IFRS 16 Leases

IFRS 2022 update – IFRS 16 Lease Liability in a Sale and Leaseback – Best read

by

IFRS 2022 update – IFRS 16 Lease Liability in a Sale and Leaseback

Effective for annual periods beginning on or after 1 January 2024.

Key requirements

On 22 September 2022, the International Accounting Standards Board (the IASB or Board) issued Lease Liability in a Sale and Leaseback (Amendments to IFRS 16) (the amendment). The amendment to IFRS 16 Leases specifies the requirements that a seller-lessee uses in measuring the lease liability arising in a sale and leaseback transaction, to ensure the seller-lessee does not recognise any amount of the gain or loss that relates to the right of use it retains.

A sale and leaseback transaction involves the transfer of an asset by an entity (the seller-lessee) to another entity (the buyer-lessor) and the leaseback of the same asset by the seller-lessee.

The amendment is intended to improve the requirements for sale and leaseback transactions in IFRS 16. It does not change the accounting for leases unrelated to sale and leaseback transactions.IFRS 16 Lease Liability in a Sale and Leaseback

Background

In a sale and leaseback transaction, the seller-lessee assesses whether the transfer of the asset satisfies the requirements in IFRS 15 Revenue from Contracts with Customers to be accounted for as a sale. If it is accounted for as a sale, paragraph 100(a) of IFRS 16 requires the seller-lessee to measure the right-of-use asset arising from the leaseback at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee.

However, IFRS 16 did not specify the measurement of the liability that arises in a sale and leaseback transaction. This has been addressed in the amendment.

Amendment to IFRS 16

After the commencement date in a sale and leaseback transaction, the seller-lessee applies paragraphs 29 to 35 of IFRS 16 to the right-of-use asset arising from the leaseback and paragraphs 36 to 46 of IFRS 16 to the lease liability arising from the leaseback. In applying paragraphs 36 to 46, the seller-lessee determines ‘lease payments’ or ‘revised lease payments’ in such a way that the seller-lessee would not recognise any amount of the gain or loss that relates to the right of use retained by the seller-lessee. Applying these requirements does not prevent the seller-lessee from recognising, in profit or loss, any gain or loss relating to the partial or full termination of a lease, as required by paragraph 46(a) of IFRS 16.

Read more

IFRS 16 Leases presentation in cash flows – Complete easy read

by

IFRS 16 Leases presentation in cash flows

Most changes from IAS 17/IFRIC 4 to IFRS 16 relate to lessees, the companies renting a car, office or warehouse.

At first, IFRS 16 has affected balance sheet and balance sheet-related ratios such as the debt/equity ratio. Aside from this, IFRS 16 also influenced the income statement, because an entity now has to recognise interest expense on the lease liability (obligation to make lease payments) and depreciation on the ‘right-of-use’ asset (that is, the asset that reflects the right to use the leased asset).

Due to this, for lease contracts previously classified as operating leases the total amount of expenses at the beginning of the lease period will be higher than under IAS 17. Another consequence of the changes in presentation is that EBIT and EBITDA will be higher for companies that have material operating leases.

IFRS 16 also changes the cash flow statement. Lease payments that relate to contracts that have previously been classified as operating leases are no longer presented as operating cash flows in full. Only the part of the lease payments that reflects interest on the lease liability can be presented as an operating cash flow (depending on the entity’s accounting policy regarding interest payments).

Cash payments for the principal portion of the lease liability are classified within financing activities. Payments for short-term leases, leases of low-value assets and variable lease payments not included in the measurement of the lease liability remain presented within operating activities.

Presentation and disclosures

In the statement of cash flows, lease payments are classified consistently with payments on other financial liabilities:

  • The part of the lease payment that represents cash payments for the principal portion of the lease liability is presented as a cash flow resulting from financing activities.
  • The part of the lease payment that represents interest portion of the lease liability is presented either as an operating cash flow or a cash flow resulting from financing activities (in accordance with the entity’s accounting policy regarding the presentation of interest payments).
  • Payments on short-term leases, for leases of low-value assets and variable lease payments not included in the measurement of the lease liability are presented as an operating cash flow.

A simple example to classify the movements in Right-of-use assets is as follows:

IFRS 16 Leases presentation in cash flows

A simple example to classify the movements in Lease liabilities is as follows:

IFRS 16 Leases presentation in cash flows

On the balance sheet, the right-of-use asset can be presented either separately or in the same line item in which the underlying asset would be presented. The lease liability can be presented either as a separate line item or together with other financial liabilities. If the right-of-use asset and the lease liability are not presented as separate line items, an entity discloses in the notes the carrying amount of those items and the line item in which they are included.

In the statement of profit or loss and other comprehensive income, the depreciation charge of the right-of-use asset is presented in the same line item/items in which similar expenses (such as depreciation of property, plant and equipment) are shown. The interest expense on the lease liability is presented as part of finance costs. However, the amount of interest expense on lease liabilities has to be disclosed in the notes.

IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows IFRS 16 Leases presentation in cash flows

IFRS 16 Leases presentation in cash flows

IRR How to calculate

by

IRR How to calculate

The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of a project zero. In other words, it is the expected compound annual rate of return that will be earned on a project or investment.

When calculating IRR, expected cash flows for a project or investment are given and the NPV equals zero. Put another way, the initial cash investment for the beginning period will be equal to the present value of the future cash flows of that investment. (Cost paid = present value of future cash flows, and hence, the net present value = 0).

Once the internal rate of return is determined, it is typically compared to a company’s hurdle rate or cost of capital. If the IRR is greater than or equal to the cost of capital, the company would accept the project as a good investment. (That is, of course, assuming this is the sole basis for the decision).

In reality, there are many other quantitative and qualitative factors that are considered in an investment decision). If the IRR is lower than the hurdle rate, then it would be rejected, if IRR is the only investment consideration.

Under IFRS 16 ‘Leases’, a similar calculation is used to calculate discount rates are used to determine the present value of the lease payments used to measure a lessee’s lease liability. Discount rates are also used to determine lease classification for a lessor and to measure a lessor’s net investment in a lease.

For lessees, the lease payments are required to be discounted using:

  • the interest rate implicit in the lease (IRIL), if that rate can be readily determined, or
  • the lessee’s incremental borrowing rate (IBR).

For lessors, the discount rate will always be the interest rate implicit in the lease.

The interest rate implicit in the lease is defined in IFRS 16 as ‘the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.’

The lessee’s incremental borrowing rate is defined in IFRS 16 as ‘the rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment’.

The incremental borrowing rate is determined on the commencement date of the lease. As a result, it will incorporate the impact of significant economic events and other changes in circumstances arising between lease inception and commencement.

Read more

Lease calculation – IFRS 16 Structured best approach

by

Lease calculation

Lease calculation provides a logical model to understand the calculations that have to be made in accounting for IFRS 16 Leases. In addition a lease contract calculation Excel model is provided to do the work. IFRS 16 Structured best approach

The 5-step lease calculations model

Use the 5-step lease calculations model to systematically document your lease calculations.

Step 1. Identification of a lease contract

a) When should this assessment be made?

An entity is required to assess whether a contract is, or contains a lease at the inception of the contract.

There is a difference between the inception date of the contract and the commencement date of the lease as follows:

Inception Date of the Contract

Commencement Date of the Lease

Is the earlier of the date of:

  • A lease agreement; and
  • A commitment by the parties to the principal terms and conditions of the lease.

The date on which a lessor makes an underlying asset available for use by a lessee.

b) When Does a Lease Exist?

A lease exists where the contract grants the right to control the use of an identified asset for a period of time in exchange for consideration.

Control over the use of an identified asset for a period of time is conveyed when, the customer has both of the following throughout the period of use (IFRS 16.B9):

  1. The right to obtain substantially all of the economic benefits from use of the identified asset; and
  2. The right to direct the use of the identified asset. IFRS 16 Structured best approach

Read more

Sale and leaseback accounting under IFRS 16

by

Sale and leaseback accounting A sale and lease back transaction is a popular way for entities to secure long-term financing from substantial property, plant and equipment assets such as land and buildings. IFRS 16 made significant changes to sale and lease back accounting in comparison with IAS 17. A sale and leaseback transaction is one where an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) for consideration and leases that asset back from the buyer-lessor. The IFRS 16 guidance on ‘failed sales’ means that some sale-and-lease back transactions are accounted for as pure financing transactions by both lessors and lessees. In a sale-and-lease back transaction, a company (the seller-lessee) transfers an underlying asset to another company (the … Read more

Sub-leases of real estate – IFRS 16 Best short read

by

Sub-leases of real estate

New classification guidance means that more sub-leases are finance leases under IFRS 16 than previously, impacting the financial position and financial performance of intermediate landlords.

A sub-lease is a transaction in which a lessee (or ‘intermediate lessor’) grants a right to use the underlying asset to a third party, and the lease (or ‘head lease’) between the original lessor and lessee remains in effect. (IFRS 16.3)

A company applies IFRS 16 to all leases of right-of-use assets in a sub-lease. The intermediate lessor accounts for the head lease and the sub-lease as two different contracts.

Sub-leases of real estate

An intermediate lessor classifies the sub-lease as a finance lease or as an operating lease with reference to the right-of-use asset arising from the head lease. That is, the intermediate lessor treats the right-of-use asset as the underlying asset in the sub-lease, not the item of property, plant or equipment that it leases from the head lessor. (IFRS 16.B58)

Read more

Landlord Lease modifications

by

Landlord Lease modifications / Rental modifications

Accounting for lease modifications has become a hot topic due to the COVID-19 pandemic, with many tenants seeking rent concessions and other changes to lease agreements.

Unlike IAS 17, IFRS 16 provides detailed guidance on the lessor accounting for lease modifications, with separate guidance for modifications to finance leases and operating leases.

A lease modification is a change in the scope of a lease, or the consideration for a lease, that was not part of its original terms and conditions. Common examples are:

  • decreasing the scope of the lease by removing the right to use one or more underlying assets;
  • decreasing the scope of the lease by shortening the contractual lease term; and
  • changing the consideration in the lease by increasing or decreasing the lease payments.

