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IFRS 16 Leases presentation in cash flows – Complete easy read

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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.

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IFRS 16 Leases presentation in cash flows

What is the most important disclosure definition under IAS 1?

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What is the disclosure definition under IFRS?

Disclosure definition – one of the best ways to explain the need for disclosures is provided in IAS 1.119 ‘management considers whether disclosure would assist users in understanding how transactions, other events and conditions are reflected in reported financial performance and financial position. Each entity considers the nature of its operations and the policies that the users of its financial statements would expect to be disclosed for that type of entity.‘

Let us point to some IFRS disclosure particularities

In IAS 1 Presentaion of Financial Statements the overall disclosure requirements are provided. Other IAS/IFRSs set out the recognition, measurement and disclosure requirements for specific transactions and other events (IAS 1.3).

An entity cannot rectify inappropriate accounting policies either by disclosure of the accounting policies used or by notes or explanatory material (IAS 1.18).

Some IAS/IFRSs specify information that is required to be included in the financial statements, which include the notes. An entity need not provide a specific disclosure required by a IFRS if the information resulting from that disclosure is not material. This is the case even if the IFRS contains a list of specific requirements or describes them as minimum requirements.

An entity shall also consider whether to provide additional disclosures when compliance with the specific requirements in IFRS is insufficient to enable users of financial statements to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance (IAS 1.31).

Minimum comparative information

In some cases, narrative information provided in the financial statements for the preceding period(s) continues to be relevant in the current period. For example, an entity discloses in the current period details of a legal dispute, the outcome of which was uncertain at the end of the preceding period and is yet to be resolved. Users may benefit from the disclosure of information that the uncertainty existed at the end of the preceding period and from the disclosure of information about the steps that have been taken during the period to resolve the uncertainty (IAS 1.38B).

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Lease calculation – IFRS 16 Structured best approach

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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

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

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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)

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Landlord Lease modifications

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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)

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Sales outside ordinary activities – best way of combining IFRS 15 IAS 16 IAS 38 and IAS 40

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Sales outside ordinary activities

Certain aspects of IFRS 15 apply to the sale or transfer of non-financial assets – e.g. intangible assets and property, plant and equipment – that are not an output of the entity’s ordinary activities.

Under IFRS 15, the guidance on measurement and derecognition applies to the transfer of a non-financial asset that is not an output of the entity’s ordinary activities, Sales outside ordinary activitiesincluding:

When an entity sells or transfers a non-financial asset that is not an output of its ordinary activities, it derecognises the asset when control transfers to the recipient, using the guidance on transfer of control in the respective standard IAS 16, IAS 38 or IAS 40 (see Transfer of control).

The resulting gain or loss is the difference between the transaction price measured under IFRS 15 (using the guidance in Step 3 of the model) and the asset’s carrying amount. In determining the transaction price (and any subsequent changes to the transaction price), an entity considers the guidance on measuring variable consideration – including the constraint, the existence of a significant financing component, non-cash consideration and consideration payable to a customer (see Step 3 – Determine the transaction price).

The resulting gain or loss is not presented as revenue. Likewise, any subsequent adjustments to the gain or loss – e.g. as a result of changes in the measurement of variable consideration – are not presented as revenue.

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Natural disasters IFRS accounting

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Natural disasters IFRS accounting

In the wake of the recent and devastating flood events in Queensland and Victoria, the destruction caused by Cyclone Yasi in Far North Queensland and the fires that have raged in Western Australia, attention for business has now turned from crisis management and clean up to addressing the longer term financial and business implications.

Business Continuity and Crisis Management

In the immediate aftermath of a disaster, the focus should be on stabilising your business.

Factors to consider include:

  • Cash flow – consider your short term cash flow requirements and evaluate how these needs might be met. This could include sourcing government grant assistance, taking advantage of concessions offered by government agencies to disaster affected business (eg ATO lodgement and payment deferrals), discussing short term financing needs with your bankers, discussions with stakeholders such as shareholders, deferring or re-prioritising (where possible) major items of expenditure and reviewing your commitments to your customers and suppliers.
  • People – employees may have been directly or indirectly impacted by the disasters, and support for staff at this time can be critical to the recovery of your business. Consideration should be given to ensuring staff are able to take an appropriate time off work (both when directly affected and also to participate in voluntary clean-up activities where appropriate), providing support services such as Employee Assistance Programs, and ensuring premises and work sites are safe. Other factors to consider include actively managing your workforce to preserve working capital, ensuring employees are focused on tasks that provide the biggest benefit to your business, and being mindful of potential legal obligations and responsibilities to employees. Above all, it is extremely important to communicate effectively with employees at times of crisis, to ensure that they remain focused on the things that matter to your business, and to ensure that a lack of information is not filled by counter-productive speculation and rumour.
  • Customers and suppliers – businesses should focus on discussing how the disasters have impacted key customers and suppliers, as disruptions to the supply-chain or sales pipeline may have significant adverse impacts on cash flow. Consideration should not just be given to those suppliers and customers directly impacted, but also to the indirect impacts (e.g. suppliers to your supplier / customers of your customer etc).

In the longer term, many businesses will need to consider and perhaps recreate their business continuity plans/crisis management strategies moving forward. Despite many businesses having these plans in place, the “acid test” of true crisis has highlighted that many businesses were not as well prepared as they thought. Many plans had never been properly tested in the past.

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Landlord Lease payments

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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:

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Going concern and pandemics

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Going concern and pandemics

IAS 1 Presentation of Financial Statements requires management, when preparing financial statements, to make an assessment of an entity’s ability to continue as a going concern, and whether the going concern assumption is appropriate.

Furthermore, disclosures are required when the going concern basis is not used or when management is aware, in making their assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern.

Disclosure of significant judgement is also required where the assessment of the existence of a material uncertainty is a significant judgement.

In assessing whether the going concern assumption is appropriate, the standard requires that all available information about the future, which is at least, but not limited to, twelve months from the end of the reporting period, should be taken into account.

This assessment needs to be performed up to the date on which the financial statements are issued.

Refer to ‘Current vulnerability due to concentration and liquidity risks‘ below for further discussion on the current vulnerability entities are facing due to concentration and liquidity risks.

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

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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

* 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

Seller-tenant

Transfer to buyer-landlord is a sale

* 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

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