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New Lease standard IFRS 16

Background

IFRS 16 “Leases”, the new standard on lease contracts, will replace the old IAS 17 “Leases” for reporting periods beginning on or after 1 January 2019.

This will have a significant impact on our clients who report under IFRS with material operating leases. Examples of such leases include, but are not limited to, long-term rental of your business premises, long-term hire of plant and equipment and lease of business computer equipment.

Under the new standard, most leases (see exceptions below) will now need to be recognised on the balance sheet and treated as a finance lease.

Recognition

A right-of-use asset and a lease liability at present value of lease payments should be recognised on the balance sheet.

The lease liability is calculated as all the lease payments not paid at the commencement date discounted by the interest implicit in the lease or the incremental borrowing rate i.e. the rate you would have to pay to borrow the funds for a similar asset over a similar term and with similar security.

If your company has the right to obtain substantially all economic benefits and has the right to direct the use of the asset, it is considered a “right-of-use” asset.

Choice

IFRS 16 offer a choice for implementation of the standard.

  1. Full retrospective approach: Restating opening balances of the earliest period presented in the financial statements. For periods beginning on 1 January 2019 this would mean the transition date is 1 January 2018.
  2. Modified retrospective approach: Make an equity adjustment on 1 January 2019. Comparative figures remain the same as presented.

We will apply the modified retrospective approach in the worked example below.

Worked Example

Company S leases a floor of a building for £100,000 per annum. The lease commenced on 1 January 2015 and has a term of 10 years. Lease payments are payable annually in advance. There is no rate implicit in the lease, no direct costs or lease incentives. Company S incremental borrowing rate is 5% per annum.

It is the year ended 31 December 2019.

Restatement of opening balances 1 January 2019

Year

Lease payment

Discount factor

(1/(1.05)^n))

n = no. of years

Present Value of lease payments
2015 100,000 1.000 100,000
2016 100,000 0.952 95,238
2017 100,000 0.907 90,703
2018 100,000 0.864 86,384
2019 100,000 0.823 82,270
2020 100,000 0.784 78,353
2021 100,000 0.746 74,622
2022 100,000 0.711 71,068
2023 100,000 0.677 67,684
2024 100,000 0.645 64,461
  1,000,000   810,782

 

Year

Lease liability b/f

(A)

Lease payment

(B)

Interest

(C = A*5%)

Decrease in lease liability

(D = B – C)

Lease liability c/f

(E = A – D)

2015 810,782 100,000 35,539 64,461 746,321
2016 746,321 100,000 32,316 67,684 678,637
2017 678,637 100,000 28,932 71,068 607,569
2018 607,569 100,000 25,378 74,622 532,948
2019 532,948 100,000 21,647 78,353 454,595
2020 454,595 100,000 17,730 82,270 372,325
2021 372,325 100,000 13,616 86,384 285,941
2022 285,941 100,000 9,297 90,703 195,238
2023 195,238 100,000 4,762 95,238 100,000
2024 100,000 100,000 0 100,000 0

We need to recognise lease asset (future economic benefit of the rental premises) and the lease liability (what the company owes for the future benefit of the rental premises). To do this we use the value calculated from the present value of the lease payments.

1.    Dr          Right-of-Use Asset                   810,782

             Cr            Lease liability                                         810,782

       We also need to reverse the lease payments before 1 January 2019 under IAS 17 from 2015 – 2018. No cash has actually been returned but this adjustment is simply to adjust equity correctly:

2.    Dr            Bank                                     400,000

               Cr            Retained earnings                                400,000

3.     Account for the lease payments before 1 January 2019 under IFRS 16 (there were four):

        Dr            Lease liability                                        277,835          

        Dr            Retained earnings (interest)              122,165 (2015 – 2018 interest as above)

        Cr            Bank                                                       400,000

4.     Calculate the depreciation of the right-of-use asset before 1 January 2019 under IFRS 16.

Company S depreciates right-of-use assets at straight line over the lease term.

Year NBV b/f Depreciation (Straight line over 10 years) Accumulated Depreciation NBV c/f
2015 810,782 81,078 81,078 729,704
2016 729,704 81,078 162,156 648,626
2017 648,626 81,078 243,235 567,548
2018 567,548 81,078 324,313 486,469
2019 486,469 81,078 405,391 405,391
2020 405,391 81,078 486,469 324,313
2021 324,313 81,078 567,548 243,235
2022 243,235 81,078 648,626 162,156
2023 162,156 81,078 729,704 81,078
2024 81,078 81,078 810,782

Four years have already gone by, therefore journal is:

Dr Retained earnings          324,312 (81,078 x 4)

          Cr Accumulated Depreciation ROU asset        324,312

All of these journals can be done at once as follows:

Dr Right-of-use asset           £486,470 (PV of future lease payments – Accumulated Depreciation)

Dr Retained earnings          £46,477 (Depreciation + 4 years of interest – 4 years of payments)

Cr Lease liability                   £532,947 (PV of lease liability – 4 years of payments + 4 years of interest

Current year movements under IFRS 16

Now we have transitioned to IFRS 16, we need to make our postings for the year to 31 December 2019. Journals are as follows:

1. Recognition of interest, payment and reduction in lease liability.

             Dr Lease liability                  £78,353

             Dr Interest expense            £21,647

                                Cr Bank                                  £100,000

2. Recognition of current year depreciation and accumulated depreciation

              Dr Depreciation  £81,078

                                 Cr Accumulated Depreciation ROU asset        £81,078

Presentation

Balance Sheet

Right-of-use assets should be presented separately from other assets on the balance sheet or disclosed separately in the notes.

Likewise, lease liabilities are either presented separately from other liabilities on the balance sheet or disclosed separately in the notes.

Profit & Loss

Interest on the lease and depreciation expense should be recognised separately.

Cash Flow

Principal payments on the lease liability are presented in financing activities.

Any exceptions?

No assets or liabilities are required for short-term leases (leases of 12 months or less) or for leases of low-value assets (e.g. lease of a laptop).

Specific advice should be obtained before taking action, or refraining from taking action, in relation to the above. If you would like advice or further information, please speak to your usual Shipleys contact.

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