Leases explained along defined terms to obtain a quick overview. An overview is provided here.
Definitions from IFRS 16 Leases are:
IFRS 16 Leases: 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.
Lease payments – Payments made by a lessee to a lessor relating to the right to use an underlying asset during the lease term, comprising the following:
- fixed payments (including in-substance fixed payments), less any lease incentives;
- 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; and
- payments of penalties for terminating the lease, if the lease term reflects the lessee exercising an option to terminate the lease.
For the lessee, lease payments also include amounts expected to be payable by the lessee under residual value guarantees. Lease payments do not include payments allocated to non-lease components of a contract, unless the lessee elects to combine non-lease components with a lease component and to account for them as a single lease component.
For the lessor, lease payments also include 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. Lease payments do not include payments allocated to non-lease components.
Optional lease payments – Payments to be made by a lessee to a lessor for the right to use an underlying asset during periods covered by an option to extend or terminate a lease that are not included in the lease term.
Fixed payments – Payments made by a lessee to a lessor for the right to use an underlying asset during the lease term, excluding variable lease payments.
Minimum lease payments -The payments over the lease term that the lessee is, or can be, required to make, excluding contingent rent, costs for services and, where appropriate, taxes to be paid by and reimbursed to the lessor, together with:
- For a lessee, any amounts guaranteed by the lessee or by a party related to the lessee; or
- For a lessor, any residual value guaranteed to the lessor by:
- The lessee;
- A party related to the lessee; or
- An independent third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.
However, if the lessee has an option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised, the minimum lease payments comprise the minimum payments payable over the lease term to the expected date of exercise of this purchase option and the payment required to exercise it.
Variable lease payments – The portion of payments made by a lessee to a lessor for the right to use an underlying asset during the lease term that varies because of changes in facts or circumstances occurring after the commencement date, other than the passage of time.
Lease term – The non-cancellable period for which a lessee has the right to use an underlying asset, together with both: Leases
- periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and Leases
- periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.
Useful life of a lease – The estimated remaining period, from the commencement of the lease term, without limitation by the lease term, over which the economic benefits or service potential embodied in the asset are expected to be consumed by the entity.
Short term lease – A lease contract (operational or financial) with a term not longer than 12 months.
Contingent rent – That portion of the lease payments that is not fixed in amount, but is based on the future amount of a factor that changes other than with the passage of time (e.g., percentage of future sales, amount of future use, future price indices, future market rates of interest).
IFRS 16 requires customers and suppliers to determine whether a contract is or contains a lease at the inception of the contract. The inception date of a lease is the earlier of the date of a lease agreement and the date of commitment by the parties to the principal terms and conditions of the lease.
As indicated in the Basis for Conclusions (BC 72), after the inception of the lease, but before the commencement date (see below), the requirements in IAS 37 Provisions, Contingent Liabilities and Contingent Assets apply to any contract (and, hence, any lease contract) that becomes onerous as defined in that standard.
Commencement date of the lease (commencement date) – The date on which a lessor makes an underlying asset available for use by a lessee.
Lease modifications – A change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease (for example, adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term).
Lease incentives – Payments made by a lessor to a lessee associated with a lease, or the reimbursement or assumption by a lessor of costs of a lessee.
Lessor – one that owns a property and transfers the property use (such as a house or factory) by a lease contract, also called landlord.
Gross investment in the lease – The sum of:
- the lease payments receivable by a lessor under a finance lease, and
- any unguaranteed residual value accruing to the lessor.
Net investment in the lease – The gross investment in the lease discounted at the interest rate implicit in the lease.
Lessee – One that holds real or personal property under a lease, also called renter or tenant
Lessee’s incremental borrowing rate – 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.
Guaranteed residual value – the two perspectives:
- For a lessee, that part of the residual value that is guaranteed by the lessee or by a party related to the lessee (the amount of the guarantee being the maximum amount that could, in any event, become payable); and
- For a lessor, that part of the residual value that is guaranteed by the lessee, or by a third party unrelated to the lessor, that is financially capable of discharging the obligations under the guarantee.
Practical expedient – IFRS 16 requires a lessee to account for each lease component in a contract separately from non-lease components, unless the lessee applies the practical expedient to account for lease and non-lease components as one lease.
Initial direct costs – Incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained, except for such costs incurred by a manufacturer or dealer lessor in connection with a finance lease. Leases
Unearned finance income – The difference between:
- the gross investment in the lease; and Leases
- the net investment in the lease. Leases
Incremental borrowing rate – 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.
Interest rate implicit in the lease – the rate of interest that causes the present value of:
- the lease payments, and Leases
- the unguaranteed residual value to equal the sum of Leases
- the fair value of the underlying asset, and Leases
- any initial direct costs of the lessor. Leases
Non-cancellable lease – A lease that is cancellable only: Leases
- Upon the occurrence of some remote contingency; Leases
- With the permission of the lessor; Leases
- If the lessee enters into a new lease for the same or an equivalent asset with the same lessor; or Leases
- Upon payment by the lessee of such an additional amount that, at inception of the lease, continuation of the lease is reasonably certain.
See also: Scope of IFRS 16