost of sale is recognized at carrying
amount of the asset less PV of
Any costs incurred in unguaranteed residual value (if any).
connection with obtaining
the lease is charged to P/L at
the commencement date.
Lessor Accounting: Lease of Land & Building
Separate Classification !!! ► Land = Indefinite
Economic Life

Land Building

► Account for as operating lease ► Account for as finance or operating

unless title passes to lessee at the lease, as the case may be.
end of lease term

Allocation of lease payments = In proportion of fair value of

land and building
Lease & Non-Lease Components
For a contract that contains a lease component and non lease component(s), For e.g., Contract for the lease of
an asset together with its maintenance.
 Lessee may accounts for each lease component separately from non-lease components.
 Lessor shall allocate the consideration in contract in accordance with IFRS 15 i.e. on the basis of their
relative stand-alone prices.

Lessee Perspective Lessor Perspective

A lessee may apply a practical expedient by class of underlying  Lessor shall account for each
asset, and ignore the requirement to separate non-lease components component separately.
from the lease components.
 Lessors must allocate the
consideration in the contract in
Separating lease & non lease component accordance with IFRS 15 i.e.
according to the stand-alone
 If this practical expedient is not used, a lessee allocates the selling prices of the goods and
total contract consideration to the lease and non-lease services included in each
component on the basis of their relative stand-alone prices. component.
 If standalone prices are not available, then they must be
estimated.

Not separating lease & non lease component

 If this practical expedient is used, lessee accounts for the
entire contract as a single lease contract.
Sale & Leaseback Transactions

Sells an asset

Lease back the

same asset Buyer
Seller
Lessee Lessor

Accounting Treatment depends on whether the transfer of underlying

asset from seller-lessee to buyer-lessor is a sale under IFRS 15?
Sale & Leaseback Transactions

How to conclude whether the transfer of underlying asset from seller-lessee to buyer-
lessor is a sale under IFRS 15?

IF the Seller Lessee has option to IF the Seller Lessee does not have
purchase the asset at the end of option to purchase the asset at the
lease term end of lease term

► Transfer of asset from seller-lessee to ► Transfer of asset from seller-lessee to

buyer-lessor is a NOT SALE under buyer-lessor is a SALE under IFRS 15
IFRS 15
Sale & Leaseback Transactions

Whether the transfer of underlying asset from seller-lessee to buyer-lessor is a

sale under IFRS 15?

Transfer to buyer-lessor is SALE Transfer to buyer-lessor is NOT SALE

Seller-Lessee Buyer-Lessor Seller-Lessee Buyer-Lessor

► Derecognize the ► Recognize the ► Continue to ► Do not recognize

underlying asset underlying asset recognize the the underlying
underlying asset asset
► Apply the lessee ► Apply the lessor
accounting model accounting model ► Recognize ► Recognize a
to the leaseback to the lease back financial liability financial asset
(To be covered in under IFRS 9 for under IFRS 9 for
next slide) any amount any amount paid
received from to the seller-lessee
buyer-lessor
Sale & Leaseback Transactions

Accounting Treatment for Seller-Lessee where transfer of underlying asset

from seller-lessee to buyer-lessor is a sale under IFRS 15

Lease back is a/c for as

Lease back is accounted for under IFRS 16 ▪ Short-term lease; or
▪ Low value asset

► Recognize any
gain/(loss) as a
difference between
sale proceed &
carrying value of
underlying asset

► Recognize lease
payments as expense
on straight-line basis
(or systematic basis)
over the lease term
Sub-Lease

Head Original Lessee /

Head Lease Sub Lease Sub Lessee
Lessor Intermediate Lessor

Concept of Sub-Lease
► Sublease is a transaction in which the underlying asset is re-leased by a lessee
(‘intermediate lessor’) to a 3rd party, and the lease (‘head lease’) between the
head lessor and lessee remains in effect.
► Intermediate lessor shall account for the head lease and sub lease as two separate
contracts, applying both lessee and lessor accounting requirements.
► Intermediate lessor shall classify the sub-lease as finance lease or operating lease
w.r.t to the ROU-asset arising from head lease i.e. right-of-use asset is treated as
underlying asset in sub-lease, not PPE that it leases from the head lessor.
► At commencement of sub-lease, if intermediate lessor cannot readily determine
the rate implicit in sub-lease, then it uses the discount rate of head lease to
account for sub-lease, adjusted for any initial direct costs associated with sub-
lease.
Sub-Lease

Accounting by the Original Lessee / Intermediate Lessor

IF Head Lease is accounted for under IFRS 16

IF Head Lease is
accounted for as
If Sub lease is If Sub lease is exception from IFRS 16
Operating Lease Finance Lease

► Keep recognizing the ► Derecognize ROU-asset of ► If the head lease is

ROU-asset and lease head lease transferred to sub- accounted for as a short-
liability of head lease. lessee and recognize net term lease, intermediate
investment in the sublease lessor shall classify the
► Recognize lease income
with any difference in P/L. sublease as operating lease.
from sublease on
straight-line basis (or ► Keep recognizing the lease
liability of head lease. ► If a lessee subleases an
systematic basis) over the
asset, or expects to
lease term. ► During sublease, recognize sublease an asset, the head
both finance income on lease does not qualify as a
sublease and interest expense lease of a low-value asset.
on head lease.