Changes that result from renegotiations of the original contract are lease modifications.

The exercise of an option included in the original lease contract is not a modification. There is no lease modification when a lessor reassesses the lease term if:

  • the lessee exercises an option not previously included in the lessor’s determination of the lease term;
  • the lessee does not exercise an option previously included in the lessor’s determination of the lease term;
  • an event occurs that contractually obliges the lessee to exercise an option not previously included by the lessor; or
  • an event occurs that contractually prohibits the lessee from exercising an option previously included by the lessor (see Changes in the lease term).

The following diagram summarises the accounting for lease modifications by a lessor/landlord.

Original lease is a finance lease

Change to contractual terms and conditions

Original lease is an operating lease

Increase in scope of lease by adding right of use for one or more underlying assets and at stand-alone price for increase

All other contract modifications.

Classification at inception if modification had been in effect then as:

Operating lease

Finance lease

Separate lease

Not a separate lease

Apply IFRS 9

Modifications to operating leases

Food for thought – When does a lessor account for a lease modification?

Similar to a lessee, a lessor accounts for modifications to operating and finance leases on the effective date of the modification. This is the date when both parties agree to the lease modification. (IFRS 16.79–80, IFRS 16.87)

Read more

Landlord Lease payments

by

Landlord Lease payments

Distinguishing between fixed and variable lease payments will impact the profile of a landlord’s earnings.

1. Overview

At commencement, a lessor identifies the lease payments, which include: (IFRS 16.70)

  • fixed payments, including in-substance fixed payments, less any lease incentives;Landlord Lease payments
  • variable lease payments that depend on an index or a rate;
  • the exercise price of a purchase option if the lessee is reasonably certain to exercise that option;
  • payments of penalties for terminating the lease, if the lease term reflects the assessment that the lessee will exercise an option to terminate the lease; and
  • the full amount (regardless of the likelihood that payment will be due) of any residual value guarantees provided to the lessor by the lessee, by a party related to the lessee or by a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.

Real estate leases will often include some or all of the following:

  • fixed payments (including in-substance fixed payments) (see Fixed and in-substance fixed payments), less any lease incentives (see Lease incentives);
  • variable lease payments (see Variable lease payments);
  • payments for terminating the lease early; and
  • payments for non-lease components: e.g. maintenance or utilities (see Common area maintenance and other non-lease components).

Read more

Landlord lease definition

by

Landlord lease definition

Identifying a lease of real estate is usually straightforward – but some scenarios will require judgement.

1 Overview

A lease is a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. (IFRS 16.B9)

The key factors to consider when applying the lease definition are as follows.

Landlord lease definition

2 Applying the definition to real estate

Types of properties common in real estate leases include:

  • land and buildings;
  • office space: e.g. a floor of a building;
  • retail space;
  • specified spots in a car park; and
  • residential property.

When applying the lease definition to real estate arrangements, it will usually be clear whether the arrangement meets the lease definition criteria.

Key factors to consider when applying the lease definition are as follows.

Read more

Sale-and-leaseback of real estate – IFRS 16 Best complete read

by

Sale-and-leaseback of real estate

New guidance on ‘failed sales’ means that some sale-and-leaseback transactions are accounted for as pure financing transactions by both landlords and tenants.

In a sale-and-leaseback transaction, a company (the seller-tenant) transfers an underlying asset to another company (the buyer-landlord) and leases that asset back from the buyer-landlord. (IFRS 16.98–103)

Sale-and-leaseback

To determine how to account for a sale-and-leaseback transaction, a company first considers whether the initial transfer of the underlying asset from the seller-tenant to the buyer-landlord is a sale. The company applies IFRS 15 to determine whether a sale has taken place. This assessment determines the accounting by both the buyer-landlord and the seller-tenant.

Buyer-landlord

Transfer to buyer-landlord is a sale
  • Recognise the underlying asset as property, plant and equipment or investment property*
  • Account for the leaseback in accordance with IFRS 16*

* Adjustments are required if the sale is not at fair value or the lease payments are off-market. A company is not required to assess both, however – only whichever one is more ‘readily determinable’.

Transfer to buyer-landlord is not a sale
  • Do not recognise the underlying asset
  • Recognise a financial asset under IFRS 9 for amounts transferred to or receivable from the seller-lessee

Seller-tenant

Transfer to buyer-landlord is a sale
  • Derecognise the underlying asset and apply the lessee accounting model to the leaseback*
  • Measure the right-of-use asset at the retained portion of the previous carrying amount (i.e. at cost)*
  • Recognise a gain or loss related to the rights transferred to the lessor*

* Adjustments are required if the sale is not at fair value or the lease payments are off-market. A company is not required to assess both, however – only whichever one is more ‘readily determinable’.

Transfer to buyer-landlord is not a sale
  • Continue to recognise the underlying asset
  • Recognise a financial liability under IFRS 9 for any amount received from the buyer-landlord

Read more